Company Description: Rosetta Stone (NYSE:RST) provides technology-based language learning solutions. RST continues to execute on its plan to focus on three core business lines: enterprise and education (E&E) language, literacy (Lexia Learning) and serious consumer language learners. Led by Chairman and CEO John Hass and a strong board, the company is, in our view, showing clear signs of a successful turnaround. We believe that the company will continue to materially improve its operations and will attract financial and strategic buyers interested in purchasing the company in whole or in parts. The company recently reported its sixth consecutive quarter of year-over- year operating expense reductions.
Investment Thesis: Summing the company’s net cash balance and the value of fast-growing Lexia Learning (year-end annual bookings run-rate of $40 million, coupled with 90% plus renewal rates and a 30% plus annual growth rate), implies little value for the company’s consumer and E&E language businesses. The company’s new iOS app recently won a Macworld bake-off of competing language apps. Macworld’s Seamus Bellamy found that Rosetta Stone’s app topped Duolingo and Babbel, noting it has a “feature set the other two can’t match.” Additionally, RST’s new E&E Language Program “Catalyst” was reviewed by PCMagazine and received an Editor Rating of Excellent. The editor called Catalyst “a new and smarter tool for enterprise language learning.”
Current Market Valuation:
Shares 22 million @ $8.00/share = $176 million
Net Cash: $35 million (Year-end estimate)
Enterprise Value: $141 million
Revenue: $190 million (Consumer – 45%; E&E Language – 35%; Lexia – 20%)
We assign a $100 million valuation to Lexia (2.5x year-end bookings run-rate) leaving the company’s combined language businesses (consumer and E&E) valued at $41 million. Applying a modest 1x multiple to language revenue of about $150 million sums to a total RST valuation of roughly $285 million, or $13/share. Note, consumer competitor Duolingo recently raised capital at pre-money valuation of $470 million. It is believed that Duolingo has less revenue than Rosetta Stone.
- The efficacy of Lexia’s Core 5 reading software is gaining recognition by education decision-makers as a high quality product that materially helps all children, particularly at-risk ones, acquire reading skills. Government and philanthropic money is pouring into early education digital learning.
- Independent industry analyst TechNavio estimates that the global digital English language market will grow at an estimated CAGR of 13% to 2019. We see no reason why RST does not participate in this strong secular trend with its new Catalyst product.
- Subscription and service revenue now accounts for 70% of revenue mix; Credit Suisse SaaS industry index trades at roughly 4.5x revenue. The company recently increased its 2016 guidance on revenues, EBITDA and year-end cash.
- RST’s current management and board, with significant equity ownership, is well incentivized to enhance shareholder value.
Disclosure: I am/we are long RST.
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.
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