A friend recently closed on a home purchase, using a Veterans Administration loan. The pile of documents to be signed was at least six inches high; the closing took two and a half hours; and he remarked to me—“I thought we were supposed to be in a paperless society by now!” After all, isn’t that what computers were supposed to do for us?
You’ve heard it plenty of times. With the advent of online news, traditional newspapers were supposed to disappear. Granted, the newspaper publishing business has changed dramatically, but I still pick up my newspapers from my driveway every morning.
E-books were going to eliminate bookstores and libraries, too. And while I have downloaded many books, I still love browsing my local library and the shelves at Barnes & Noble.
Online education was forecast to severely reduce the need for bricks and mortar universities. It’s true that there are thousands of online courses available today, with more than 5 million students enrolled in at least one online course, but millions of students continue to attend classes in-person at hundreds of higher-learning facilities.
And yes, digital learning was supposed to signal the end of the textbooks we carried around as children, but students are still lugging around backpacks full of hardcover books. In fact, a recent University of Washington study reported that a quarter of students still bought print versions of e-textbooks that they were able to download for free. And we’re talking about ‘young’ students—folks who can’t put their phones or tablets down for more than a few seconds!
The Future of Digital Learning
And that’s a good thing for publisher Houghton Mifflin Harcourt Company (HMHC), one of our recent Spotlight Stocks in Wall Street’s Best Investments. The company utilizes both digital and traditional educational tools to build its business. Digital is becoming the way of the future, and HMHC is capitalizing on those opportunities, but the company continues to generate revenues and income from its leadership in the traditional education arena.
Recommended by Roger Conrad and Peter Staas of Capitalist Times, Houghton Mifflin Harcourt Company is a trade publisher (11.9% of 2014 revenue) and global leader in education solutions (88.1%). Conrad and Staas had this to say about the company’s investment prospects:
“Today, the company offers exposure to an underappreciated turnaround story that hinges on its embrace of technology.
The firm’s education division controls more than 40% of the US market for reading, math and science textbooks and other instructional content aimed at students in kindergarten through 12th grade (K-12).
In addition to projected increases in K-12 enrollment over the next five years, states and municipalities’ tax revenue has started to recover from the housing crisis and Great Recession, enabling public schools to catch up on deferred spending.
The recently completed acquisition of Scholastic Corp’s (SCHL) educational technology and services business for $575 million also creates near-term opportunities for Houghton Mifflin Harcourt. Management expects the deal to be accretive to net income and free cash flow in 2016 and to generate between $10 million and $20 million in annual synergies. Equally important, Houghton Mifflin Harcourt’s larger sales force and customer base create an opportunity to cross-sell this educational content.
CEO Linda Zecher, a former Microsoft executive who took the reins of Houghton Mifflin Harcourt in September 2011, and her team of technology industry veterans focused on revamping the company’s existing digital content and re-engineering the development process to focus on cloud-hosted content.
Not only does the transition to digital content improve Houghton Mifflin Harcourt’s profit margins by reducing printing and warehousing costs, but also the shift to a subscription-based model that includes a maintenance fee for regular content updates should result in a steadier revenue stream over time. Last year, digital products and services accounted for 54% of the company’s education revenue.
Management indicated that many educational content providers plateau at $30 million to $40 million in revenue because they lack the sales and distribution system; Houghton Mifflin Harcourt has signed deals with about 100 third parties to distribute its content via HMH Player, which has about 15 million active users.
Management has introduced conservative guidance that calls for revenue to grow at a compound annual rate of 5% over the next four to five years. And management expects the company to generate 46% of its revenue from markets adjacent to education, compared with 24% today. The push into digital is expected to add 6.6 basis points to the company’s margin.
Houghton Mifflin Harcourt plans to continue to use free cash flow to repurchase shares and could pursue additional acquisitions to bolster its presence in the consumer market. Buy up to $25.00.”
Houghton Mifflin Harcourt plans to transition its K-12 education offerings to digital, specifically, to the cloud.
Our education system has just begun to take the first steps to introduce them to techniques that can tremendously boost their knowledge and learning abilities. Even countries like South Korea are far in front of the U.S. That nation recently announced that all of its students will begin the transition to digital textbooks this year. I say, “It’s about time that we caught up!”
There are a couple of reasons for this push.
Cost Savings and Smarter, Faster Education.
A Project RED study indicated that the cost per student in a traditional learning environment, including textbooks, paper, technology and connectivity, is around $3,871, while a learning environment that includes digital learning, devices, and connectivity, costs about $3,621. And while $250 doesn’t sound that exciting, when you multiply it by 50.1 million K-12 students, it is huge!
According to the U.S. Department of Education and recent studies by the National Training and Simulation Association, technology-based instruction can reduce by up to 80% the time to reach a learning objective. A PBS study says that teachers believe interactive whiteboards and tablets enrich classroom education. Whiteboards by 93% and tablets by 81%. The Federal Reserve reports that graduation rates improve 6-8% for students who have internet access at home. And let’s not forget about how technology can render quick updates to materials, whereas our current textbooks are 7-10 years old, bordering on the obsolete. That’s $7 billion worth of outdated material that we use to teach our kids every year.
Consequently, steps are being taken—finally—in the right direction. In 2013, the FCC, the U.S. Department of Education and CEO from the Digital Education Ecosystem formed a joint commission, Leading Education by Advancing Digital (LEAD), to transition U.S. education to the digital age. The Center for Digital Exchange (CDE) reports that only 22% of K-12 educational systems in this country “have a complete strategy for digital transition in place; and just 3% have completed the move to an all-digital content and curriculum environment.” That’s a huge opportunity. And propelled by the projected cost savings, federal and state budgets are beginning to add some funding to the rhetoric, increasing K-12 IT budgets almost 3%, to $10.2B last year.
HMHC certainly seems to be in the right place at the right time. Already with 40% of the K-12 instructional content market, it stands to reason that HMHC will benefit from the digital revolution. As well, the recovering economy means more education dollars; its new acquisition offers cross-selling opportunities; and the company is in the perfect spot to grab market share in the coming education digital transition.
Fundamentally and technically speaking, the shares look attractive. They are trading below their 14-day RSI of $22.45 and also less than their 200-day moving average of $22.93.
Undervalued, a turnaround, and growth—not a bad way to start 2016.
Happy New Year!
Nancy Zambell
Editor, Wall Street’s Best Investments and Wall Street’s Best Dividend Stocks
