Whitney Tilson has sent the following to ValueWalk via email.

For background on the topic see here. Whitney Tilson details about K12 Inc. (NYSE:LRN).  (see his ‘first’ article on topic  here) (a stock which Tilson is short). Whitney Tilson has been very critical of the company see ‘Criticism Isn’t Stopping me’ and Tilson on K12 ‘My response to Dear Whitney – Are we having fun yet?’).  Also see more from Tilson on the company here and here.

Whitney Tilson K12
Courtesy of Kase Capital

Tilson letter below.

To the board and management of K12 (LRN):

Since I went public with my presentation and article detailing the many reasons for my short position in K12’s stock, I’ve had the pleasure of both meeting and speaking extensively with CEO Ron Packard and also having a call with Executive Chairman Nate Davis. It’s very unusual for senior management of a company to speak with a short seller (full disclosure: I continue to have a short position in the stock, as I discuss in this article), so the fact that they were willing to do so is a credit to K12.

I found Packard and Davis to be refreshingly candid about K12’s challenges and what the company is doing to address them, and believe that both of them are genuinely sincere in wanting to do right by the students who enroll at the company’s schools. As I discuss below, however, I think their words are inconsistent with many things K12 is doing. In particular, I don’t think they fully appreciate the tension and trade-offs between their desire to maximize growth, profitability, and the share price vs. doing their best to ensure that every one of K12’s nearly 130,000 students is engaged and learning.

But before I discuss our areas of disagreement, I’d like to highlight the many things we agree on:

  • K12 is an innovative, pioneering company with a well-regarded curriculum.
  • A 100% online school is an excellent option for some students – but a terrible option for others.
  • In its early days, K12 served mostly middle- and upper-class kids with strong parent coaches.
  • In recent years K12 has seen a large influx of at-risk students – typically poor and minority youth who are behind academically and often lack a strong parent coach at home.
  • Such at-risk students are often stuck in failing bricks-and-mortar schools and thus have a great need for an alternative educational option – and even a mediocre alternative might be better than what they have now.
  • These students have distinct, very challenging needs, which K12 is endeavoring to meet.
  • However, K12 faces the problem that these students are less likely to have the motivation, self-discipline and parental support to consistently engage and succeed in an online school.
  • Students who don’t engage aren’t likely to learn much and fall behind academically, so they would probably be better off if they quickly returned to a traditional school.
  • Nevertheless, any student, regardless of background, can succeed in an online school if they engage – and it is impossible to predict with 100% accuracy up front which students will engage.
  • K12 only wants students who will engage and succeed at its schools, so it seeks to fully inform parents and students what is required for success at an online school.
  • Even though students who don’t engage might be profitable for the company because they require little teacher time and attention, K12 does not want such students to enroll and, if they do, would prefer that, once it’s clear that they are not engaging, leave K12 and re-enroll at a regular school.
  • However, if a student is determined to enroll/stay enrolled, K12’s hands are tied because, according to most states’ charter laws, the company cannot be selective in enrollment, nor can it kick any student out.

Though we agree on a great deal, there are a few areas in which we don’t. Most importantly, when I spoke with Davis, he argued that even if only 10% of at-risk students succeeded, that was better than none – because surely no student was worse off. I vehemently disagree. To attend a K12 school, a student must stop attending a traditional bricks-and-mortar school. While I suppose one could argue that some such schools are so bad that a student is better off not going to school at all, I think that’s a rare exception. Even at the worst schools, some learning is going on – and you never know when a student might encounter a special teacher who inspires him and puts his life on a better trajectory.

Thus, if a student enrolls at a K12 school but fails to log in regularly, interact with teachers, complete assignments, etc., then real harm is being done. The student is learning little or nothing, falling further behind academically, and is at even greater risk of permanently dropping out, which is a sure route to a broken, ruined life. For these students, K12 is likely an educational catastrophe.

Thus, I would argue strongly that K12 has an educational – and, I’d argue, moral – duty to do its very best to only serve students who are benefiting from its program.

I don’t think K12 today is anywhere close to fulfilling its duty. Based on numerous interviews with former employees and others familiar with the company, I believe that K12 is focused primarily on growth, marketing to and enrolling pretty much anyone, which leads to large numbers of unengaged and failing students, as reflected in the sky-high dropout rates and terrible state test scores. (I know that we disagree on the validity of the state tests vs. your internally administered Scantron tests, but surely we can agree that if a student isn’t even showing up for school – whether online or bricks-and-mortar – he isn’t likely to be learning much.)

To rectify this situation, K12 needs to do two things:

1) Do a better job up front, during the enrollment process, of screening out students who are highly likely to fail in an online school. Though K12, by law, can’t refuse admittance, it can adjust its marketing, require in-person meetings with all new students, identify those who have little chance of succeeding, and give parents that unvarnished information.

The Colorado Virtual Academy implemented all of these things during recruiting for the current school year and the result was that the number of approved new students fell from more than 3,000 to about 900. Not surprisingly, the school is now performing much better, as evidenced by the fact that 93% of students are actively engaged on a daily basis vs. less than 70% last year. This is what needs to happen at every K12 school.

2) I agree, however, that upfront screening can only do so much, which is why taking action shortly after the school year begins is so important. Once it’s clear a student isn’t engaging, which I estimate is the case with 20-50% of K12’s students (depending on how one defines “engaging”), the company should be doing everything

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