March 22, 2011 - 4:25pm EST by
2011 2012
Price: 11.13 EPS $0.00 $0.00
Shares Out. (in M): 30 P/E 0.0x 0.0x
Market Cap (in $M): 330 P/FCF 0.0x 0.0x
Net Debt (in $M): -17 EBIT 0 0
TEV ($): 313 TEV/EBIT 0.0x 0.0x

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Renaissance Learning is a leader in K-12 software with approximately 73,000 out of 115,000 schools using at least one RLRN product. RLRN's Accelerated Reader (AR) software has one of, if not the, strongest market share and renewal rates in the industry. We believe that very few investors have followed this company carefully as the business has undergone a very significant transformation over the last four years. In fact, free cash flow margins have improved from the mid teens to 31%. This improvement in part has been driven by a SAAS model launch called Renaissance Place that has grown from -0- to 34,000+ schools, driving subscription revenue from 37% to nearly 70% with overall renewal rates running 90%.

Functionally, Renaissance Place is a much better product due to very low cost implementation, distribution, and a number of useful product features. For instance, when a child finishes reading a book and takes a test on it, the system emails the parent a host of data on the child's results (grading grade level, % correct, top 10 books boys/girls are reading, etc). The system also has a number of other benefits: teachers do not have to grade math/reading quizzes, the results are real time (kids can instantly view what they missed and practice on weaknesses as well as see their reading ability and progress), and parent/teacher/administrator/school district rankings are shown.

The school we visited in CA has a current enrollment of 378 kids with the principal setting a goal of 200 million words read for the school year (up from 50 million 4 years ago). Test scores have improved significantly at this school. RLRN business has a number of other attractive user attributes such as low cost leadership whereby the average cost per student for AR software is .45 cents a student a month. Given the scale, the business is targeting low 30% operating margins. The company continues to add north of 10,000 new books to their 150,000 books with quizzes (which cost $75mn to develop).

The company recently hiked prices for AR from $4.00 to $4.25 and STAR Enterprise from .99 to $2.49 per student per year. Management has been very fair with investors paying out dividends totaling $7.30 a share while repurchasing another $5 per share in stock at an average price of $18...that is $12.30 of buybacks/repurchases over the last 7 years on current EV of $10. Despite the difficult macro economic backdrop, RLRN has dramatically strengthened their business and set new operating records in sales and cash flow in 2010. Given these substantial competitive advantages, it is not surprising that RLRN has averaged 25%+ ROIC over the last 15 years.

Finally, we believe the stock is substantially undervalued as insiders hold 70% of the equity (similar to the situation at TZOO that we wrote up). Management has done very little on getting their story out (just saw first IR presentation filed with SEC in late Feb), macro headwinds of budget issues, and the company screens badly as book value -$1 per share even though last year operating cash flow was $1.50 per share (hard to build up book value when the company has paid $7.30 in dividends). At approximately 7x trailing operating cash flow we believe this business is worth close to twice the current price with very limited downside given the very strong and predictable cash flows and debt free balance sheet. Despite record revenue, record FCF margins, CF per share improving from .90 to $1.50 per share over the last 4 years, recurring revenue doubling, and retention rates on AR near 95%, the stock is close to making 10 year lows.

Accelerated Reader Value Proposition
• Tight Budgets and large class sizes (benefits RLRN, as AR software allows a teacher to easily monitor students' progress and target time/effort to students that need help)
• Curriculum neutral (kids can read anything fiction/nonfiction and across grade levels)
• Speed to Grade (grades instantly)
• Real Time results for all (principal, Teachers, Students, Parents)
• SAAS based system emails parents real time test results, books read, comprehension, etc
• Kids in US take approximately 1.5 million AR Quizzes per day (here is a link to real time results: )

The company sums up fairly succinctly Accelerated Readers value proposition in their 2010 annual report:
"We believe that Accelerated Reader and our other products have achieved their significant market positions as a result of demonstrated effectiveness in assisting educators accelerate learning and improve essential skills by facilitating increased student practice, increasing the quality, quantity, and timeliness of performance data available to educators, helping educators motivate students and providing student access to low cost computing solutions. Our products help educators manage student practice of curriculum, provide targeted instruction, keep students engaged, and measure student progress in order to accelerate student learning."

Star Enterprise
• Diagnostic Test that determines a child's reading/math level in about 10 minutes
• 45,000 schools use about 33% of total market (19 million kids took a STAR exam in 2009-2010)
• Just increased price from $.99 to $2.49 or 2.5x. Once this flows through, 45,000 schools should have significant impact over time.

Accelerated Math
• 85% renewal rates
• Creates math assignments tailored to each student's current level, helping to differentiate math instruction, addressing each student's individual needs

• Well entrenched products
• Number of competitive advantages: low cost leadership, significant market share, very high renewal rates (90%), 25 year history
• Distribution: 60% of the market and 50% of the customers on SAAS based model
• Bundling products: all RLRN products (Accelerated Math, STAR, and Accelerated Reader, etc) cost $15/student per year. Currently 50K schools on AR, 45K schools on STAR, and 15K on Accelerated Math.
• Price Hikes, especially STAR which increased price from .99 to $2.49 per student per year on 45,000 school base
• Obama focus on data drive educational outcomes
• US educational underperformance: out of 25 industrialized countries, the US ranks in bottom quintile in both Math and Reading.
• Cheap 7x trailing Operating Cash Flow
• Long history of returning excess cash to shareholders, $12 per share in Dividends/Buybacks last 7 years (100%+ of current ev)
• Debt free balance sheet

Longer term growth
International Expansion
Acquisitions (useful given significant installed base)

Disclaimer: This does not constitute a recommendation to buy or sell this stock. We own shares in this company, and we may buy or sell shares at any time without updating the board. 


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