Description

Investools dominates the investor education market, and is on pace to do in excess of $100,000,000 in revenues, trades at 5.8x ev/fcf ’04 and 3.8x ev/fcf ’05, while growing +40%. IED’s business is highly attractive, (9% fcf through 1H04, 14% +/- fcf estimate through 6 august 04*), extremely low capital intensity, (inventory turns 14 times qtr, a/r turns every 7 days, Capex 6% cash from ops ‘04E), while transforming into a more predictable high margin recurring revenue business model, deferred revenues +128% ytd). IED is exactly unchanged over the last 6 months (when I previously posted), however the story is significantly better (very strong growth, new products), ridiculously cheap (.7x ev/revs, 5.8x ev/fcf), and exceptionally misunderstood (see below). There are a number of material catalysts coming that should cause significant price appreciation over next 6-12 months to $4.50-$5 range. The stock is fairly liquid trading nearly 150,000 shares a day.

*cf ops $4.928mm 1H04,
$500K buyback July ’04
$156K cash paid 360 gp
plug $1.47mm cash generated 7/04,
= $7.05mm on $48mm in revenues
(company noted in 2q release cash was $20mm 6 aug 04)

Investools dominants the investor education business (#1 player with brands: Business Week, CNBC, and Motley Fool, plus others) graduating approximately 3,300 students a month (over 122,000 last 5 years/on pace this yr for 50,000+) with average revenue per student in excess of $3,000 (which should begin to move up with new products).

Misperceptions
a) the company only does well in a bull market

Demographic of average IED student
$700,000+ in equities
$1mm+ net worth
$125,000 average annual income
42% have annual incomes in excess of $100,000
93% own their own home
77% are married
76% college educated
Slightly under 50 years old

The company does well in various market conditions because the average student has significant net worth over $1mm+, with $700,000+ in equities, average slightly under 50 years old, well educated professionals that want to have active role in planning for their coming retirement. They are not day traders, they are serious long term investors.

If you have $700,000 in equities with a broker you probably pay between 1.25%-1.75% a year in fees/commissions or about $8,750-$12,225 every year versus Investools program that costs on average $3K+/-. The program is NOT pitched this way just an observation on why the product seems to do so well.

NASDAQ returns vs. student growth

’98 +39% (students graduated 1,191)
“99 +86% (students graduated 9,297, +680%)
’00 -39% (s. graduated 19,686, +111.75%)
’01 -21% (s. graduated 20,274, +3%)
’02 -32% (s. graduated 17,976, -11.33%)
’03 +50% (s graduated 25,648, +42.68%)
’04 E-7% (s. graduated 53,000, +106%EST)

Toolbox Subscriber’s % growth qtr/qtr
1Q02 21,300
2Q02 21,600 1.41%
3Q02 22,300 3.24%
4Q02 23,700 6.28%
1Q03 25,100 5.91%
2Q03 26,800 6.77%
3Q03 29,800 11.19%
4Q03 32,500 9.06%
1Q04 39,600 21.85%
2Q04 43,500 9.85%
3Q04 48,000E 10.34%
4Q04 53,000E 10.42%

Other key point is management, strategy, new products, and product segmentation, is starting to have a major positive impact over the last 2 year evolution. This is obvious in that the NASDAQ is down this year and company student growth will be over 100% with significant FCF margins.


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b) Perceived problem with the company: NOT PROFITABLE from GAAP basis

IED is rapidly expanding and showing marginal losses as the company is recognizes the upfront costs including direct selling costs, revenue sharing arrangements, cost of hosting workshops, material costs, and credit card fees, while transitioning into high margin recurring revenue model.

The company is now on pace to generate about $1,200,000 a month in free cash flow, and is buying back stock fairly aggressively, announced in late June, first 2 weeks of July bought back 252,000 shares before quiet period started.

Average deferred revenue per student
’00A $126
’01A $177.57 (+40%)
’02A $267.02 (+50%)
’03A $335.31 (+26%)
’04E $468.87 (+40%)

I expect this business to continue to rapidly grow with a) PHD b) Masters c) Multi-year subscriptions.

Customer satisfaction and retention
User satisfaction and goodwill is very important for the model for obvious reasons because it boosts retention and dramatically lowers customer acquisition costs on future sales, while making it very likely to go back to student base, with new programs (masters/PHD) and products (coaching) to resell, in turn boosting, lifetime value of the student.
65% retention rate, on toolbox
More than 75% renew for 1 year or longer.
97% of graduates say program met or exceeded expectations after paying $3,000+

Attractive business and business model
Investools economics are highly attractive given:
Extremely high barriers to entry:
a) Brand: effects customer acquisition costs plus IED has exclusive rights to #1 brands
b) Customer acquisition costs: extremely high $1000+, need EOS with multiple brands to make strategy work, plus infrastructure and learning curve.
Almost no working capital needs, despite enormous growth, very little inventory (14x turns a quarter) and A/r stays out 7 days
Very little cap ex about $700-800K a year should be able to generate $11-13mm in CF (12/31/03-8/6/04 generated $7mm+ in cash) and think for ’05 $18-19mm in CF.

So the company can continue growing at very high rates while generating significant amounts of free cash.

The CEO is exceptionally sharp, and the largest shareholder. He spends an hour a day with senior management daily on margin improvement, and has/is doing a terrific job. I think the company is in early stages of FCF margins improvement and will be able to approach 20% sometime in 2005.

To be clear this product is NOT for everyone, there are 53 million households that own equities, 32 million households do not use brokers as their primary source of advice, 10 million households actively advice outside investment information, IED has a database of 700,000, currently and has graduated over 122,000 students last 5 years (including being on pace for nearly 53,000 this year).

I believe there are a number of strategic acquirers that would love to own Investools, including Apollo, Washington Post subsidiary (Kaplan), Princeton Review (REVU), and CBS Marketwatch (MKTW).
All are strategic fits, especially MarketWatch, great way to monetize huge user base, given customer acquisition costs.


Valuation
Education peer group IED
Ev/revs 3.0x .67x
Ev/cf 12x 5.8x
Top growth 38% 42%

Implies 3x ev/revs = $6.67 and 12x ev/cf= $4.15 average = $5.41 (+170%)
12x ‘04E cash flow + $20mm in cash = $170/45 = $3.78 (+89%)

Two small cap comps are The Street.com and CBS Marketwatch, Investools has far better economics and better growth prospects while having the COMBINED revenue of both MTKW and TSCM.

EV/revs revs (ttm) # analysts cover
TSCM 2.1x $30mm 2
MKTW 3.7x $63mm 3
IED .67x $90mm 0


New catalysts:

Masters program $7,000 2 yr subscription to tool box, masters options classes, and 12 personal training seminars

Doctorate $17,000, advanced personal training classes, VIP status, personal one on one training.
(advanced programs: masters and doctorate + (coaching) caused revenues to go up 71% quarter over quarter from $7.6mm to $13mm, now nearly half of the company’s quarterly revenue.

(http://www.sec.gov/Archives/edgar/data/1145124/000110465904024930/a04-9755_1ex99d1.htm)

13 August 04
“Increased student acquisition incentives to our co-marketing partners, as well as a series of advanced product bundles being offered at price points up to $16,999, have exceeded our expectations for the growth in our graduates and increased their lifetime value. Management's focus on creating the highest quality investor education products bundled around our InvestorToolbox website will continue to provide growth opportunities with improving margins for our shareholders."

Multi year subscriptions: 2 & 3 year subscriptions to toolbox, combined with masters and PHD multi-year products.

Potential Partnerships: with CBS Marketwatch, Yahoo Finance, E-trade, Ameritrade, would be great for the company because significant cost to acquire subscriber, a revenue sharing deal would make a lot of sense.

Lifetime value of subscriber: this should be well north of $10,000 now. A year ago it was $8K. You can really see with high user satisfaction and retention how this model will be quite attractive on additional future sales.

2 business’s inside of IED (see previous write up for details)

OFFLINE: $75mm in revenue, very high barrier to entry business, customer acquisition costs are prohibitive to succeed with one stand alone brand.

ONLINE: $30mm dollar business, growing in excess of 45% a year, Internet subscription based business, 100’s of preset screens, results, ability to back test, portfolio tracking, news, insider buying, and numerous other features. Sold in 6 month, 1, 2, and 3 year subscriptions, must be a graduate of offline workshop to be able to purchase toolbox membership.

Catalyst

Very strong economics, business model, outlook, and growth trajectory
Very cheap stock: .67x ev/revs ’04, 5.8x/3.8x ev/fcf ’04E/’05E for #1 player in industry
Student growth +100% yr/yr, with strong recurring revenue model
New products: masters $8000 and Doctorate $17,000 vs. current $3K products
Combined with very strong initial results
14% FCF ’04E and high teens FCF margin for ‘05E
8% buyback
Average retention continues to climb now over 1 yr
User satisfaction hit or exceeded expectations 97%, after paying $3,000+
WALL STREET COVERAGE (smaller comps avg 2 analysts)