VIC — Whitney Tilson’s Big Short

Final Notes from the Value Investing Congress on Tilson's Big Short Bet

By Travis Johnson, Stock Gumshoe, September 17, 2013

Whitney Tilson sold his presentation big this year, saying he had put together a Einhorn-esque slide deck of 120 pages with a short argument about K12 (LRN).

On shorts in general, he said he has done awfully with shorts for a few years — but he sees a world that is so target-rich with crazy, juicy, obvious, shorts that he can’t capitulate …. even if stupidly overvalued stocks can certainly become more stupidly overvalued.

K12, with the cute ticker LRN, runs online charter schools in several states. It offers revenue growth of 32% annually for ten years, it is projecting 32% earnings per share growth, average revenue per student is growing, they have very high parent and student satisfaction, they have strong political support, the product is not completely illegitimate, it definitely works for at least some niches of students, and online learning has enormous buzz.

Why short?

Aggressive recruitment has led to dismal academic results and sky-high dropout rates, student turnover is more than 50% per year and they’ve been targeting increasingly inappropriate students to fuel growth. Recruitment of at-risk students makes them more money, because the parents tend to demand less.

There have been so many regulatory issues and accusations of malfeasance that he’s convinced the problems are endemic.

Similar to subprime lending or for-profit colleges, it makes sense on a small scale but the incentives and growth ambitious make it terrible and ripe for fraud.

He is a champion of charter schools, but is bearish on K12 because it’s a bad school and a bad stock.

Revenue has been growing dramatically, net income has risen but less dramatically. And that revenue growth is slowing, which is a big worry at 50X earnings. While revenue has slowed, the margins have also come down — that’s not supposed to happen.

Free cash flow has been about break even over ten years and has been aggressive. They capitalize their software and curriculum development instead of expensing it, which is very aggressive and even doesn’t do it. Auditing and CFO don’t impress.

Short interest is only 14% of the shares, because the stock has risen.

Tilson also interviewed several of the employees and teachers, all tell same story of “Growth at any cost” mentality — sign up as many students as you can using boiler room call centers, when they add a new school ...

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