Hedge fund manager Whitney Tilson, who runs Kase Capital, is crushing it on his latest short position, but he’s not going to cover, yet.
Last month, Tilson revealed that he’s short K12, Inc, a for-profit education company (you can check out his presentation on the company here).
The stock fell more than 38% today after the company lowered its revenue guidance.
Tilson said at the Value Investing Congress last month that K12 Inc. reminds him of subprime housing.
“K12 reminds me of the subprime mortgage lenders and for-profit colleges when they were flying high — and the ending will be similar I believe.”
On Monday night, Tilson said he met the CEO of K12, Ron Packard. He said they talked for 4 1/2 hours and that he likes the CEO, too.
He also said that he’s not covering his short position, yet.
Here’s the email he sent out to one of his listservs:
Forrest Gump: My momma always said, “Life was like a box of chocolates. You never know what you’re gonna get.”
That line came to mind as I was thinking about the wild turn of events the last few days vis-à-vis K12. The stock is down 37% today and has been cut in half since I went public with my concerns about the company (and my funds’ short position) three weeks ago (the latest version of my presentation is postedhere).
But let me start the story two days ago: on Monday night, I went to a dinner hosted Mayor Bloomberg at Gracie Mansion for folks attending the Education Nation conference that was going on earlier this week in NYC. It was a great event with lots of my friends there, including Jeanne Allen — the first time I’d seen her since our back and forth early last week. We had a nice chat and even got our picture taken (with Eva Moskowitz) in case anyone thinks there are any hard feelings between us:
And then she said, “You know Ron Packard [the founder and CEO of K12] is here. Let me introduce you.” In light of what I’ve said and written very publicly about him and his company in the last three weeks, I feared an ugly confrontation so I demurred.
Those of you who know Jeanne, however, know that she’s very persistent so not long afterward, as I was talking to some other friends, she came over with Ron and introduced us. We shook hands and he said he’d read my presentation and thought I got some things wrong. I said I’d love to hear what and we started talking. And talking and talking… Somebody gave a speech — and we kept talking. Then some performers sang — and we moved to the side of the tent and kept talking. The party ended, everyone left, the crew folded up all the tables, and the clock struck midnight (3 ½ hours later) — and we kept talking. We figured they were going to kick us out, so we left and walked a few blocks up to the corner of 88thand Lex — and kept talking. Finally, at about 12:45am, my worried wife called me and said, “Where are you?!” I said, “You’re never going to believe who I’m standing here talking to…” So after 4 ½ hours, we both hopped into cabs and went our respective ways.
I have been shorting stocks for over a decade and have gone public with my short thesis on a handful of occasions and, as a result, have been sued, deposed, subpoenaed and investigated (there are good reasons why very few short sellers ever speak publicly) — but I can’t recall the CEO of a company I’m short being willing to engage in a lengthy, frank conversation like Ron and I had on Monday. (My only similar experience was when Reed Hastings published a response to my article in December 2010 in which I detailed why I was short Netflix at that time; after the stock collapsed, I went long it and still hold it — it’s been one of my best investments ever.)
I want to respect the privacy of our conversation, so I’m not going to detail what Ron said, but do want share some of my thoughts.
First, I liked Ron. I found him very personable, I think he honestly believed everything he said to me, he didn’t get angry or defensive when I pushed him on some pretty tough stuff I’ve heard and written about K12, and we have a lot in common: early in our careers, he was at McKinsey and I was at BCG; we’re both interested in stock picking (long and short); and of course we’re both passionate about improving and reforming education and the role technology can play. I think Ron is an incredible visionary and entrepreneur, and he’s built an important and innovative company. I now see that there’s a lot of good in K12.
Before I met Ron, I thought he and the other leaders of K12 were deliberately targeting and enrolling kids they knew were certain to fail in order to maximise their revenue, run their stock price up, and make a few more millions for themselves. I no longer believe this about Ron. I think he wants to do right by kids and that, if given the option of taking a student he knew wouldn’t be successful at a K12 school, but would be highly profitable for the company, he wouldn’t want that student. He believes — and I think he’s right — that there’s lots of room for the company to grow for a long time serving only students who will benefit from a K12 school.
So I don’t think there was ever a meeting at K12 in which the company decided to pursue maximum growth at any cost, even if it resulted in a lot of kids enrolling who were highly likely to fail and suffer a major educational setback. Yet even if it wasn’t intended, that’s exactly what I’m convinced is happening right now for a meaningful percentage of K12’s students (I’ve heard estimates as high as 85%, based on the very low number of K12 students who are demonstrating proficiency).
I think that a number years ago (coinciding, not coincidentally, with the company going public in late 2007), K12, in balancing its desire for growth vs. doing right by kids, let that balance get way out of whack.
I’ve seen it happen at countless companies — the board and management team get on a treadmill of scrambling to meet analyst expectations every quarter, they start to think (albeit perhaps subconsciously) that it’s their job to keep the stock price up, and they start doing all sorts of unnatural, short-term-oriented, unethical and, in the worst case, illegal things to keep the game going.
Fueling this is the genuine passion Ron and others at K12 have for online education. They have a missionary’s zeal to make it available to the world, which is great, but I also think that blinds them to the reality (as I see it) that a full-time online school is a terrible educational option for the majority of students, especially at-risk ones. Thus, I think it’s incumbent upon K12 to do its absolute level best to enroll only those students for whom one of its schools is the best option. Ron said that K12 is already taking steps to ensure this (and perhaps the tepid FY 2014 guidance the company issued last night in part reflects this), but I’m 100% certain that there’s a lot more that K12 can and should be doing.
So with the stock down so much, am I covering my short? In a word: No. In light of yesterday’s guidance (which, while below expectations, still showed enrollment growth of 5.7% year over year), I don’t think K12 has come to grips with the reality that it doesn’t just need to slow its growth, but must actually shrink its enrollment — and not by a little, but by a lot — to weed out the students who are not appropriate for a full-time online school and thus are not engaging or succeeding. Instead, my read of K12’s press release yesterday is that it’s doing what most companies in this situation do — deny reality, rip the Band Aid off slowly, and prolong the pain.
What K12 really needs to do is come clean with all of its stakeholders (investors, employees, regulators, legislators, etc.) and say something like:
While we didn’t intend to do so, we grew too fast in recent years, resulting in many students enrolling in K12 schools who shouldn’t have. That’s not only obviously bad for those kids, but is also bad for us in the long run. Consequently, going forward, we are going to focus 100% on improving its academic outcomes, both by doing everything we can to ensure that only kids who are well positioned to succeed in a full-time online school enroll, and also by investing heavily to better serve our increasing number of at-risk students.
If K12 did this, for sure its revenues and profits would fall in the next year or two and the stock would get hit (again), but I’m convinced that the company would be far more valuable in the long run. Look at what’s happened to Netflix’s stock since it stopped trying to be profitable, and look at Amazon since its inception — it’s basically never been profitable! Investors don’t care about near-term profits as long as they’re convinced that the company is a growing market leader that, once it matures, will be highly profitable down the road (sometimes even very far down the road).
Once K12 takes these steps, I will cover my short — and might even go long the stock!
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