Description

Investment Thesis

We believe the new INVESTools (IEDU) / ThinkorSwim(TOS) combination of two extremely high quality businesses that remain deeply undervalued given the complexity and uncertainty of the merger and the underlying misperception of the education business.  Currently, we believe that the business trades at 6.5x EV / 2007E EBITDA for a business with the following characteristics:

•     2006 – 2007 revenue growth of 60% from $320mn to $500mn for the combined entity

•     Organic growth rates: Education 40% and Brokerage 100%.

•     Substantial returns on invested capital; +173% 2006E ROIC for the education business*

•     2007E cash flow of $2 a share

• FCF/TA-(cash, marketable securities, intangibles, and goodwill)

If these metrics are achieved, we think the stock is somewhere between $26 - $43 in 2007, representing 100% - 200% upside with a 20% downside of $10-11.

What has changed over the past 16 months?

a)    In September, IEDU acquired a top-rated online brokerage ThinkorSwim (TOS) for $340 million in cash and equity, and Creating a powerful Subsidy that should slash Customer Acquisition Costs by 50% while growing accounts by 200% from Sept 2006 to year end 2007.  

b)    IEDU education sales transaction volume continued to average 40% CAGR since 2002: ‘02A $53mn ‘03A $77mn ‘04A $122mn ‘05A $176mn ‘06E $265mn ‘07E $360-400mn

c)    IEDU Education Adjusted EBITDA margins have expanded from 14% in 2005 to low 20%’s in 2006 (mgt thinks that 25-30% is achievable)

What we see changing over the next 12 - 18 months?

Sales Transaction Volume (STV) Growth

From what we track, we estimate IEDU will increase their direct channel events by 65% - 70% in 2007 from 700 offline direct preview events in 2006 to an estimated 1200+ events including a national user conference in Orlando.  By way of comparison, IEDU for the first 8 weeks of 2006 ran 101 preview events vs. 186 in 2007 or up 84% growth (sourced from the IEDU website).  Each preview event draws approximately 100 people and yields approximately 25-30 new graduates.  These statistics are important for two reasons.  On the education side of the business, we expect 1,200+ * 25-30+ graduates per event or 30,000-36,000 new graduates, which will translate into approximately $150-180 mn in STV assuming the current product upsell rates.  IEDU is an innovation machine, with 68% of the revenue coming from products developed in the last 3 years. IEDU rolls out several new products a quarter which we will give no credit to.

The indirect channel, those students acquired through Learning Annex, Money in Training and Peter Lowe, should generate, as guided by the company, similar sales transaction volumes of $150 mn on 30,000 graduates. We think this is highly conservative to assume -0- growth in the indirect channel, as we will explain below.

Another $50-65 mn of sales transaction volume should be generated by continuing education of the existing graduate base.  This assumes each graduate spends approximate $500 / year on 84,000 and online coaching.

TOS, independent of the merger, should grow investor events from 200 to 350-400, plus a national user conference in Chicago.  In addition to this organic growth, IEDU preview events should funnel customers to TOS.  We have seen this conversion already working as TOS has signed up 4,000 new members from late September to last week in November when they have previously grown about 625 per month (see proxy filed 12/13/06 page 38).  We can only attribute this growth to IEDU related customer acquisition.  TOS had 15,300 accounts at the time the deal was announced (Sept 2006) and we estimate 21,000 accounts by year end 2006 and 45,000 - 47,000 by year end 2007.

Therefore, we estimate 2007 revenue as the sum of the education and brokerage business at:

Education sales transaction volume:       $350 - $395 mn

Brokerage business revenue:               $130 - $150mn

Total 2007E revenue:                      $480 - $545 mn

Margin Expansion

IEDU/TOS Subsidy: should cause the TOS Customer Acquisiton Costs (CAC) to fall 50% from $280 to $140 per customer in 2007 while growing accounts by 200% over 15 months.  Previously, we believe that IEDU was subsidizing OXPS’ true market costs to acquire customers based on account quality and cost.  This relationship IEDU / OXPS relationship has ended and IEDU is currently directing this subsidy to its TOS online brokerage. Once IEDU ended OXPS subsidy within sixty days OXPS missed new accounting openings by 40% and the stock fell 32% in a month. 

Here is a summary of how IEDU / TOS relationship works:

a)    First, TOS pays IEDU a fixed rate of $175K a month to acquire new customers, IEDU acquires customers for preview classes and channel partners (Which combined Direct + Indirect will spend nearly $80-90mn), TOS will be able to leverage this ad spending. From April 1, 2005 to June 30, 2006 IEDU opened a total of 22,789 accounts for OXPS/SCHW (see 8K September 21, 2006 page 14). These 22,789 accounts were opened with low incentive to IEDU we estimate they were getting $60-70 per account and approximately 850 preview events over the 15 months, and as we mentioned above we expect over 1200 just in 2007.

b)    Second, given that we think IEDU should help open 25-30K new accounts and TOS will pay IEDU $2.1mn that would come to ($2,100,000/25,000)= $84 cost per new account from IEDU. To put this in perspective, TRAD pays $690, SCHW/ET/AMTD = $600-800 per account, while OXPS pays $130 per account (we will see what this ultimately has to go to since IEDU subsidy has been cut).

c)    Third, Pay back period for TOS with the IEDU subsidy will be approximately 4 weeks which is by far best in the industry. This is a combination of average TOS account (pre-merger) generated $318 in EBIT per quarter vs. $152 OXPS, $62 AMTD, $55 ET. Payback period for TOS competitors range 3-9x as long! So this is the subsidy to acquire accounts of this level of profitability and quality one would expect to pay considerably more. 

d)    Estimating Total funded accounts are 45,000 - 47,000 year end 2007. IEDU contributes 25,000 and TOS contributes 6,000 in 2007E, which would be an 80/20 split. TOS current customer acquisition cost is $280 and given IEDU/TOS subsidy should be $2100K/25K= $84 per account, resulting in a combined weighted CAC of $140. So we think estimating $125-$145 per account acquired, for the arguably the highest quality accounts in the industry. I think this number is reasonable, in the first 8 weeks the company was at a run rate 24,000 new funded accounts, and now IEDU has increased its direct events 65-70% and TOS should double their events in 2007. IEDU could possibly do as well as 36,000 new accounts for TOS, given substantial direct preview ramp but 25K should be fairly easy. 

High quality accounts (IEDU students Affluent, educated, TOS and IEDU preach on the option side time decay strategies), average TOS account 139 annual trades and $1,272 in EBIT per account per year (pre-deal).

Net Net: One of two things should happen: IEDU education gets significant premium for this subsidy or the market gives TOS a huge premium because of the pay back period, growth rates, margins either way IEDU investors should win.

OXPS runs at 65% EBIT Margins vs. TOS retail margins of 48%.  TOS as the business continues to scale we think TOS should continue to expand OM, one easy way is that their CAC will plummet with the IEDU subsidy. TOS as a more mature company should have at least 55% EBIT margins on Retail alone and comparable margins as institutional scales up.

We estimate 2007 cash flow as the sum of the education and brokerage business at:

Education cash flow:                      $70 - $100 mn

Brokerage business cash flow:             $35 - $50 mn

Total 2007E cash flow:                    $105 - $150 mn

Shares outstanding post merger            67 mn

2007E total cash flow per share           $1.60 - $2.40

Multiple Expansion

There will be a year when IEDU/TOS gets discovered by main stream, where tier 1 Sell Side firms start coverage and the multiple of this business looks more like NTRI or other high margin high growth businesses than a dying seminar company. The mix of following characteristics should help and we think 2007 should be the year:

•     Critical mass $500mn in revenue, $900mn market cap/$980mn EV

•     High growth: 40% education/ 100% brokerage

•     #1 investor education/highly rated online broker (Barrons Rated their software #1 for online option brokers)

•     High user satisfaction

•     IEDU Subsidy for TOS

•     High margin businesses: Education @ 20%+ / Brokerage @ 45%+

•     High returns on capital

What remains consistent in the story?

a)    “Pavlovian- like” preview events in which the company has given over 3500 (that we have tracked), and running now around 80-100 a month (which creates a highly controllable business, and they give you preview classes on their website). We estimate 100 people per preview class attend with 25-30% buying the 5 step workshop for $2000. From there students have no questions asked 100% money back guarantee to use the toolbox and review materials until the end of the first day of their 2 day class. At the end of the second day the student can buy Trading rooms, Bachelor, Masters, PHD, or do nothing. Purchasing an additional product is known as an “Upsell” rate. So take upsell rate per degree and multiply by paid graduates and you get the unit break down.  The Pavlovian aspect:  IEDU attracts about 100 people to preview classes, and consistently around 25-30% will buy something go to the most recent quarter for details on Up-sell rates and mix. I would urge anyone thinking about this stock to attend an IEDU branded event (www.investools.com) and see in person. From what we track on the Direct Channel only, we believe that IEDU is tracking to around 1200 preview events in their direct channel with 100 people per event that should equate to 120,000 gross attendees and around 30,000+ students based on my comments above.

b)    High user satisfaction (see Below part D)

c)    Highly misunderstood: 9 out of 10 people will say “no one will pay $2-21K for non-accredited education, it must be a scam?” and that’s the opportunity because the data on Up-Sell rates, Money back guarantee, retention on the toolbox (70%+, on IEDU branded 80%+), We have not been able to find any support of unhappy or unsatisfied students. Relative to $500,000,000 in Sales with 76 customer complaints over the last three years into one of 18 different categories (with only 13 complaints related to sales practices with over 100,000 paid graduates). The Better Business Bureau gives IEDU a satisfactory rating. IEDU dominates the business with an estimated 4x share (in terms of Sales) than next closest education competitor. One of the most notable differentiators from the entire industry: A) the business is based on recurring revenue and therefore must have high user satisfaction, while some competitors try to take your entire wallet in the first meeting and could care less about the students success or failure. IEDU does what it takes to keep students highly satisfied, from our experience (we have been up to Masters Level and 3 year toolbox subscriber).

d)    High moat: IEDU education business in the 10K was referred to by the company as “…a considerable competitive advantage compared to other education providers.” To take it a step further the advantage is the confluence of: Product ladder with price points $2-21K, which will allows the company to gain access to distribution by spending about 30% of Sales Transaction Volume to acquire customers between the Direct and Indirect channels while maintaining a 20%+ adjusted EBITDA margin. We estimate IEDU Education business in 2006 will range between $80-85 million dollars total direct/indirect. IEDU next largest education competitor revenue is about 2/3 of their marketing budget. For 2007, IEDU should spend well over $100mn acquiring customers which would place it #4 in US of public brokerages in customer acquisition budget. 

e)    To get a feel of the program, there is a very strong sense of community from the graduates: See Yahoo/Groups Investools some 6,000 people who have independently formed to discuss Investools in 133 different groups, the annual user conference sold out in month and half with close to 1800 people in Las Vegas paying a grand for 2 days, this year their will be 2 user conferences Orlando and Chicago McCormick Place. 

Attractive Business Model

No Capital Tied up in the education business, DSOs 6 days, Essentially no inventory, Minimal CAPEX 15%+/- CFO

Market Opportunity:

•     IEDU is targeting what Forrester Research calls “the Mass Affluent” which are 33 million Americans that have a $150-1000K liquid net worth with an average age of 49 who are worried about retirement.

•     9 out of 10 401Ks are self directed

•     IEDU targets people with HHI of $100K+ up that are typically Doctors, Attorneys, Engineers, and Entrepreneurs.

•     We think IEDU is in the early stages of gaining market share in the US alone.

What we have not counted in 2007

For our model we give -0- credit:

•     No growth in the In-direct channel

•     No impact from partnerships with Nasdaq.com, Yahoo Finance, Businessweek.com, and Forbes.com Industry Leading Partnerships: (collectively these generate 30,000,000 page views a month, IEDU has to pay nothing and provides content for these partners to sell ads around should help lower CAC’s with the exposure).

•     No impact from National short TV ads that Ogilvy has been working on for 8 months