Loads of intangible assets and deferred revenue clouds true economics: Brokerage on the balance sheet shows identifiable assets of $423mn of which $329mn is goodwill/intangible assets. On the liability side the balance sheet has $120mn in deferred revenue, where the vast majority of the costs have already been expensed. In reality what appears to be at first glance a to be a capital intensive business model is really a business that requires close to no capital to run and while sustaining high growth rates. (Working Cap: -$40mn, Intangible assets $329mn, Deferred revenue $120mn, CFO $60mn with $7mn in CAPEX, Tangible Equity -$120mn). As education continues with new front end price points we expect EBIT Margins and Operating Cash Flow to grow substantially driven by the brokerage business with 45% EBIT margins.

Sell Side analysts estimates show no growth for 2009: Due to education revenue plummeting, brokerage revenue growth slowing and the reduced tax shield. We think SWIM should generate $60mn in CFO in 2008 and $98mn in 2009 with annual CAPEX in the $7-8mn range.

Education was confusing, which can be easily simplified in looking at the overall business by taking loses from education and adding marketing spend from brokerage to see what the customer acquisition cost is for brokerage which runs $400-600 per brokerage customer. Approximately 50% of education students open a TOS brokerage account. Investools education allows the company to spend approximately $70mn a year to acquire students. Education has over 380,000 paid grads and approximately 100,000 subscribers to their proprietary Investools toolbox which pay $600 a year to subscribe. Education model while complex has proven its value in extremely strong brokerage account growth over the last 27 months (+566%). Education is an attractive business with very high barriers to entry and very low barriers to exit, which has played out in Investools slamming on the brakes and reducing events by 70% in 2008 yet adjusted EBITDA margins were actually up 50 bps yr/yr. Education has very low fixed costs and high variable costs. The tools and information are largely web based with a very good value proposition (i have been a toolbox subscriber for several years and think it is a valuable service: you can build literally any kind of stock screener, shows weekly money flows into sectors/industries, ranks stocks on 13 point scale on 5 year cash flow growth, sound balance sheet, ROE, Insider buying, etc, there are literally hundreds of other good features). Investools invested over $30mn in building out this platform over the last 10 years. It is essentially a simplified Bloomberg for retail investors, which costs $50 per month.Education revenue will decline sharply with the change in pricing to $299 from $999 while unit volumes should remain flat or decline slightly.

The hair: Education has a formal SEC investigation on how several intructors sold the service on several occasions. The instructors in question were promptly fired. We are comfortable that this will be a minor issue. Our comfort stems from immediately after this occurred Investools hired Pete Santori from FINRA/NASD, who was for 13 years Chief Counsel of market regulation, second Investools went to great lengths to ensure compliance before this happend whereby they would record every word from start to finish of every event, finally this happened with Russ Whitney (a competitor) and the total fines thus far have been minimal around $500K for far more egregious violations.  We estimate to be wildly conservative that this SEC issue is costing investors about $1 a share or $68mn. Finally, Investools has the most generous policy in the industry offering a 100% money back guarantee no questions asked (which is usually 10-14 days) in which a user can use the toolbox and read materials.   

Why this mispricing should not last: Growth should continue given user satisfaction is very high, unique customer acquisition channels with Investools, combined with very heavy marketing spend.

Users love the products and the company is rapidly gaining market share through referrals. Some quick examples:

Barrons annual ranking of 25+ brokers has rated TOS #1 or #2 last three years running

Shows 90% of users rate TOS favorably vs. 72% for OXPS and 60% for TRAD but compares close to 100 brokers http://www.elitetrader.com/br/index.cfm?action=view&R_FirmID=146

2008 results: 54,000 fully funded accounts 12/07 to 98,000 fully funded accounts 12/08 or 81% growth.

Marketing Spend of approximately $70mn a year for both TOS and Investools

Investools should graduate their 400,000th student in Feb-Mar 2009.... this is literally 100,000's higher than the next competitor and these are paid graduates.

Net Net: the company has unique customer acquistion channelsbetween education and brokerage, outstanding products that show up in high user satisfaction, and significant marketing dollars to continue to take share in online brokerage.