K12 And Whitney Tilson: The Anatomy Of A Classic Short

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Here’s a quote from Tilson’s 110-slide presentation on his K12 Inc. (NYSE:LRN) Short Position at the Value Investing Congress Presentation in New York on September 18, 2013:

Whitney Tilson K12
Courtesy of Kase Capital

“October 2007. At that time, I went through my short book, stock by stock, and said, “OK. Am I willing to cover MBIA at $70? Hell no, not a single share! Allied Capital at $30? Hell no, not a single share! Farmer Mac at $30? Hell no, not a single share!” And on it went… I couldn’t bring myself to cover a single share of any stock I was short – they were all “trembling-with-greed” shorts.

And that’s exactly how I feel today. I look at K12 Inc. (NYSE:LRN) and the other 10 stocks I’m short – all of which I think are absurdly overvalued and sure to collapse – and feel intensely that covering them now would be the most boneheaded capitulation trade of all time.”

Cut to Yesterday, October 9: The bloodbath unfolds

k12 stock-chart-lrn

K12 Inc. (NYSE:LRN) collapsed after the company reported slower than estimated enrolment growth saying: “We believe the increase in Managed Public School enrollments fell short of internal expectations due to several factors, which include, among others:

  • The Company’s inability to convert the increased volume of student applications into enrollments at a level achieved during previous years due to performance in its enrollment centers and, to a lesser extent;
  • The delayed start of the open enrollment period for certain schools.”

At this point it may be worthwhile again to go back to Tilson’s presentation and look at the slide where he discusses the justification for his K12 Inc. (NYSE:LRN) short:


Quite clearly, Tilson was prescient, and K12 was a “trembling-with-greed” stock, judging from its subsequent fall.

What’s Ahead for K12?

Analysts at Morgan Stanley (NYSE:MS) cut their revenue estimates for FY14 to $924M and operating income to $54.5M. Price target gets moved lower to $36 from $39 but the firm remains Overweight on K12 Inc. (NYSE:LRN).

Baird downgraded the company from Outperform to Neutral and slashed PT form $40 to $25. Baird estimate 2014 net revenue at $917M and operating income at $54.3M, saying the company’s new guidance “materially impacts our prior view of the company’s intermediate- to long-term growth profile and likely results in significantly reduced investor confidence, in our view. We also note the worse-than-expected enrollment figures come during the key fall enrollment period (hence potentially remaining a headwind for at least the NTM) and come during an unusually strong year of enrollment cap increases in existing states.”

Analysts at Stifel, Nicolaus & Co reaffirmed their Buy rating but reduced the PT from $39 to $26. “Although we expect the stock to be in the penalty box for some time based the limited ability to resurrect enrollment during the course of the year and damaged credibility, downside should be limited from current depressed levels and the ability to continue to grow is still intact, in our opinion.” They expect 2014 revenue at $919.6M and operating income at $55.8M.

Analysts at BMO Capital downgraded K12 Inc. (NYSE:LRN) to Market Perform from Outperform and axed its PT to $22. “Although management plans to provide more color on a conference call on Thursday after the close, this “vacuum” adds more uncertainty to this story. In addition, we see few near-term catalysts as F1Q enrollment results generally set the stage for the full fiscal year performance. While short sellers have been more vocal in recent days and we believe have driven much of the stock’s recent decline, part of their thesis (slower enrollment growth) may be only beginning to play out – even if for different reasons than expected.” Revenue for 2014 is expected at $919M and operating income at $52M.

The Last Word

Tilson said to the Business Insider today:

“So with the stock down so much, am I covering my short? In a word: No. In light of yesterday’s guidance (which, while below expectations, still showed enrollment growth of 5.7 percent year over year), I don’t think K12 has come to grips with the reality that it doesn’t just need to slow its growth, but must actually shrink its enrollment – and not by a little, but by a lot – to weed out the students who are not appropriate for a full-time online school and thus are not engaging or succeeding.”

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