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Franklin Covey Co. (FC): Laughing Water Capital Loves This Small-Cap Education Stock

Franklin Covey Co. (NYSE:FC) is one of the favorite stocks of Laughing Water Capital. In its Q3 investor letter (you can download a copy here), the hedge fund cited the company’s massive addressable market and a management team with “a proven affinity for rewarding shareholders through repurchasing shares” as reasons for its bullish stance. Let’s take a look at comments made by Matthew Sweeney, the founder and managing partner of Laughing Water Capital, on the corporate training and consulting company in the letter to investors:

I have been following FC off and on since 2014 when I first met the management team, and it recently entered our portfolio as a smaller position. FC is in the business of performance improvement, with a strategy based on the ideas first laid out in the best-selling book, “The 7 Habits of Highly Effective People.” Insiders own 33% of the company, and check Charlie Munger’s “cannibal” box, having repurchased almost 20% of outstanding shares since I first met with them. The crux of the thesis is based on stepping over what should be a very low hurdle: customers like getting more value for the same price.

In short, historically customers have been able to order FC’s training materials a la carte, paying one price (~$200 per employee) for training materials on a specific topic. The materials are considered best in breed, and renewal rates are high. However, recently the company has shifted gears and began offering access to training materials across all topics for one price via their “All Access Pass.” While this should represent incredible value to existing customers and has already opened doors to new customers, there are a few wrinkles that have impaired recent results and caused the stock to trade down. First, under the old model FC was selling to HR managers who could make purchase decisions out of their existing budget, leading to a short sales cycle. Under the All Access Pass, customers must sign a 1 year contract, which typically requires legal review, and thus a longer sales cycle. Second, under the new model, GAAP accounting requires that revenue be recognized ratably over the course of the contract, while expenses are recognized during the period that they are incurred. In other words, if FC sells a one year subscription, in the first quarter they must recognize all of the expenses associated with that subscription, but they can only recognize one quarter worth of revenue.

These two items combined have been a drag on recent results, but over time they should lead to higher revenues and lower expenses: a potent combination. In the near term, as the launch of All Access Pass is lapped, deferred revenue will be recognized, which should catalyze shares by mid 2018. Longer term, the company’s addressable market is enormous, the combination of secular growth and a management team with a proven affinity for rewarding shareholders through repurchasing shares is attractive, and there is potential to separate the company’s education business from its corporate business, which the market would likely reward.

Utah-based Franklin Covey Co. (NYSE:FC) is a $260-million market cap firm that creates and sells content, training, and tools to organizations and individuals.

For its fiscal 2017 fourth quarter ended on August 31, the company reported revenue of $59.5 million, down from $64.8 million in the same quarter last year. It posted a profit of $4.7 million, or $.33 earnings per share, compared to $7.7 million, or $.55 per share, in the same period of fiscal 2016. For fiscal 2017, revenue dropped to $185.3 million compared to $200.1 million in fiscal 2016. The company booked a loss of $7.2 million, or $.52) per share, for fiscal 2017, compared to income of $7.0 million, or $.47 per share, in the prior year.

Shares of Franklin Covey are down nearly 7% so far this year. However, over the last 12 months, the stock has jumped more than 4%.

Meanwhile, among hedge funds tracked by Insider Monkey, there were eight funds with positions in Franklin Covey Co. (NYSE:FC) as of the end of the second quarter.

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