Instructure (NYSE:INST), the cloud-based learning product, is a new issue (stock IPO'ed in November 2015) that has very little coverage on Seeking Alpha besides reviews in regards to the company's IPO. As an investor, I need to understand the product before I invest in a company. I also need to understand the biggest risks associated with the stock. With that in mind, I decided to write an article on the stock from the viewpoint of a user (I currently am one). I also wanted to highlight the biggest risk I see in the stock, which is something investors may not be considering.
My Personal Experience of Canvas
Instructure's main product is Canvas, a cloud-based platform used by universities and secondary schools much in the way that Blackboard (the company's biggest competitor) is used. Blackboard is actually the biggest competition, and a platform my current school, Northwestern University, used to use (we changed to canvas, as did my girlfriend's school - she is a middle school teacher):
I am a student at the Kellogg School of Management and we use Canvas as an organizational hub for our coursework. The site is generally quite intuitive and offers a solid user experience for students (I will note, as I did before, that my girlfriend who is a school teacher, now uses Canvas and had very similar opinions as I did).
When I was an undergrad student, textbooks were the norm, communication between professors and students occurred via email, and quizzes were always taken in class. Not so anymore. Canvas provides a home for everything related to each course. Through Canvas, students can access digital files (readings, homework assignments, class slides, etc.), post questions to a forum for the professor or fellow students to answer, submit homework assignments and even take quizzes online.
Canvas has effectively eliminated the procedural questions that used to fill up valuable course time - the "when is this homework due?" or "how many words should this paper be?" kinds of questions. When in doubt, check Canvas.
Each course on Canvas has a home page that highlights any imminent assignments due or important course news. The home page contains links to subpages that allow students to access further course material. To submit an assignment, you just upload your document to Canvas and click "submit." Once you have posted an assignment, the professor can review it, post a grade to Canvas and then provide feedback through Canvas as well. The site allows for transparency into the grading process and even lets students enter different grades into the site to see how their overall grade would be affected (see picture below for the on-site grading interface).
One area of difficulty I have with Canvas, however, is that the user experience varies considerably based on how comfortable professors are with the program. More technologically adept professors will post all files related to the course while others may not use Canvas at all. I would suggest that INST installs more training programs to gain further acceptance from teachers and professors.
Canvas, when used as intended, adds a lot of value, but there is too much variability at this point between courses that use it right and those that don't. Also, there doesn't appear to be a tutorial to help those who are having difficulty with the program. While the interface is intuitive to most, Canvas should invest in materials to help ensure consistency in use.
It is interesting that both schools in this discussion have moved from Blackboard to Canvas - I think this is a trend that will continue and will be a tailwind to INST in the future. But, the platform isn't to a point where it is logically easy to make the switch - I think more operational improvements are necessary to gain full adoption.
The Biggest Risk Associated with INST That Investors Might not Notice
When looking at INST, the two quick risks that come to mind are acceptance of Canvas and the adoption of the employer-based platform. There's no doubt that these are risks, but the biggest risk going unnoticed from a shareholder perspective is further dilution from secondary offerings.
INST currently has 27.5MM shares outstanding (not accounting for stock-based compensation, which takes us to about 30MM). On face value, that is pretty good - I usually look for small caps that can normalize under 50MM shares (any more dilution than this and it's hard to get leverage on growth). INST currently has $70MM in cash on the balance sheet, but is burning approx. 15MM per quarter. That not a bad thing at this point - most of the money is being spent on customer acquisition. Though the company does not break out these metrics in their 10-K, my rough estimates show that LTV-to-CAC is greater than 5x, so the company should be investing in customer acquisition.
But, it does means it's likely that secondary offerings do occur. I believe that INST has cash on hand for operating expenses for the next 12 months, but that the company will not reach break-even levels over that time period. In order to sell to schools, the company will need to scale its sales force while it grows. I believe it will take about $400MM in revenue to reach break-even levels with the future elevated levels of R&D and sales & marketing.
Even if the company grows revenue 50% annually, it will still take several years (~3-4 years) to reach break-even levels. Under this scenario, and accounting for a cash cushion, I believe the company will have to raise at least an additional $100MM of equity over the coming years (~15-20% of the current market cap). Investors do not look highly on secondary offerings, which could cause a selloff to occur. Using a $15 avg. price for secondary offerings, and including the ~$20MM in stock-based comp paid over the last several years (at lower valuation), I think the company's float could increase by ~30% over the coming years. This number is based upon a 50% annual growth rate. If adoption slows, this number could be even higher.
Due to this risk and my experience with the business, I think it's a legitimate product that will gain more adoption, but I also think it is not investable until the total share count shakes out. It is for sure a stock you should keep on your radar, but considering further dilution and the current market that could sell off stocks that don't currently make money, I believe investors will have a chance to buy cheaper in the future.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.