Investing in Education Technology

It's an Edtech Boom!

By Tim Conneally   

The clouds of yellow chalk dust from clapping erasers have dissipated. The sweet aroma of a freshly printed ditto has worn off. The continuous blast of hot air from the filmstrip projector has fallen still.

Those vivid sensuous experiences have faded into the history of education. They've been replaced by a hodgepodge of new technologies and bucketloads of data.

Nowadays, a school kid is more likely to play an educational iPhone game than a game of dodge ball, and more likely to do his homework online than beside a textbook.

It might seem highly unromantic to those of us who learned cursive script and the Dewey Decimal System, but technology has worked its way into every aspect of education. From K-12 to college, graduate, and post-graduate, all the way to continuing education and professional skill development, learning and technology go together like pencils and erasers.

There are dozens of sub-sectors within the overarching "edtech" category, each providing tons of opportunity for investors. Some of the biggest spaces are:

  • Massive Open Online Courses (MOOCs)
  • Learning Management Systems (LMS)
  • E-textbooks
  • Mobile learning applications
  • Gamification of education
  • Classroom Intelligence
  • Bring-your-own-device (BYOD) systems integration

The competition is extremely healthy. In the case of LMS — the software for organizing gradebooks, assignments, and online discussion — there are more than fifty different pieces of software that schools can choose from.

There is no doubt the sector is booming.

But there are a couple of important trends taking shape right now that demand your attention as an investor.

Pearson Plc. (NYSE: PSO) Wants a Change

Longtime textbook publisher Pearson is at a transitional point.

Despite carrying a good book value and showing a good income, Pearson's earnings-per-share have dropped nearly 70% this year. Its stock has a downtrending RSI, and it recently hit a double top with support at $20.75. Deutsche Bank gave it a sell rating, while a handful of analysts knocked it down to an outperform or hold rating.

In short, it's not a strong investment at this point.

Yet Pearson is the edtech sector's most aggressive company, with twelve acquisitions and three investorships in the space thus far.

In 2013 alone it acquired Brazilian company Grupo Multi, ADHD testing company BioBehavioral Diagnostics, and BYOD company Learning Catalytics. It's got its hands in all the new trends, and in many cases it is the biggest financial contributor to education tech projects.

So what gives?

Problems

Market shifts upsetting existent businesses:

Pearson, like nearly every company in the publishing business, is shifting to a mostly-digital portfolio.  This will demand lots of changes.

This month, Pearson will be closing a 1.2 million square foot warehouse in Lebanon, Indiana. The company cited a "reduction of our reliance on paper-based warehouse space."

In November, Pearson sold off its Mergermarket Financial News Group assets to private equity firm BC Partners. This included Debtwire, Dealreporter, and Wealthmonitor. Pearson's Chief Executive John Fallon said the sale was to provide "additional financial capacity to accelerate our push into digital learning, educational services, and emerging markets..."

You must remember that this is not a sudden or surprising change. Digital publishing casts a big shadow over the paper publishing business, and this change has been looming for years.

In fact, I declared "E-textbooks are destroying the old publishing business model" more than two years ago, when Nature Publishing broke its 135-year-old business model to create a $49 e-textbook for college biology classes.

Pearson shows us how leading education publishers are morphing their business models.

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Alleged malfeasance, no longer an allegation:

Pearson agreed this month to pay $7.7 million to NY Attorney General Eric Schneiderman because the company was found to have been misusing its charitable assets to benefit its affiliated for-profit corporation with Common Core K-12 academic standards adopted by 45 US states.

If this arrangement was ever actually creating revenue for Pearson, it's not any more.

Prices falling:

A recent report from the Organisation for Economic Co-Operation and Development (OECD) clearly explained the situation in the United States:

  • Socio-economic background has a stronger impact on skills proficiency in the United States than in other countries.
  • To improve the skill set of the American workforce, education needs to be as accessible as possible.

In the quest to make this happen, universities, consortia, and legislators are fighting for lower prices on learning materials such as textbooks and educational software.

In 2008, Congress passed the Higher Education Opportunity Act into law. The law was intended to keep educational materials down at a more affordable level for students, and it is incorporated into university policies across the country.

In November 2013, a bill called the Affordable College Textbook Act entered Congress. That bill cited the success of the Open Source Textbook Initiative that created a free textbook for higher education.  

Similarly, tech initiatives are putting downward pressure on software offerings. Edtech software such as LMS's have free, open-source alternatives that cost universities nearly nothing to pick up and deploy, and massively open online courses such as those from Khan Academy offer students access to top-quality lectures and texts for free.

In total, there is massive pressure to keep the prices of educational products low.

So Pearson's old revenue streams are drying up, and it's reaching out to get its bearings in the tech-first generation.

Chegg (NYSE: CHGG), The Lost IPO

Chegg, the "Netflix of textbooks," went public one week after Twitter did, so it barely registered a blip on the media's radar as its shares opened and almost immediately tumbled in value.

The textbook rental company has attracted a lot of customers and plenty of angel investors since it debuted in 2005, but it still hasn't turned a profit. The public offering gained the company approximately $200 million, but it still has a negative income and negative book value.

On the upside, it's investing a whopping 67.9% of its capital into growth.

You see, this is because Chegg is weathering the same sea change as Pearson. In 2010, non-print material made up only about 1% of Chegg's business. It worked almost entirely with printed textbooks.

In 2012, however, non-print materials rose to 13% of Chegg's revenue. In 2013, that jumped up to 20%. If trends continue (hint: they will), Chegg is going all-digital, and the IPO money is going toward converting Chegg into a higher education services company.

Chegg offers services besides textbook rental, such as homework and study assistance, scheduling and organization, scholarship search, and career planning. As it grows as a student services company, Chegg could open itself to a wider stream of revenue and grow bigger than it could have if it had remained focused on textbooks.

What's more, Chegg is among the top ten acquirers of smaller edtech companies, and it is primed to acquire bright new companies to help it grow.

CHGG is trading low, and the time to buy is right now.

Why Now?

Conditions are favorable for edtech investment.

  • Edtech venture fundings passed the billion dollar mark in 2012, and top ten of 2013 totaled half a billion dollars themselves. Conservatively speaking, 2014 looks like it will keep pace with 2013 in terms of venture capital.
  • The United States is desperate to strengthen its workforce through education, and legislation is shaping the market to favor lower-cost tech solutions.
  • The edtech market has proven to be disciplined. Education's seasonal nature gives schools unique windows to test product efficacy, and schools turn around underperforming products with relative ease.
  • Education technology is not a zero-sum game. There are more than a hundred different edtech products out there now, and many can be applied simultaneously with little effect on competition.

In the coming weeks, I'll be interviewing more than a dozen important figures in the edtech community: startups, investors, legislators, and educators. So keep your eyes on me for the latest in this vibrant sector. 

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