Adam Buckstein 的 Stride 投资论点 $LRN

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Today we’re talking about Stride. It used to be called K12, and it trades under LRN—“learn.” You can see a full disclaimer at the end. Remember, this is not investing advice, but Adam has done great work on this. This is a really interesting idea.

Sometimes I have companies on the podcast because I want to learn more about them. The guest says they’re interesting, and then sometimes there are companies, situations, and setups where I could see myself buying and investing in them one day. Stride, LRN, falls squarely into that category. They’re trading cheap, there’s the stress, and there are a lot of questions about the business. But I think if you’re willing to do enough gumshoe work, you can hopefully start to get answers to those questions, and Adam has done that. We’re going to talk about it on the podcast.

I’m excited to have Adam Buckstein on for the first time. Adam, how’s it going?

Great. How are you doing, Andrew?

I’m doing great. I’m really excited for this one because sometimes I’ll do episodes on stocks I’m looking to learn about, and sometimes a company is right up my alley. This one is right up my alley.

Before we get started, a quick disclaimer: nothing on this podcast is investing advice. You can see the full disclaimer at the end of the podcast, so keep that in mind. Adam, the company we’re going to talk about today—is it Stride or K12? I never know, but I believe it’s Stride.

No, they changed the name. It was K12, and they changed the name to Stride. They rebranded a few years ago, and the ticker remained the same. So, it’s always been LRN.

The ticker is LRN. Obviously, they’re trying to convey “learn,” which might give you an idea of what they’re doing. But, Adam, I’ll stop rambling there and turn it over to you. What is Stride, formerly K12, and why are they so interesting?

Basically, Stride is the largest provider of virtual public schools in the U.S. They have about 100 schools in 30 different states. I think it’s important to start with how it’s structured because a lot of people lump them into the for-profit education category, and it’s a totally different business model.

Stride contracts with independent boards on behalf of school districts and charter schools. It’s about 50/50. Those boards decide, for whatever reason, that they want to have a virtual public school in place of the brick-and-mortar school in that state. They’ll send out an RFP, Stride will bid on the contract, and they’ll run the entire school, soup to nuts—everything from teachers, administration, and guidance counselors to laptops.

They’ll get the contract, which is usually 3 to 5 years in length, and they get paid by the state. That’s the business model. It’s really K–12, so it’s a totally different product depending on the age. At the younger grades, you need a learning coach. High school is very focused on career readiness, so they have a leading career, kind of vo-tech-type online program. It’s very timely—right in the right space at the right time.

They’ve been doing this for 25 years. They’re the category leader and are 2 times bigger than their nearest competitor, which is a division of Pearson.

No, that’s a great overview, and I’m really glad you addressed that. I just want to focus on one thing you said there. A lot of investors with as many gray hairs on their heads as I’m starting to get are going to remember the for-profit education companies. These were the University of Phoenixes, but there were some bad actors. These were for-profit colleges that, back in 2008 and 2012, were all the rage, with tons and tons of issues.

This is another distinction, too, and along those lines is funding. I didn’t talk about funding, but you said it’s provided by the states.

At the postsecondary level, it’s Title IV funding, and that’s a totally different risk dynamic. You have a lot of stroke-of-the-pen risk, which happened during the Obama administration because you’re taking Title IV funding. It’s all student loans. There are no student loans here.

This is, again, a tuition-free public school. As a citizen of the United States of America, your local municipality provides education. So, instead of going to the brick-and-mortar school down the block or within a 20-mile radius, the state is providing you an option, but there’s no financing here.

The big implication is that there’s a lot less fraud. I’m not saying there’s no fraud, but it’s just a totally different risk dynamic.

Yeah. For the for-profits, people remember they were literally going to food courts and getting people to sign up for these documents and everything. This is, “Hey, you’ve got a 7-year-old, an 11-year-old, whatever it is—you’re sending them to public school.”

The numbers are interesting, and I want to get to the numbers, but I want to dive a little bit further into the business because I do think that’s critical. Tell me why, during the COVID era, people were choosing to send their school-age kids to school virtually.

One thing that pops to my mind as a parent is that you say, “Hey, these guys are going to run the virtual school,” and I’d say, “Oh, well, I don’t know if I’d want my kids to go to virtual school. I have to stay home and make sure my kids are safe at home. They’re not getting the social interaction.”

So, let’s walk through why districts are choosing to offer a virtual public school and why parents are choosing to send their kids to a virtual public school. I’m driving into a few different things, but I’ll pause there.

Pre-COVID, this was a very niche business. I was an investor before COVID, and I always saw the potential because there’s a certain subset of students that would prefer to basically do school from home.

There are probably a ton of different reasons why that would work for a student, and again, it depends on the age, whether they’re in elementary school or high school. Some of the biggest reasons cited are bullying—I grew up going to public school, and some people are just miserable—health reasons, and religious reasons. People are concerned about school violence.

There’s also a practical reason. Let’s say you live in rural New Mexico. There’s no public school within 60 miles, so this provides an option and you don’t have to do the big commute.

Post-COVID, it kind of kept growing by word of mouth. A lot of people figured out that they just preferred this for a lot of other reasons, and it’s snowballed. It’s mostly grown through word of mouth.

But as a percentage of the overall U.S. student population, the number I’ve heard cited is that there are 55 million students in the K–12 system. Stride is the largest, with 250,000 students. Pearson has 120,000. You have some mom-and-pops, but no one is above 50,000 students.

So you're talking about a population of 1% to 2%—probably closer to 1% than 2%—of the overall population. When people are offered this option and choice, for example, in Oklahoma, 5% of students are now choosing the virtual public school option, which is fascinating. I'm not saying we're going to get to that nationally, but it just feels like it's very underpenetrated at this point. Five percent honestly kind of feels about right when you start throwing in all the different factors, but I have no clue. I can't say there's any statistics there. It's just kind of like, 5% of the population will do anything, right?

Well, there's also another thing, too. Post-COVID, the big issue—you're talking about your young kids, right? It's kind of inconceivable: How could you have your second grader at home online? But a lot of parents are working from home, so now they can be the learning coaches. Some parents even prefer that; they want to be more hands-on and involved with their kids. That didn't exist pre-COVID. Now you have this whole subset of people who can be their children's learning coaches, and that's opened up another huge segment of the population that previously wouldn't have considered this.

Let me ask you: You mentioned Oklahoma, and they've got contracts throughout the nation, but let's just use a random Oklahoma. Let's say they've got 100,000 students in the overall school system, and they hire Stride—they hire K12—to run their virtual school. How does the payment kind of work? Is it, "Hey, every head that goes into the virtual school is what we pay you"? Is it a fixed payment whether 1,000 or 2,000 kids go in? How does that kind of work?

Yeah. It's the same funding formula as the brick-and-mortar schools. Every state is going to be different, so the money follows the student, so to speak. On average, it's about $9,000 to $10,000 per student per year. The question becomes: What if a student starts the school year and then goes back, or changes their mind, or whatever happens? There are very strict compliance requirements around what's called withdrawal criteria: If a student is absent for a certain amount of time, they're taken off the rolls. Stride is obligated to report it back to the district.

How they true up at the end just depends on the state, but that's part of the complexity and difficulty of executing this business, because the student population is—they're leaving the brick-and-mortar school, so by definition they're already more mobile. They're running away from something; some of them might even be homeless. That's part of the challenge: ensuring compliance and that there isn't truancy.

Perfect. Let's go to—this is where I think one of the debates I've had, but the big debate I heard when I talked to smarter investors here, right? It's the ultimate outcomes. They say, "Hey, this is a business. We can talk about all sorts of things." I think people get pretty quickly past the original for-profit parallels; I think people get past that. There are other questions around that. You mentioned enrollment and everything, but the big question I've had debates about is the outcomes.

If you're having 100 people learn from home versus 100 people go in person, I think there's a lot of debate among investors about whether the outcomes are going to be the same socially. I mean, I can't say I've had teenage kids yet, but I've got cousins. If I sat a teenager at the computer for 8 hours or sent them to school, I'm pretty sure they're going to learn more at school. So a lot of people have said, "Hey, I just don't think the kids are going to learn," ignoring all the emotional components. So I want to ask that question to you: What are the results? What are the results of this program, and how do they measure that?

Yeah. I spent a lot of time thinking about this. Again, we have to take into consideration that we're literally talking about 12 grades. The outcomes for a senior, and how you're grading relative to someone in kindergarten, are going to be totally different metrics.

They have to abide by local and state regulations, so all the students are tested. They all have to take standardized tests. What you're referring to is that they don't necessarily test as well as the brick-and-mortar schools, although I think directionally it's moving; it's getting better. We speak to the company about it, and it's very easy to write a hit piece about how their outcomes are not as good.

I think the one thing that makes the most sense—the positive—is that students who leave, who are "mobile," who are going from one school to another, are by definition usually behind grade or underperforming. So the right way to look at it, if you don't want to get polemical, is that when a student goes to a school, they're probably already behind grade level. Based on their own baseline, how are they progressing?

But it's tough. After the blowup, I spent a lot of time looking at these parent forums, and you see a woman whose child is undergoing chemotherapy. I'm not saying that's every case, but a lot of these children have ADHD. Some of them have IEPs, which is a special designation indicating that they have disabilities. They're running away from the public school for a reason: They haven't been successful. So you're always going to be able to show some salacious statistic that they're underperforming the brick-and-mortar school, but it's not the right apples-to-apples comparison. Eventually, I think the demand from the parents and the students is going to overcome the naysayers. It already is.

No, that was great. But if I can just press you on this point, by the way, it was fun to hear you say IEPs because my wife is an occupational therapist, so I hear IEPs thrown around all the time. But let me just—I have no disagreement. It's tough if you've got, as you mentioned, some of these kids who might be underhoused or have ADHD, whatever it is.

It's tough if you've got someone—let's say they're in 4th grade, but they're reading at a 2nd-grade level—and you're comparing them to standardized testing. I have no doubt they're starting from behind the curve. But if you took that 4th grader who's reading at a 2nd-grade level and put them into this program, do they have statistics on how their outcomes would compare to if they had stayed in the same school? Does that make sense? Kind of like, "This guy was in the 60th percentile, and you put him in our thing, and he learned at the 65th percentile or 55th percentile," whatever it is.

No, I haven't seen that. My suspicion is that it really is very contextual. It depends on the student, depends on the school, depends on the age. We're talking about kids literally from K all the way through 12th grade.

I think, as a final point, I don't know if this issue is ever going to go away, but what has changed—the sea change—is that demand has increased. Usually, I feel like regulation follows demand, and parents want school choice, so they're going in with open eyes.

It's interesting, too: We grew up in an age where I went to the local public school and never thought twice about it, whereas now people are increasingly talking about flexing back and forth. It's like, "Okay, one year I'm going to be online, but next year I'll go back to the school." It's kind of a different paradigm in education. I think it's really a nascent industry and has to be understood.

Eventually, I would hope that regulators would have a more nuanced view of it. Texas recently passed a bill which basically, in a way, was kind of codifying and recognizing that virtual schools are going to be a part of the school system, and we have to find a way to work with them, because maybe their outcomes aren't going to be as good as brick-and-mortar schools.

Perfect. I forgot that question. What I was referring to there was the outcomes for online learning overall, just to be clear; it wasn't specifically Stride. You mentioned Pearson, the big competitor: 250,000 at Stride to 125,000 at Pearson. How are these companies competing with each other?

If I'm the state of New Mexico and I'm setting up an online public school, how do they compete with each other? Because if you think about it, if a state is spending $10,000 per student to go to public school and you put that student online, there's a lot less overhead that comes with it online. So you could imagine this being—if they're doing it on the same per-head basis—there's a lot of margin there.

And even if you're taking it down, this scales really well. You're having them learn in online courses, not always with an in-person teacher, all that sort of stuff. The numbers say this is a very, very good business, by the way. I want to talk about the competition between firms when they're competing for these projects, because when states put out big RFPs, lots of people are going to come out for this kind of high-margin revenue.

Yeah. You always talk about, “What does the market not see that perhaps I’m seeing?” I think this is one of the areas where people don’t appreciate how difficult this business is, because it is highly regulated and you’re taking taxpayer money. So whenever that comes into question, you have to be very compliant, and there are always going to be a lot of people chasing those government contracts.

I think the bigger players—and this is an industry where Stride and Pearson are the biggest—the number 3 is a fraction of the size of Pearson, and the 3rd and 4th are fractions of that size. Bottom line is, once you contract with a school, I get the sense that it’s very sticky. Not that Stride has never lost a school. They have 100 in their portfolio, and they’ll probably lose some schools every year and gain schools.

But once you’re already in there, the reason why it’s sticky is the nature of a school. This year, they’re already planning the calendar for next year, right? Students want to have continuity, and you have teachers. It needs to be emphasized: it’s not a piece of software. They have 6,000 teachers that they’ve hired. This is a combination of asynchronous and synchronous learning.

When you’re bidding on a contract, you have to be realistic. How are you going to staff up, and how are you going to prove to the regulator that you have systems in place that will be able to track truancy? I think that’s the Achilles’ heel. That’s the biggest thing: are these students engaged in the platform? No one does a better job than Stride, of course.

When you have a big portfolio like that, you could always shine a light on something. But I get the sense that it’s very sticky. They’re not necessarily bidding on contracts and taking contracts away from other ones. They’re just growing within their own schools. Some schools are capped, but most increasingly are not capped, so they don’t need to take away someone else’s school. They can just grow within their own school.

No, look, I think there are 3 things that really attract me to this idea. We’ll talk valuation in a second, but I think discussing the business, particularly here, is more interesting than just saying, “Hey, it’s really cheap,” though it is really cheap.

The 2 things are the stickiness, as you mentioned. Once you get that contract, it feels like the outcomes would have to be really, really bad, because it’s hard for me to imagine a district being like, “Hey, we’re going to go virtual,” and then taking the virtual option away. Virtual is cheaper than having people go in person, and you’re taking an option away. It just seems really hard to go that route.

I’m not saying it’s impossible, but it feels like it would have to be pretty bad for a school to say, “Hey, we’ve had you guys for 3 years. The people are learning, the students are used to our curriculum, and we’re just going to yank all that away for a new curriculum to save—I’m sure it’s some money, but we’re going to yank all that away.” That feels really, really tough to me. You’d have a lot of upset parents, a lot of bad outcomes, and a lot of upset children. Again, it’s not impossible, but it feels really sticky to me.

Because it’s so much cheaper than in person, I’m sure the way these school districts look at it is, “Hey, it’s $10,000 per kid in person. It’s $4,000 if it’s online. Why are we going to switch to $3,750 when it’s going to be devastating for the students?” I threw a lot out there. I’ll just let you respond to any point I just made.

Yeah, I don’t think the districts—the money is clearly cheaper, and it depends on the state and how much the brick-and-mortar school costs. In some states, the difference is maybe only 30% cheaper, which surprised me when I heard that.

But I keep going back to the fact that executing in this business at scale is very difficult. I think the biggest risk to Stride in terms of these partner school boards is that they’re quote-unquote independent boards. I’ve sat in on these meetings while doing primary research. Everything’s online, so every month or every quarter, these boards that run the school have public sessions. One thing you see when you listen in is that there’s just so much complexity.

There are so many balls that they’re juggling, and one piece of it is the IT bit. The IT alone—just having an app and having an online platform—is beyond the scope of any school district or even charter school. It’s just too hard for them to outsource it, buy everything off the shelf, and then cobble it together. They don’t want to be dealing with that.

They’re just trying to make sure everyone has what they need. All the disabled students have to be taken care of. That’s the thing: if you’re a virtual school, you don’t get a pass. You still have to take all comers. You can’t say no to students who have disabilities, so they’re just fighting bigger fish.

As long as the provider is good enough, this whole thing with what happened with Stride’s LMS was clearly a huge whiff. But I think it’s very likely that they’ll recover from it.

We’ll talk about the LMS in a second—remind me—but I just want to hit on a few more points. The other interesting thing about Stride to me is, as you mentioned, individual schools are very tough. But you could imagine that once you do the system right—the app, all this sort of stuff—you record the classes and everything.

As you said, it’s not all literally YouTube videos; there are live teacher sessions as well. But a lot of this is fixed cost, right? Developing the app, developing the tech stack, getting the—

The curriculum is the most expensive part of it, because the curriculum has to be custom-built per grade and per geography. The Texas standards are different from the Florida standards—not dramatically, but it has to be able to conform to the standardized tests that they’re going to take. So that’s part of the—

You know, and interesting—not to bring politics into it—states really regulate what can and can’t be shown. You can imagine that there’s some legal liability and some real customization of the platforms that need to be—

Actually, the point I was driving to was, I’m not saying that this is a monopoly, winner-take-all business and that no one else can run these. But you can imagine that this probably trends—right now, it’s kind of duopolistic between Stride and Pearson, unless I’m mistaken.

You can imagine how this tends toward 2 or 3 big players. Andrew and Adam aren’t exactly going to go do a startup because of the tech cost, the curriculum development, and the schmoozing and boozing of public officials to earn that. I could imagine how this tends toward, let’s call it, oligopoly. That’s interesting there as well.

Yeah, definitely. It’s all about scale advantages and being able to spread that fixed overhead over as many students as possible. For example, Stride offers free tutoring for 2nd- and 3rd-graders in English language arts. I was just thinking about that: if you’re an upstart, you can’t do that because you can’t afford it.

But because Stride has this huge network and can flex this staff of 6,000 teachers, that’s a goodie that they can offer when they’re bidding on a contract and say, “Hey, we’re going to offer this. No one else is going to offer that.” It’s almost like an Amazon effect in the industry. The biggest ones are able to offer the most, and it’s a virtuous circle.

I think that’s definitely going to your tutoring. I could imagine also, if you look at their website, a chess club, right? That seems silly, but if you’re doing an online chess club where there’s 1 moderator—or probably a few moderators—if you’re a startup getting 1 school, that’s a big expense, right? Especially if, let’s say, 10 of 100 students signed up for it. I don’t know.

But if you’re grabbing it from across the country, you can flex it across a lot more students. So that’s interesting. Last 2 things, actually.

First, let's talk about economic sensitivity, because I could imagine this going any which way. You could say there's no sensitivity: this is public-school-dependent; it's part of it. You could say there is some sensitivity: times get tough, states start looking for budgets left and right, and they just unilaterally cut funding. Or you could tell me, “Hey, it's countercyclical. Times get tough, and states say, ‘Let's try to nudge some more students to virtual learning, where it's a little bit cheaper.’” So I'd love to talk about economic sensitivity right now.

Yeah. It's not—I don't think—I've never heard that it's countercyclical, but what I have heard is that almost every single year, including during the Great Financial Crisis, there was a bump up in what states were willing to pay per pupil. So it strikes me as recession-resistant. It's almost, for lack of a better word, like a utility.

Again, that's the social contract that we have in the U.S.: if you're a citizen, the government provides K–12 compulsory education. In fact, if you don't send your kid, you could go to jail. In Missouri, there was a famous case. It's a big deal.

Until that changes—and I don't see that changing anytime soon—that's a big deal. Also, again, I don't want to get into talking about it being cheaper than brick-and-mortar schools, because this is kids' education. I don't think you have to comment on that. It's not really about the fact that it's more efficient, although it is, of course. You're scaling these things, and it is a cheaper per-student cost, especially on the East Coast and West Coast. But again, this business is going to do fine in a recession.

Look, agreed. I was just wondering, “Hey, am I missing something? Is it actually going to be a little bit more countercyclical?” But I'm with you. You don't want to only talk about cost, because again, I think the key question that the smart guys I've talked to here drive to is, “Hey, can we trust the outcomes?” If the outcomes are just as good as in-person, then this is a screaming buy. If the outcomes turn out to be 20% as good as in-person—I'm just choosing a number—then this is probably a short in the long run, because eventually schools or school systems are going to say, “We can't do this.” And if the outcomes, as you said, are very hard to measure but are within the realm of reason, it's probably good business.

So that's the last question I want to ask on the business. One of the interesting things is, if you live in—I lived in Kenner, Louisiana—you knew what school you were zoned for. It was just kind of, “Hey, if you're going to public school, that's the public school you're going to.”

Here, they have a little bit of—you know, I don't think it naturally comes to people that they can sign up for the online school. So they have customer acquisition costs; they have to go get it. I just want to ask you: how do they acquire their customers, their students? How do they go about that? Then we can get into the marketing, because the other place—I don't think it's as strong as the outcomes case—is something I've heard about in for-profit education: aggressive marketing to people, and maybe they don't know what they're signed up for. So I threw a lot out to you. I'll pause there.

Yeah. I think the funnel starts with marketing in midsummer, and I don't think there are any big secrets here. It's probably a lot of social media—a lot of Facebook and a lot of Instagram. They've gotten much better in terms of starting to get a lot more leverage on their SG&A and the top line. The company claims it's mostly sold through word of mouth.

One student finds out about it, and a lot of people still don't know that it exists. They think they know about work from home, but school from home? They're like, “What? Sounds like Ferris Bueller’s Day Off. That really exists?” But it does, and increasingly, it makes sense for a lot more people.

In 10 years from now, that's my bet. I just feel like this is a business where I could see it being much bigger 10 years from now—more accepted with the next generation. And look, you brought this up at the beginning of the podcast: what about social outcomes, which are of course critical? That piece has to be solved for.

There are different approaches. These schools do have meetups—again, depending on geography—to try to facilitate in-person interactions. But clearly, that's something parents need to step in on. It's more important in elementary school; in high school, people are more independent and can probably figure it out on their own.

Again, I feel like a lot of people who are choosing this option are getting bullied in school. That's the number one reason that you hear. Maybe that was pre-pandemic, but now maybe there are different reasons. Socially, they're just grateful that they have this option because they don't have to meet the high school bully in the hall again and have their lunch taken.

It's funny you say this, because I do a half day of research, but I'm really interested in this one. I've got some expert interviews, and bullying is what comes up so much. I actually thought it would be the reverse. I thought super-rural areas would be the most likely, and then religious preferences and learning disabilities would be other big reasons.

I thought instead of bullying, it would be the bully—somebody who's been expelled or somebody who's having a lot of behavioral issues, who might have a more structured environment at home. I don't know if that's true or not, but bullying came up a lot. I'm just a little surprised by that.

Maybe it's because I don't think I was that heavily bullied in grammar school, despite my nerdy tastes. Is it that common where somebody's getting bullied so badly that they're like, “I don't want to be around anyone. I can't transfer. I just want to do this from home”?

Yeah. I'm in these parent forums, and you see posts like, “My second-grader is miserable. Every day, she's either getting physically assaulted or she just can't take it anymore. We're going online.” You do see a lot of that.

Look, kids are cruel. I have 6 kids.

I'm not surprised by any of this. I see the sibling-on-sibling crime, and it's just like—

You can imagine what happened. I went to public school. Crazy stuff happened. But, you know—

It makes me sad that kids are cruel and that it comes to that. As I've said on the pod, I just had my second, and she's just turned 7 weeks old. It's been rough. You said 6, and my brain froze for a second. All the gears stopped—if you think about the gears turning in clocks, all the gears stopped, and a little sand went in there. You have 6 of them. My lord.

Andrew, you could do it. It's all about operating leverage. You play zone.

One of my friends texted me—he has 4—and he was like, “Look, the hardest shift was from 1 to 2. After you go from 1 to 2, it's all downhill from there.” So that made me feel a little bit better.

Look, I think we've done a really nice job talking through the different levers and everything. Again, I think this is one where people hear the numbers and they jump out at you, but you have to understand what you're getting. Anything else you think we should have mentioned or glossed over? Anything we should be talking about?

So, I guess you wanted to dig into the 60% drop in the stock. I mean, the market is telling us something.

Well, I do have notes on that. What Adam is referring to is that in October, they came out with earnings, and the stock dropped 50% to 60% overnight. A week or 2 later, this is a $3 billion company, and they said, “Hey, we're coming out with a $500 million stock repurchase.” I think I was getting there when I kept saying, “Hey, this is cheap. This is cheap. This is cheap.”

But before we even get to “this is cheap,” why don't we talk about the big blowup in October? What drove that? Why do a lot of people think this is an overreaction? All that.

Yeah. Their fiscal year ends in June because they want to have their fiscal first quarter correspond to the September quarter, since that's when the academic calendar is. They never give guidance beforehand.

They reported their fiscal first quarter in October because that was the September quarter. They figure out how many kids signed up for school, and it's a very transparent, predictable business because it's a fixed price. Then you have your census and some attrition, and you basically know what you're going to earn for the rest of the year.

They had said back in August, when they reported their fiscal fourth quarter, that even though their policy was never to give guidance because things were still fluid and they were aggressively recruiting over the summer, for the first time since I had been following the company—which had been a long time—they said demand was so unprecedented that they were going to have at least 10% to 15% enrollment growth. That was pretty out of character, and I think the market understandably got very excited. But it wasn't guidance; it was just what they expected to have when the count date came in September. Incidentally, they did it.

They came in at the lower end of the guidance. They printed 11% enrollment growth when they reported in October. But what happened was that the CEO said they had lost 10,000 to 15,000 enrollments because of problems with a new IT system they had implemented over the summer. Basically, there were 2 pieces of software.

Before that, they had been doing this for 25 years and using custom-built software, but they decided to upgrade. This was an upgrade to an off-the-shelf learning management system called Canvas, which is the best in North America. It wasn't like they were going El Cheapo. They also upgraded their student information system, which is basically the onboarding; it's a program called PowerSchool. They ran pilots, but whatever—it was a disaster.

Look, everybody says, “Short somebody with an SAP implementation.” This is an SAP implementation on the school side, right?

It was so bad that all the momentum they had experienced was gone. I was just looking back at last year. I kind of forgot that this was literally a Rule of 40 company. Last year, they printed 24% adjusted EBITDA margins and 18% topline growth. It was a breakout year last year.

So you have a breakout year, you give the soft guidance, you have a lot of momentum coming into the stock, and then you have a misstep. It's like, watch out below. We can speculate about it, but it felt very overdone. This wasn't a balance-sheet issue. This wasn't an allegation of fraud. This wasn't something existential, so it felt very overdone. Maybe it was tax-loss selling. Who knows? It's very hard to know why it was so bad.

My personal theory is that, going back to for-profit education, people in this industry are guilty until proven innocent. I've been looking around, and Bleecker Street Research came out with a pretty decent short report on Perdoceo Education Corporation, ticker PRDO, talking about how they have a real problem with something called ghost students.

It's kind of what we were talking about before: the postsecondary schools, the community colleges, get Title IV funding from the government. Basically, the government pays for the tuition, but they also give you a $2,000 stipend on top of the $10,000 tuition. There are literally crime syndicates that have popped up to enroll students in these schools, and it's rampant at community colleges. I've seen reports—there's a crazy amount of it. They're called stipend skimmers. They're skimming this stipend and enrolling these students. But that doesn't exist in K–12. There's no stipend, so it's a totally different funding mechanism.

So when I see the stock selling off by 60%, you have to respect the market. I feel like that panic and fear was probably people thinking that this is another one of those shady for-profit education companies that's going to go out of business, and it just feeds on itself. But I'd still love to hear your thoughts. That's my best explanation.

No, I think you're right, though. I'd love to get your thoughts on this: around the same time, they lose the New Mexico contract, right? I think it's only 4,000 students, but I'm looking right now at the NBC News on this. It bleeds out over the year, so it's hard to say exactly when all the different pieces come. I'm looking right now at a mid-October NBC piece.

By the way, the timing is critical, because that New Mexico thing—I was going to get to that. As you said, it kind of bleeds out over the year, so I think the timing is important to understand.

There was a school that they had in western New Mexico, in rural New Mexico, called the Gallup-McKinley County Schools. They had 4,000 students, and there was a contract dispute with the superintendent of that school. This goes back to April 2025. There's a whole story: he actually applied for a job at Stride, didn't get the job, and then filed a lawsuit. Stride is claiming there was an ethics violation, but whatever—he filed a lawsuit, and they lost that school.

Stride was able to stand up another school in the state of New Mexico and literally took all those students. It just shows you how this business works: they have multiple schools in each state. So, in the October census, the quote-unquote miss had nothing to do with the Gallup-McKinley County Schools. That's ongoing litigation, and it's serious. We can talk about it and go into why I'm not so concerned about it, but I feel that was in the back of people's heads, along with the short sellers that have come after other for-profit schools.

There have also been other short sellers. Fuzzy Panda Research came out with a short report in 2024 about COVID funding that they claimed represented 30% of Stride's EBITDA, and it was just totally wrong. It was like 1%. I feel like it feeds on itself when you have a stock that's down that much. People just say, “Yeah, forget about it. I don't want to deal with it.”

No, look, again, I think both the real opportunity and some of the risk is exactly what you're saying. This is not the for-profit community-college schools that were rife with fraud and all that sort of stuff, but it's very close, right? It's online schooling, and you're getting it from public schools. I can see how people say, “Oh, it gets very close to that.” I did not know that all the New Mexico students enrolled.

Along the lines of the for-profit risk, you look at the NBC article that I talked about. The headline is, “A virtual education company was a lifeline to a rural district. Now they're at war: dueling lawsuits draw government scrutiny.” You see all that, and you do see the runs. I think investors are perhaps rightly scared of their own shadow here. You hear “government suing a learning company for outcomes,” and you say, “Oh my God, I was right. It was for-profit. It was for-profit all over again.”

But let's start with our downside, right? Again, I don't want to beat a dead horse, but this is actually a very interesting test case in terms of understanding the durability and antifragility of the business model. In the worst case, let's say they lose this lawsuit—which I don't think is going to happen. If you actually read the lawsuit, I think they have a very strong defense against most of the claims.

They have multiple schools in each state, and this is an issue with one school. I don't see contagion. People who are happy in Oklahoma aren't suddenly going to say, “Hey, look what happened in New Mexico.” I just don't see that happening, where the boards are suddenly going to say, “Look what happened in New Mexico.”

One other thing that's important, where there's so much fear, is that if you read the actual lawsuit, there were 21 students in question, and it wasn't that Stride was hiding them. These students had a certain withdrawal criterion: once you're absent for 10 days, you have to report it. These students withdrew in October or November, and Stride told the district in December. It wasn't like they were hiding them. It seems to be more nuanced than existential.

One more question on the New Mexico lawsuit. New Mexico, again—one of the tough things with these is that everything isn't just going to play out along the lines that you and I said. The data can be cut up a lot of different ways. It's not going to be played out in court. If you get into a fight here, it's going to be a fight at the public school boards. Anybody who's watched one of those YouTube videos knows that these public school board meetings are passionate. They can get heated, all that sort of stuff.

When they broke the Stride contract, New Mexico published a deck that says, “Hey, we gave Stride the contract, we gave them every chance, the outcomes were terrible,” all this sort of stuff. How has Stride responded to that allegation from New Mexico? I'm looking at one deck that says reading proficiency went from the state average, like 27% or something, for the Stride students in 2021 to 22%. It just falls off a cliff. How have they responded to that allegation from New Mexico?

I think it goes back to what we said before: you have to use the proper baseline.

I mean, this argument is almost like imagining a CEO of a hospital system evaluating the different divisions and saying, “Oh my gosh, look how bad the outcomes are in the ER and intensive care. Look at the morbidity, and look at orthopedics.” Well, no—different people are coming to the emergency room than are getting plastic surgery.

The students coming to a virtual public school aren’t simply running away from a public school. They’re usually 1 grade behind, if not multiple grade levels behind, and they have other trauma, learning disabilities, and everything else. Show me an apples-to-apples comparison, and then we can have something to talk about. Until I see that, it just seems like semantics.

That analogy was so good. Did you come up with that off the top of your head? That’s what happens when you have a big position go against you and you think about it all the time.

If I take nothing else away from this talk—and I’m taking quite a bit away—I’m stealing that analogy. It was so good. The outcomes in the ER if you compare them to the pediatrician—so, so good.

One more thing: I had one bull talk to me, and he said, “Hey, one thing I’m concerned about here is AI risk. Right now it looks great, but if you run AI for 3 years, could you have AI custom-generating programs for people and running them for a fraction of the price?” I’ll bias the witnesses a little bit and say I think they’re living in a science-fiction world. But I do think it’s worth asking the question.

You could imagine that maybe AI isn’t writing all of it. We mentioned that going from Texas to Florida requires customizing the curriculum. Maybe you get the standard curriculum, and AI is really good at customizing it, so it brings the moat down. I’d love to ask about the AI risk or AI opportunity here.

Yeah, I heard a line from the economist Tyler Cowen recently. He said, “AI isn’t going to take your job. It’s the human who knows how to use AI better than you who’s going to take your job.” I think it’s more of that: AI is just going to make this offering better.

I don’t see how you get around having, first of all, a regulated teacher. Anything that’s regulated is going to adopt AI last because it’s taxpayer-funded. I think it’s going to be on a lag, but there are just so many pieces here. You’re literally talking about an entire school. It has the logo, and they have caps and gowns, graduation, and guidance counselors.

A big piece of it is the curriculum. Stride pays a ridiculous $60–70 million a year in curriculum costs, and they’re constantly upgrading the curriculum and making it better. Who knows, but I feel like it will be a net beneficiary. I think AI could probably help them on their COGS, and I think they’ll be able to incorporate it.

You’re never going to get around having a physical teacher. Parents go on these parent forums, and they’re calling their teacher because they want to speak to their teacher—to their kid’s teacher. That’s what we’re used to. Right now, we’re still trying to simulate the schools that we grew up with, and I think that’s what this generation of parents feels most comfortable with.

They want a throat to choke, and AI is probably just going to make the curriculum side of it better.

Who knows?

Perfect.

Well, we mentioned and alluded to the numbers here. As I said, we’re almost at the hour mark. I think this is one of those cases where understanding the business and the thesis is much more important. That’s probably always more important, but particularly here, because if we jump into the numbers, I think they’ll hit people over the head really quickly.

I mean, where do you want to start? It just—

You pick.

I think what’s most interesting is that it just gushes free cash flow. I would point to 2 things. Number 1, free cash flow: you could just look at trailing-twelve-month free cash flow to enterprise value, and it’s solidly double-digit. Remember, this was a Rule of 40 company last year, so that screams “way too cheap” to me.

The other thing I would point out is operating leverage. I feel like they’ve done an amazing job on gross margin. 5 years ago, gross margin was in the low 30s; now it’s in the high 30s. Adjusted EBITDA margin has almost doubled in the last 5 years.

To explain what’s going on there, in 2018 they had roughly 75 schools in 30 states. They really haven’t expanded the states—it’s basically red and blue states, except for California. So they had 75 schools in 30 states, and last year they added 25 schools, bringing them to roughly 100 schools in 30 states. But they’ve more than doubled the number of enrolled students.

What you’re seeing is that they’re getting a lot more efficient. They are constrained by certain student-teacher ratios, which each state sets. Those ratios are obviously going to be higher than at a brick-and-mortar school, but the point is that they’re showing you the flywheel is working. They’re able to spread the fixed costs against a larger and larger base of students and generate better economic returns for shareholders.

No, that’s great. The numbers I was really getting at are these: this is a $3 billion market-cap company right now. The stock price is approaching $70 per share, so roughly a $3 billion equity value.

If you go to 2024, the most recent completed fiscal year, there was $425 million in cash flow from operations and about $50 million in mainly capitalized software expense. That’s $375 million in free cash flow to equity—distributable free cash flow.

So you’re buying it for roughly 9 times free cash flow to equity. They have about as much cash as debt on the balance sheet—maybe a little more cash than debt—so it’s probably cheaper than that once you adjust for cash.

I mentioned the $3 billion market cap. They were buying back $500 million of stock as of November, after the big stock drop. And as you’ve said, until very recently, this was a business that was growing 18% per year over the past 5 years.

Not only is it trading below 10 times free cash flow to equity, but it’s growing. If this returns to growth, you get the double whammy of a great business growing quickly, trading at a 10% free-cash-flow yield, and buying back stock. That’s what you dream of as an investor, right? That sounds like a Greenblatt special situation.

Yeah, that’s exactly right. I couldn’t have said it better.

We’ve covered a lot here. Let me end with this question: every business has risks, and we’ve talked about a lot of them. What risk do you think the market is overestimating here, and what risk do you think the market is underestimating—something that keeps you up a little more at night than the average person looking at the stock?

I think the market is overestimating that the growth algorithm has been broken. This year, I’m not making a call on next quarter’s earnings. We may have to wait until the next school year because there really was an issue. Like you said, you should always short the S&P implementation, and that’s exactly what happened here.

But I don’t buy that, and I’m seeing so many other data points that point to the health of the underlying market and demand. To think that because they missed—it wasn’t just 1 quarter; it was a whole year—that would call the entire opportunity into question seems overdone.

On the other side, the risk that keeps me up at night is execution. This is a regulated business, and I feel like ultimately it benefits those who are bigger and stronger because it becomes a game of regulatory capture.

Stride will only survive if it remains high quality and durable. This goes back to the point about the friends you were speaking to and the outcomes. The outcomes are mostly about compliance, because kids have to be in school.

If you’re a state legislator, you want to make sure these kids are actually logging in, participating, and being tracked. I feel like Stride is doing a better job of tracking them than anyone else is.

But that doesn't mean it's easy. It's tough; that's the dynamic in schools: everyone's trying to cheat the system, right? That's the nature of it. But I think they're doing a better job than anyone. They're certainly spending more money on it, right? No one else is coming close to their level of reporting, systems, and compliance.

I don't think this is the case at all. But one risk that does keep me up a little bit is what happened with Carvana. When it looked like they were going to fail, it was, “Hey, every online seller of used cars has failed.” When it looked like Carvana was going to fail, I think the answer would have been, “Hey, you just can't make online selling of used cars work for X, Y, Z reasons.” I don't know why that was. Maybe Carvana should have failed, maybe it didn't, but I don't know why you couldn't make it work.

But there are some businesses where, hey, you just can't do these economically. I think one risk that would keep me up—I think they've disproven it at this point—would be that Adam and Andrew talked about all these reasons why virtual is important, doing it online, all this sort of stuff. But maybe you just can't make the outcomes resemble anything close to what they are in person.

Even if that's the case, as we talked about, for bullying, for rural areas, or for religion, maybe there are still reasons to do it. But that would be the one thing I would worry about. If somebody came out with a definitive study that said, “Hey, unless you have such overwhelming health concerns, the outcomes are just so much better in person, you need to send your kids in person,” that would be the one thing I would worry about.

Yeah, no, I hear that. I heard another blogger, just to bring in a reference from a totally different industry, talking about cannabis reform, and he made a point that I thought was very insightful: demand drives regulation. He was talking about Trump rescheduling marijuana, and so I'd say, as long as the demand is there, I feel like regulation will catch up with it. If I can leave you with anything from my primary research, it's that there's just a ton of demand.

Yep.

There was a bill in May that Governor Abbott signed in Texas, and the lead sponsor basically said that he thinks virtual public education is going to double in Texas, from 52,000 to 100,000, between now and 2028. That's just 1 data point in a very important state. That's, I think, 1 of Stride's most important states.

I just feel that, as long as the demand is there, and parents and students are going in with open eyes, that will eventually win out over this legitimate argument. But it's kind of not a legitimate argument because it's somewhat polemical. It's trying to stick it to the virtual public schools: they're enrolling weaker students, and it's not fair.

I like how you describe that. The other thing that strikes me here is that passionate voter groups are what you want to work for. Let's hypothetically say I'm sending my kids in person no matter what, right? I don't care if you have a virtual policy or not. But if you want to send your kids virtually and the district isn't allowing you to or isn't funding it, you're basically a one-issue voter, right?

So you've got a small group—let's say 5% of the population—that is voting almost as a group of one-issue voters. What politician in their right mind isn't going to do the calculus and say, “Oh, my God, we need to make this an offering”? I think you've got that.

Oh, 1 last question. Sorry to spring this one on you, but it was something I thought of.

Teachers' unions are very, very powerful, right? 1 area where I could see pushback is from a teachers' union. I don't know if they're unionizing teachers at Stride or not, but there are going to be fewer teachers per student online—there have to be.

Is there any union pushback to doing this?

2 points. Since I've been following it, that used to be a huge issue: the unions were very against this and very against school choice in general. I think that totally changed after COVID. It's almost like this was a must-have: you have to have a reasonable virtual public school option. God forbid COVID happens again, or whatever it is.

I think that kind of quieted the teachers' unions, but they're still lurking there. They're very political, well-funded, and very against school choice.

The second point I would make is that Stride actually does have some unionized teachers, I think in California. So it's not like it's totally nonunionized. But that's a real concern. Who wants to have enemies? It's just a reality. This is controversial.

Perfect. Adam, you've done great work. I don't know if we mentioned earlier that you're a finalist for the SumZero Idea of the Year Award with this very pitch. If people are listening to that, they'll get a preview, but congratulations on that, man. That's awesome. I think you should win. I don't know anything about the other 2, but I think you should win.

We've covered a lot here. Just 1 last thing: anything we didn't hit? Anything you think we should hit harder? Anything else?

No, I think that was right.

This was really good. Again, you did a great job with this idea. It's super well thought out. If nothing else, I'm stealing this: “The outcomes in the ER are worse than at the pediatrician's.” But this was awesome. Thanks for coming on for the first time, and I'm looking forward to having you again in the near future.