As a former teacher and administrator in our nation's K-12 education system, it would be hard to find someone more bearish on publicly traded education companies than me.
I expected the end of for-profit education long before the crash came, and I was wary of Blackboard as an investment before it was taken private. Simply put, when profits are introduced into how we educate our youth, the emergence of impropriety is far too common.
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That's why I surprised myself this week when I started investigating Instructure (NYSE: INST), a company that got its start by providing a cloud-based platform -- dubbed Canvas -- for educational institutions, and has now expanded into corporate training via its Bridge platform, and interactive videos on Arc.
While this is a small-cap stock, a recent IPO, unprofitable, and shares have doubled since February of last year, I don't think it's as risky as those characteristics might make it seem. For long-term investors, I don't consider volatility a risk. Instead, permanent losses of invested capital -- over a yearslong time frame -- is the chief concern.
Here's why I'm optimistic when it comes to Instructure.
A meaningful moat
By far the most important thing in mitigating risk with any investment is a thorough investigation of a company's moat. With Instructure, I think a very solid moat is in place in the form of high switching costs.
It's no secret that the internet is going to fundamentally change the way that education works -- both in the K-12 and higher education realm. Early entrants into the platform building to meet this shift were clunky; as a college student in 2004, I can still remember how awful it was to try and use Blackboard to accomplish anything.
But with Canvas, Instructure seems to be on to something. More than 2,000 different organizations use Instructure, and that likely comes out to much more than the same number of schools. That's because when a district uses Canvas, it only counts as one customer, even though several schools could be using the platform.
Revenue retention has been above 100% ever since the company went public, meaning that customers are sticking around. And sales have been booming as ever more schools and companies sign on.
Because of the nature of the business, as more and more customers sign on, margins improve dramatically.
Crucially, switching costs are also very high. If revenue retention alone doesn't convince you, consider the headaches -- both financially and mentally -- of retraining your entire teaching force to use a new platform. As a former teacher, I can tell you with 100% certainty: No principal or administrator wants to deal with this.
Cash to keep the company safe
Of course, not being profitable -- or pulling in positive free cash flow -- can take a toll on a company's balance sheet. But in the regard, Instructure seems to be fairly safe. Currently, the company has over $38 million in cash on hand and absolutely no long-term debt.
While cash burn has been significant in the past few years, management is confident that trend will reverse itself in the third quarter of this year, when most new schools go online with their subscriptions. Said CFO Steve Kaminsky in the most recent conference call: "We remain confident that will be cash flow positive in the second half of this year extending into the full year of 2018, where the cash generated in Q3 will be larger than the use of cash for quarters 1, 2 and 4 combined."
If that's not accomplished, then I may be understating the risks. But I believe management can deliver on this promise.
A mission with many forms
But perhaps the biggest reason to think that Instructure isn't as risky as it's characteristics might have you assume is its mission: "To make software that makes people smarter."
That might sound like a trivial thing to focus on, but it has the three traits I look for in a company's mission:
- Simple: It can help dictate employee activities toward an end goal.
- Powerful: This isn't just about making money. It's about helping the world.
- Optionable: There isn't just one path to creating software that makes people smarter.
The last is what I'm most focused on here. The company started with Canvas as a way to meet the needs of colleges and universities in Utah, and then expanded. Because of its success, it began to offer a training platform -- Bridge -- to businesses outside of education. It's most recent effort -- Arc -- aims to make videos interactive for both platforms.
The point isn't that Instructure has it all figured out. Rather, it's that the company has demonstrated -- over its very young life -- that it is nimble enough to try different ways to accomplish its overarching goals. That type of flexibility reduces the risks of relying on one way of generating revenue -- which can quickly be disrupted in today's world.
Take those things together and I believe that while the stock's ride may be bumpy over the short term, there's a lot to like about the company's mitigation of long-term risks thus far.
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