A Tale Of Two Education Stocks
By Theodore Spencer

(FORTUNE Magazine) – One of the more painful lessons learned by investors over the past year has been that earnings do matter. Every sickening plunge in the indexes seems to be instructing people to focus on profits instead of mere potential. But at least one corner of the stock market still looks and feels a lot like 1999--for-profit education stocks.

Consider the share prices of the two leading public companies in the K-12 field, Edison Schools and Nobel Learning Communities, which both trade on the Nasdaq. Edison hasn't earned a dime, yet its stock has risen 75% since going public in November 1999. In fact, the company now sports a market cap of $1.4 billion. Nobel, on the other hand, has already broken into the black, but its shares have climbed a paltry 9% during the same period.

Both Nobel and Edison, along with a handful of other competitors, are trying to grab a piece of the estimated $360 billion spent on public K-12 education each year. For-profit education companies are allotted a certain portion of that money based on the number of students in their schools. The basic business model is to run public schools more efficiently than a local district can, with lower administration costs; profits come from whatever money is left over. Both companies are expanding quickly, thanks to parents' growing frustrated with increasingly shoddy schools. In February 1999 there were 100 public schools run by for-profit companies; today there are 290.

In part, Edison's success has come from the name recognition of CEO Chris Whittle--who founded and later sold Channel 1, a company that broadcast commercial programming into classrooms--and the pedigree of its chairman, ex-Yale President Benno Schmidt. Since Edison went public, its stock has climbed from $18 to $30, and cheerleading bankers, led by Merrill Lynch (which took Edison public), say it should crack $40 within a year.

However, there's still that nagging problem of earnings. As of Sept. 30, 2000, the company, which started running schools in 1995, has lost $196.3 million. In fact, it's projected to lose money until 2004. Whittle has said he needs about 440 schools to turn profitable--right now Edison has 113.

"If you're in it for the short term, Edison is a volatile stock," says Jeff Silber, an analyst with Gerard Klaur Mattison & Co. "Because the company is growing so rapidly, not every school is going to work, and that means there's risk."

Nobel is different from Edison in that its bread and butter has been running private K-8 schools, and it's only now expanding into charter schools. Profits are typically more predictable in private schools, and Nobel carefully screens demographics before getting into a market. The company runs more than 150 private schools in 16 states, plus four charter schools, and has earned a good report card so far: On average, Nobel students test more than two years above their grade level in both reading and math.

At Nobel's Philadelphia Academy Charter School, children file in orderly ranks through the halls, wearing blue polo shirts and khakis. Spanking-new computers fill tech labs, and class size is limited to just 22. You'd think you were in some tony private school in Greenwich, Conn., except that the Philadelphia Academy sits in a converted aircraft-parts factory behind a strip mall.

Efficiencies like cheap real estate have helped Nobel get past the profitability point quickly, but its stock still trades at just $6 and has never risen above $18. One reason is the company's modest size: With a market cap of a mere $37 million, it gets scant coverage on Wall Street. But Nobel's financials are solid. Revenue more than doubled from fiscal 1998 to fiscal 2000 (ended in June). Granted, Edison is growing its revenue faster, but Nobel also has actual earnings, actual profits, today. And analysts project those earnings will grow 30% in 2001.

"The key value is that Nobel is profitable and has deep experience relative to Edison," says Peter Stokes of EduVentures.com, a company that monitors the for-profit education industry. In other words, take a lesson from the market in 2000 and stick with companies currently making money.