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K12's Troubles Mounting in the U.S.

First, until such time as they are coded "withdrawn" these students continue to generate revenue for K12 from state tax dollars. Second, it creates a massive incentive (a necessity in fact) for K12 to aggressively court new students to replace the dropouts. This has given rise to a host of critics who assert that K12 is a fantastic marketer but, as described in the New York Times, a dismal educator.

So far there has been voluminous debate over the appropriateness and effectiveness of the virtual education program offered by LRN. Supporters and detractors seem equally vocal. Surprisingly there has been very little analysis conducted on the company's share price prospects. Relative to its 2011 high of $39.74, the stock appears cheap at the current price of around $22.

However, this price ignores the fact that the stock is still trading at a sky high PE of 70 times trailing earnings. Stocks with valuations like this must deliver consistent and considerable growth. However, as revealed in LRN's last quarterly conference call, growth has been suffering and looks to face substantial headwinds going forward. Fourth-quarter net income was sliced by 46%, almost cut in half. This news alone caused the stock to plunge by nearly 20% in intraday trading. The company gave revenue guidance of $680 milion to $690 million for 2012, but did not give net income guidance. The company was notably hit by provisions for cuts in state funding, which has given rise to investor concern that this issue could balloon in 2012.

Many local school district critics of LRN have made the critical observation that LRN is reaping tremendous profits from state tax dollars. On the other hand, until lately, investors have viewed this as a very positive situation. In fact both sides are wrong.

For 2011, LRN generated revenues of $618 million, mostly coming directly from state tax dollars. This is the big number which has critics upset. Yet almost none of this flows to the bottom line at LRN. Total net income for 2012 was only $10.7 million, representing a net margin of a mere 1.7%. This is a company that is truly on the fence between profitability and losses, which stands in great contrast to the critics who feel that LRN is pulling a massive windfall from states. The problem for LRN is that the expenses of running this ever expanding marketing machine are simply too high. In fact, for 2011, this company which made only $10.7 million over the entire organization paid its CEO Ron Packard $5 million alone.

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