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“This small Virginia firm holds the key to China’s economic future”

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The following article covers a teaser ad that has just started to be run again by the Motley Fool. Our article was originally published on February 2, 2011 when the ad first started to run, and the ad is substantially the same but the article below has not been updated or revised so some of the numbers below are quite out of date (the answer to the tease is still the same, of course).

The stock teased is far below where it was when the ad first ran 18 months ago, but has doubled since the lows of this past winter. The company has not posted a profit this year, but analysts believe it will do so next year. We’re including the full text of the original article and the full text of the original comments about the company, since readers posted a great many substantive comments on this one.

Well, whaddya know — this must be “Motley Fool Week” here at Stock Gumshoe. A couple days ago we looked at some of their teaser stocks for their flagship Stock Advisor newsletter … and now they’ve issued a “Special Report” obliquely teasing yet another pick.

And it’s a pretty good tease, too, with relatively few clues — but your friendly neighborhood Gumshoe does love a challenge. So let’s see who this is, shall we?

The “special report” on this stock is being sent to new subscribers to their newsletter — they call this report “One Breakthrough Company with the Key to Global Commerce,” so they’re not exactly being shy.

The stock teased is a pick of David Gardner’s, the more growth-focused and technology-happy of the Fool brothers, and it is, once again, for the Stock Advisor newsletter that he co-writes with his brother Tom. There’s plenty in the ad about his great success with long-term investments in stocks like Marvel and Amazon.com, but I went over some of that earlier in the week. Suffice to say that he likes rapid growth companies that are “top dogs” and “first movers” in their particular market, and he likes them even more when Wall Street is skeptical or when people think they’re overvalued.

Here’s the lead-in to get you excited:

“A small Northern Virginia company (with key patents and a team of bulldog lawyers) has discovered a way to provide a “a bread necessity” in places like Mumbai, Hong Kong, and Mexico City…

“While at the same time, replacing centuries old institutions in cash strapped American states and towns, and even U.S. government agencies.”

Intriguing, no? It continues. This stock is apparently a …

“… ‘first mover’ and already ‘top-dog’ in a $80 billion-a-year industry… with giants like Google now trying desperately to get a piece of the action”

Then we get a littany of clues about this company’s product:

“This company’s remarkable product is nearly 35% faster than existing alternatives ….

“… has achieved 7 times the name recognition of its nearest rival …

“… far superior product costs consumers (individuals, companies, along with both private and public institutions) 20% to 50% less than alternatives … with high gross margins of over 85% …

” … The company makes the vast majority of its revenue through direct sales — its website, call centers, and kiosks — and is expanding that retail presence around the world….”

So that sounds pretty impressive, no? Especially the 85% gross margins part … but nary a clue about exactly what kind of business they’re in (as you’ll see in a moment, any clue along those lines would instantly reveal the “secret” for most investors).

There’s also a connection to the states and their budget crises, which is timely — the teaser notes that …

“… on Wednesday, January 19 a sizable new contract was announced in Evansville, Indiana. The deal shakes up an old-fashioned public institution, saving the state a ton of money, and providing it a product five times better (according to one vital measure) than the existing alternative…

“And then there’s the monumental shakeup in New Jersey. You might have seen it reported on the evening news. In June of last year, this company’s breakthrough product REPLACED a centuries-old process and provided a better product for 80% less cost to the state!

“USA Today noticed, reporting that this breakthrough company “has become wildly successful”… and quoting a bevy of world-renown business experts who state unequivocally that this company’s product plays a “crucial” role in the future of global commerce!”

And Dave Gardner thinks this product might be 10X better than existing alternatives, and could become one of the major stock stories of this decade. So who is he teasing?

First, we need a couple more clues:

“According to Nielsen research, the worldwide market for this company’s product is over $80 billion. The United States represents just a small fraction of that, with around $5 billion. Yet this company makes about 80% of its revenue here, meaning there is a huge and largely untapped source of international growth.

“Last quarter, this company’s international sales rose more than 115% from a year earlier. The company makes the vast majority of its revenue through direct sales — its website, call centers, and kiosks — and it is expanding that retail presence in Europe and Asia.

“Its patented approach itself makes this growth easier because the system is adaptable to many markets.

“Even in the United States, there’s plenty of room for growth. The company’s $263 million in revenue over the past four quarters gives it a small share in a fractured market, but it’s rapidly gaining ground. Altogether, its revenue has grown at a 40% compound rate over the past three years.”

So now that’s enough to definitively name the stock for you — this is Rosetta Stone (RST), one of the more widely covered IPOs when it went public a little less than two years ago, very near the nadir of the financial crisis.

You’ve almost certainly seen their ads on TV and their kiosks in your local mall, but they basically provide language learning software — and yes, I’m willing to believe that second language learning is an $80 billion global business (though far larger and more commercial in China than probably anywhere else), and that foreign language acquisition is the “key” to global commerce, so the tease is a decent match conceptually.

But in the details, it’s a lead-pipe cinch — RST did record $263 million in sales over the last four quarters (OK, $262.9 million — rounding is allowed). Their latest quarter showed 119% year over year growth in international sales, which is not exactly 115%, but we’ll allow for some fudging there as well. And US sales did make up just over 80% of revenue, 83% as of the last quarter (and 93% a year ago, so you can see how the pie is changing).

And some New Jersey school districts did get quite a bit of national attention last Summer when they fired language teachers and gave the kids Rosetta Stone software to use instead. And Evansville did sign a contract with RST for a pilot program to expand language learning in their schools just a few weeks ago, as teased.

I remember being very impressed with Rosetta Stone’s marketing and branding a few years ago and looking to see if they were public (they weren’t at the time), but I didn’t get all that excited about the IPO when it came in the Spring of 2009 — frankly, the stock looked pretty expensive and it wasn’t a time when I was lunging for pricey growth stocks (though in retrospect, growth stocks were great buys back then — not RST, which is right around the $18 IPO price but well down from the $25 it actually traded at on the first day and from the $30 they hit shortly after, but growth stocks in general). Now that it’s had almost two years to “settle” in the public markets and give us a better idea of their ongoing financials, what do we think about the stock now?

Well, I don’t know about you, but I’m getting a little more interested. I haven’t dug into every filing by any means, but I am intrigued by a company with growing sales that has blown out earnings estimates in the past four quarters by a pretty impressive margin — often more than 50%, and trades at a premium to the market but not a particularly high premium (the stock changes hands for about 20X trailing earnings right now). Thanks to the IPO proceeds and to continuing cash flow generation, they also have a lot of cash — about $5 per share, so if you take out the cash as some analysts do the PE gets down to about 14, more of a standard market multiple.

For whatever reason (and RST does seem to have some challenges — heavy spending on marketing, some executive departures, and I’m sure others) analysts are forecasting that earnings will still not be up to the 2009 levels by the end of this year (they earned $1.22 in 2009, analysts expect 2010 to finish with 70 cents, and they forecast $1.05 in 2011). They’re also estimating 31 cents for earnings in the fourth quarter of 2010, which is the bottom of RST’s guided (and wide) range of 31-41 cents (at least, that’s the range they guided when they released the third quarter results).

The big question for Rosetta Stone seems to be whether they have a defensible market niche, and whether they’ll be able to continue to increase sales internationally and to institutions, including cost-cutting schools — that’s a question I can’t answer for you, I’ve never tried the product and certainly am no expert on the industry.

Morningstar’s analyst, as you might expect, is quite cautious compared to Mr. Gardner and pegs the fair value at about $20, noting that there is significant potential for competition from far larger software companies and that RST doesn’t have much of a “moat.”

And for what it’s worth, David Gardner did publicly share some more of his thinking about Rosetta Stone with another Motley Fool writer back in December. There has been pretty heavy coverage of RST and their challenges and opportunities in recent months, including a pretty good article in Barron’s in December if you want to get an overview.

So I’m getting a little more intrigued by RST these days, but I’ll need to learn a lot more about them (hopefully in English) before I consider investing. It’s your money that’s at stake though, so what do you think? Is this an unappreciated growth darling, or an accident waiting to happen? Something inbetween? Let us know with a comment below.

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36 Responses to “This small Virginia firm holds the key to China’s economic future”

  1. As a life-long language learner (French, Spanish and now Portuguese) I have never used Rosetta Stone products because they are too expensive and because there is little personal attention which is crucial when struggling with the sounds and cadence of a new language. I can take a 3 – 4 month class at a community college near by for the price of one unit of Rosetta Stone *about $300 per) and have a live teacher for coaching and interaction with other students and learners. Breaking into institutional markets may be a partial answer for RST, but individuals will always find it expensive to purchase the 5 units required.

  2. I've personally used RST to learn Spanish. While it is a bit pricey, the benefits are huge for the adult learner. If you don't have time to go to classes, you're a traveling professional with time to kill in airports, or are simply a fully employed adult, this is hand down the most convenient way to learn. The world is shrinking, globalization is not a fad, and while students may graduate equipped to handle the global economy, I think the adults already in it need a simple, quick and convenient way to learn. I basically learned Spanish over the course of a few months on airplanes when I had nothing else to do.

    Is the adult learner market a reasonable justification for this being a growth darling? I'm not sure, but a couple billion people primed to learn English in 90 days or less seems worth further consideration.

  3. I think that in this time of Employment Uncertainty, we need to have the tools available for teaching our younger generation multiple languages so they can venture into numerous areas of employment in all areas of the world. Rosetta Stone allows them to learn on their own time. Tthis is great knowing that most of the younger generation spends most of their time on Social Networking, maybe the S.N.'s will provide online tutorial classes.

  4. Was interested in buying RSTprogram for my son who wants to learn Japanese. He researched it with some students who had used it and feedback was that it was good to learn words but not for general conversation. Quite expensive and no ability to sell on ebay or such when you've completed the program. New competitor out now whose focus is on conversation, fast learning, 5 cds per language @$64 each. Pimsler approach- has anyone tried that?

  5. RST recently introduced a new subscription model which makes it more likely customers will stick with the lessons and more attractive for educational institutions as it comes with live help from language experts. The stock has been punished by last year's departure of both CEO and CFO and the company missed some of the institutional purchasing cycle with its new subscription model product. This stock looks very good 2 to 5 years from now as consumer confidence increases, the subscription model takes hold and management positions become steady. I've been in for over a year and while it has been volatile between about $18 and $25, I see RST as a $35 stock within 2 years.

  6. Every language program has its pluses and minuses. In researching and developing some programs I found the Rosetta Stone and Pimsleur to have there share of each. I'm not inclined to purchase stock for either program. In retrospect I missed out on EDU the company teaching English in China whose stock made considerable advances last year.

    Some of my programs were contracted to McGraw-Hill (for Subliminal Japanese see http://www.mhprofessional.com/product.php?cat=114…. One program they didn't contract for was Speed English for native speakers of Japanese. Would anyone be interested in configuring this program for use on the internet or through an app?

  7. Now the company that invents a small portable unit that can literally translate multiple languages by simply speaking into the unit and then translate both parties languages to one another is going to be a technology that I definitely want to buy stock in. Anybody know of such a miracle company out there?

  8. Rosetta Stone's success is an example of the triumph of marketing. The program is pathetically simple. The user is presented with four pictures while a sentence in the language appears over the top and a voice reads it aloud. The user selects the appropriate photo, getting a check mark for success or an X for failure. There are variations (no text, no audio, etc), but the concept is the same. An already dull idea becomes excruciatingly tedious after a few minutes of use.

    From my own experience, using a recorded program such as Pimsleur (quite basic) or Michel Thomas (better) along with a basic grammar/text book is a better start. Combine this with internet chat rooms in the foreign language of interest.

  9. Thanks for the useful comments, folks. For what it's worth, we've probably all seen their ads and they do seem to spend a ton on marketing — gross margin is around 85%, operating margin is about 11%, the selling and marketing expenses (operating kiosks and call centers as well as just advertising) are, I assume, a big part of that 75% or so of revenues. Scaleable at high gross margins, but one would have to assume that they can't grow without spending a lot on marketing, whether or not their product is worthwhile.

  10. I don’t know that they are scalable at high margins. Most of the people wanting to learn English can’t afford to pay $300 and don’t have their own dedicated computer. A company that caters to them and to Westerners wanting to learn Chinese is better. David has had his flops!

  11. I used similar programs in the past, before RST became the big player in computerized language teaching. There was a company that put out similar programs to teach various Asian languages back in the late nineties. I have to think there is a competetor or two lurking in the market place. RST may control it's niche' at the current time but, businesses like this tend to breed competition. As with Google in the search space, it's usually a second or third player that comes along and over – takes a market space with something marketed as bigger and better, unless solid patents for proprietary knowledge are had. cheers.

  12. Rosetta Stone is crapware. you absolutely will never learn to speak a foreign language using it unless you plan on speaking only to foreign dogs and cats.

    There is nothing and I mean NOTHING unique about this software. its shows pictures and text paired with sound.

    Sorry folks, but that is not how you learn to speak a language.

    I am a clinical psycholinguistic specialist.

    Let me put it this way: If RST was a bona fide language learning system that could actually teach you to speak a foreign language, then you should be able to give it to young children experiencing high neuroplastic receptivity and they would earn it just like they absorb language by interacting with people in their environment. Of course, with RST, this would never happen.

    Learning to speak any language necessarily involves interacting and having a relationship with other people. No canned software package is going to give you this.

    RST and its similars are a total fraud.

  13. If its as good as Michel Thomas I'd be very surprised – had my rusty schoolboy french back up to semi-acceptable conversational in 3-4 days 'bout 4 yrs ago.

    Just down the road from this netcafe is a bookshop with a pirate copy of Rosetta on dvd – about 30 languages on 1 disc for 450 Nrs – 5 bucks to you

    Might buy it. Not of course that i condone piracy in any form at all, at all.

  14. get an account set up at investopedia.com and you can trade this stock with money that they give you in an account in a game type/ real life stock market. Then you can watch and trade some of these stocks that everyone seems to have different ideas on and see for yourself and make your own decision on what works for you.

  15. Rosetta tends to keep a pretty tight hold on the software, I had a computer crash, and didn't of course uninstall it. When I tried to reinstall the software it would not do it. I had to call and provide a receipt for the RST!!

  16. Rosetta Stone is Crap. We are building a language learning website ourselves…but im not here to tell you how great our idea is. Im here to tell you that the future of language learning is online. There are many players out there and though there is lots of room for improvement I can name a few sites that are free or cheap and much better than rosetta stone. Rosetta stone went public because they realized that the future is online and they are in trouble. If they try to compete with other companies they will canibolize their own market. In regards to international, yes language learning is huge…but rosetta stone spent 15 years and a lot of money building brand awareness in the US for their crappy product. Internationally they have a different set of competition. And with cheap english teaching expats, books, language institutes and the online sites they will have a lot of competition. The online sites are going to increasingly take a chunk out of Rosetta's revenues even domestically. And regarding getting into 3rd world countries? Forget about it. People in China buy 3 dollar CDs of whatever from the market.

  17. Let me put it another way…Software does not allow you to crowd source where users can help build the community…the web can. Rosetta Stone has made like 3 versions of Software in 19 year history. Websites are updated and improved every few weeks. And most importantly, you cant communicate with rosetta stone software. I would short the stock. :)

  18. Thanks for all the input. It was a good read. Sometimes these sites come up with a good recommendation but you really have to do your own research to find out the truth. Sounds like RST has a short future with it’s high price point and sub-quality product. If there’s a demand, someone will make it cheaper, better, and faster. I did buy into the “dark solar” company ‘Natcore’ that was another ‘teaser’ put out there. It made me a quick 50% in one week, so I can’t complain.

  19. This is off the subject but is anyone familiar with this Market Trend Signal by Jesse Webb?Its on the Stock Gumshoe website. Thanks in advance.

  20. I just saw the a ad. for Pimsler (video) on the net, I was real impressed. First lesson is is 30 minute basic commincation in that language. It is all done with someone in there accent, so that is a big plus. You can study how ever you want too, as it is on an CD. Then later in the program you start the grammar part. I think it is the way a language should be taught. I am going to be ordering Spanish, very soon for I believe $264.00, not bad!

    RST Too much competion, not a good product, from what I have heard.

  21. I studied German in high school and even majored in German in college for a year before changing and I can’t remember any of it. I used Rosetta stone to learn Chinese and, having travelled to China eight times now, I can say that I am not afraid to use my Chinese while in country. I married a Chinese woman, who asked me if I am a genius because she couldn’t believe how quickly I learned the language.

  22. Facebook (NasdaqGS: FB – news) has agreed to acquire Mobile Technologies, a firm specializing in voice translation software, the two companies said, without providing financial details of the transaction.

  23. Yes it already exists I have it saved somewhere on my computer…maybe I can find it and come back to post it . no tease intended seriously.

  24. I have a spanish translator on my evo 4g that allows me to voice in and it translates into spanish . Is that what you mean, it free!

  25. If I understand it correctly most of this 'phenomenal' growth is to occur in overseas markets.
    I've lived in Tokyo for three years and you see these huge rosetta stone displays in every mall and bookstore, usually with some paid flunkey hanging around nearby.

    What I've never seen is; anyone take more than a cursory glance at them, or anyone standing in line at the counter clutching a copy plus cash or anyone able to speak English who hasn't also lived abroad for years.

    Tokyo is also full of ex-English teachers. i.e they couldn't make any money at it despite the outrageous prices charged by the language schools – very little of which goes to the teachers.

    I think to make a 'ton of money', teaching languages here, you need to launch a gossip manga (comic) featuring a Korean girl band with about fifteen, mostly superfluous members. They should gossip about other 'celebs' in little bubbles of English coming out of their air-heads.

  26. Haven't spent a so much time in China so can't comment on whether they'd rather spend their money on Rosetta Stone or Korean girl bands but I do know that anything that can possibly be pirated, will be – e.g computer programs.

  27. Counterfeit Rosetta is easy to get there perhaps that is why people only take a "cursory glance" there- the general populace knows they can get almost any software on the black market and it does not seem to be so taboo there at least not to the peeps i have talked to and bought from.

  28. Hi, Carol.
    About three years-ago, I bought a Pimsler course in basic Thai and it did serve to break the ice. Is all of it based upon the perspicuity of our efforts? Vouloir est Pouvoir?
    Regards

  29. Using Pimsler right now …Russian. I'm coaching a russian hockey player that moved to our area. After one CD I was able to say hello, goodbye, excuse me, do you understand english, I'm American, I speak a little russian and more. I went through the 1st cd twice and now have it down. I can speak Russian better than 2 years of high school spanish and I'm only 2 cd's into it. Highly recommended.

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