RST - Rosetta Stone, Inc.

[Carvel46]

Company is shifting to enterprise channel (seems to have found religion and has stopped chasing consumer segment growth).

I don't understand the product. Anyone used the product?

Anyone own the name?

 

http://www.roumellasset.com/pdf/update_2Q2014.pdf

 

Rosetta Stone, Inc., RST. Rosetta Stone is the global leader in technology-enabled language learning. The company offers language-learning and reading instruction to consumers, businesses, government entities, and schools via packaged software and online subscriptions. The language offerings emphasize a unique “dynamic immersion” methodology that relies on the associative pairing of images, texts, and sounds to mimic the way people naturally learn native languages. In the past two years, the company has made four acquisitions aimed at strengthening its own language reach and to better leverage its brand by cross-selling related products. Rosetta generates roughly 20% of revenue from overseas and is head- quartered in Arlington, Virginia.

 

RST is a company in transition led by Stephen Swad, CEO, who was brought in three years ago to build a profitable and sustainable business model. Readers may recall seeing Rosetta Stone kiosks in airports a few years back. Today, those (low ROI) kiosks are gone and more of the company’s consumer business is delivered online or through selling agreements with retailers such as Amazon, Costco, and Apple’s iTunes. However, the consumer business is not the company’s primary attraction to us. The company is emphasizing its Enterprise & Education (E&E) business, where its high level of service and support is a differentiated and valued attribute. For instance, a number of agencies within the U.S. Department of Defense contract with RST to provide language learning to its employees and receive a dedicated website and access to key support personnel. Coaching support is highly correlated with language-learning suc- cess. E&E revenue is now $115 million annually, with renewal rates of 75%. The company’s total SaaS subscription revenue is now about $140 million and represents roughly 50% of total revenue.

One of RST’s primary cross-selling opportunities results from its 2013 acquisition of K–12 instructional reading software company Lexia for $22.5 million. RST’s products are already used in 20,000 (out of 125,000) K–12 schools in North America.

 

The company’s purchase of Fit Brains, a top-five player in brain exercise software (a space in which industry leader Lumosity is spending heavily to increase its popularity), provides another opportunity to leverage the brand. Overall, the company enjoys 80%-plus gross margins and is looking to leverage R&D investments, and reduce sales and marketing expenses, while taking advantage of the already significant sunk brand costs to create a profitable business model with high recurring revenues. The company has guided for approximately $20 million in EBITDA in 2014 and will generate about $10 million in free cash flow this year, which will be held back by integra- tion costs that will likely decline in 2015

 

RST is unleveraged and possesses a healthy cash balance. By year-end, we anticipate RST will have $70 million in cash, or roughly 35% of its current $200 million market capitalization. If you back-out an additional $70 million spent on recent acquisitions, the implied value for RST’s core business is a mere $60 million. What is the brand worth? It’s a difficult question to answer, but we believe nonetheless that it is a significant off-balance-sheet asset. In the last five years, the company has spent more than $500 million on sales and marketing and enjoys a 74% brand recognition rate. Looked at another way, the company’s year-end enterprise value of $130 million is less than 1x its highly recurring SaaS revenue, 80% of which comes from its growing E&E business. SaaS companies typically trade for generous mul- tiples of revenue.

 

In January, The Economist summed up the digital language learning space as follows: “Technology is starting to change language learning. [berlitz] is a bit of a digital dawdler. Most of its smartphone apps are repurposed versions of its old books.... Rosetta Stone, an American technology company, provides a contrast, supplementing technology with human teaching rather than vice versa. Its software has a clever interface that eschews traditional drills in favour of pictures and examples that gradually and intuitively build vocabulary and grammar skills.... From 2006 to 2009 the company more than tripled R&D spending, customising each language offering and adding cultural and social features. Well-built tablet and smartphone apps let students learn anywhere.”

 

Why is it cheap? The primary reason involves recent negative sales trends in RST’s consumer segment. The emergence of free apps for people looking to “get by” for their upcoming trip to Europe has un- doubtedly taken market share in this segment. Second, investors are understandably skeptical of the company’s ability to integrate recent acquisitions. Our variant view is that while total revenues have been roughly flat over the last three years, the 20% decline in product revenue is masking 48% growth in the more profitable subscription business. Moreover, according to independent sources, the industry is growing. For instance, the global e-learning market research firm Ambient Insight estimates that global digital English-language-learning products are growing by double digits. Universities, K–12 schools, companies, and government entities are all increasingly using technology. RST’s institutional business lies in front of this trend.

 

We sat down with CEO Steve Swad and his team and believe they have a credible vision and well- articulated growth strategy. Steve has taken more than 60% of his total compensation in stock for the last two years. Key industry contacts indicate real excitement within the company’s sales force stemming from the new direction and underscore our belief in Steve and his team.

At day’s end, we believe RST “weighs” far more today than its price implies. To wit, a mere two times the current SaaS-based revenue plus its estimated year-end cash balance equates to roughly $300 mil- lion, compared to the current $200 million market capitalization. This exercise ascribes no value to the company’s consumer business, which generates $200 million in revenue. At the price we paid, the odds of a good return appear to us to be strongly in our favor.

 

Other write-ups:

http://www.valuewalk.com/2014/09/john-lewis-compounders-engagement-a-double-barreled-focus-on-value-creation/

https://www.arielinvestments.com/repository/func,download/filecatid,222/ (page 22)

 

[yadayada]

looked at it, seems like rockstar management. But put it on too hard pile. Rosetta gets bad reviews and seems overpriced. And it looks like insiders are selling large amounts of stock. Looks like they don't even believe in it?

[Saj]

I'm a huge fan of the product. Paid $300 or so a few months back and am satisfied. No idea why they can't make money though, so not too interested as an investment until they do.

[cubsfan]

The product is terrific, so surprised to hear the poor reviews.

I bought it about 1 year ago for my sister-in-law who is French.

She uses it every day and loves it.

 

It seems there is a tipping point for subscription revenue and if the brand is any good

the cash flow should happen. The market is big enough, and it appears to be a very

cost effective way to learn a new language for someone that is serious about it.

[mattone]

The company lays out the upside case in a recent IR presentation, look at slide #13 (towards the end):

http://www.sec.gov/Archives/edgar/data/1351285/000110465914048501/a14-16075_1ex99d1.htm

They give Saas-like multiples to the E&E business and lower multiples to Consumer side.  I think they can achieve those valuations if they show that the whole business can run profitably with decent margins.  To get there, two factors come to mind:

- E&E has to show organic growth in the double digits - it has grown in the low single digits and mgmt stated they think it will grow ~10% by the 4th quarter

- the Consumer business has to stop bleeding.  As ARPU continues to decline (and there is no reason to believe that will stop), it will be hard to stabilize revenue (even though they are selling more units).  My guess is Consumer revenue will continue to decline and stabilize in the $150-170mm range.  Hence cost-containment is key for the Consumer business.

 

I think this recent 13D from Nierenberg sums it up pretty well (read 4 bullet points under Purpose of Transaction):

http://www.sec.gov/Archives/edgar/data/1282683/000101359414000549/rosetta13da-081114.htm

points #2 and #3 are particularly important.

Management is receptive to shareholder input and hopefully they can cut costs (within their control) and manage to grow E&E (outcome not in their control).

 

[yadayada]

- E&E has to show organic growth in the double digits - it has grown in the low single digits and mgmt stated they think it will grow ~10% by the 4th quarter

- the Consumer business has to stop bleeding.  As ARPU continues to decline (and there is no reason to believe that will stop), it will be hard to stabilize revenue (even though they are selling more units).  My guess is Consumer revenue will continue to decline and stabilize in the $150-170mm range.  Hence cost-containment is key for the Consumer business.

 

So basicly a 20 feet hurdle. And insiders don't not even believe in it themselves because they are all selling.

[mattone]

The 3q14 results showed good progress.  Their E&E business grew at 10% organically, thanks to their literacy offering (Lexia) growing at 32%.  They guided to even higher growth going forward, so E&E should be comfortably growing in double digits.

The consumer side actually performed pretty well, with volumes growing at lower price points - revenues havent stabilized yet but bookings have (leading indicator) and if 4q14 bookings grow vs 4q13 then we may have reached a low point and we'll see revenue growth going forward on the consumer side. 

Mgmt stated that consumer demand at $200 price point is good - indicating that may be where prices stabilize (vs $300+ a couple of years ago).  Product unit volumes are good; 663K units LTM vs 659K same period last year and 622K the year before that.  That doesnt include online subs which have grown nicely: 130K vs 87K vs 57K (9/2014, 9/2013, 9/2012 respectively).  With these growth rates and price stabilization, the upside in the stock is substantial.

Mgmt did guide to the low-end of the EBITDA guidance for the year, around $18mm, implying a 9xEBITDA.  Next year the EBITDA figure should be considerably higher.

[jawn619]

Lnkd buys Lynda for 1.5 Billion. This is about 15x RST's current enterprise value...

[Gamecock-YT]

I think this recent 13D from Nierenberg sums it up pretty well (read 4 bullet points under Purpose of Transaction):

http://www.sec.gov/Archives/edgar/data/1282683/000101359414000549/rosetta13da-081114.htm

points #2 and #3 are particularly important.

Management is receptive to shareholder input and hopefully they can cut costs (within their control) and manage to grow E&E (outcome not in their control).

 

http://www.sec.gov/Archives/edgar/data/1282683/000101359415000302/rosetta13da-041715.htm

 

He just got a board seat too. Pretty good 13D.

[cubsfan]

That was a excellent read about focusing the company.