Over the last 8 months there have been three negative articles on INVESTools (SWIM). We will take the other side of the debate focused on the most recent article dated 12/17/2007. In full disclosure we are long SWIM.
First, one could have made 99% of the arguments that the article stated 1,2,3,4 or 5 years ago and, depending on the time frame, you would have lost between 2000% and 20% following this reasoning if you had shorted SWIM. INVESTools has a high degree of difficulty to fully understand what drives the value of the business.
The core driver of the earnings is their ability to rapidly grow their business in two attractive market segments, Education and Brokerage, with the added bonus of a marketing subsidy for the brokerage arm.
The Investor Education business dominates the market with market share of 4-5x their next closest competitor from what we can find. The Education side has grown from $55mn to $250 from 2003 to 2006, while margins have improved from 7% to a high of 21% and the company generated $50mn in Free Cash Flow in 2006. However, with the acquisition of the Brokerage arm, the management has accelerated acquiring customers and is now spending 30% of Education's sales transaction revenue acquiring students (calculated by adding back the indirect marketing channel spend and the direct), which is hurting the profitability of the Education business in the short term but creating very high margin growth on the Brokerage side, which, in turn, is causing the Brokerage business to grow at a rate of 4-5x that of the industry average.
So what is happening here? Here is where it gets a little confusing. Simply put, approximately 67% of the Education students opening a brokerage account with ThinkorSwim (#1 rated by Barron's 2007) with an average balance of $45K and trading 150 times a year this produces annual EBIT of $1,200 per account with fairly low churn rates. Therefore, management has an incentive to grow this business and it makes sense to increase unit volumes in Education by dropping the front end price points for the entry level product. So now the initial price points are lower in Education and unit volumes are ramping at a significant rate. In fact, INVESTools depended 100% on other brands to bring in customers two short years ago, and today the INVESTools brand represents over 75% of new students that come in the door.
The marketing with the infomercials is not the best, from what you would like to see as an investor. What are the risks? It comes down to suitability. Are they overselling the product is the key question.
Let's look at some facts. INVESTools has sold $550,000,000 worth of educational products/services over the last 3 years to over 100,000 paying consumers. According to the Better Business Bureau, there are a total of 18 complaints relating to sales/marketing practices and the over that time frame products range from $1,000-24,000 on education, or one complaint for every $30mn dollars worth of product/service sold. Why? INVESTools business is built on a lifetime value strategy where user satisfaction and retention is critical, due to the high customer acquisition costs and the extremely high incremental margins on any renewal. As an attendee of north of 45 preview events and someone who has attended every national user conference held over the last several years in (Las Vegas, Orlando, and Chicago), believe me when I say that the core INVESTools customer loves the product.
To put this in perspective, why else in one of the worst markets, August 2007, would INVESTools/ThinkorSwim 2-day user conference sell out with 2,200 people flying to Chicago paying $999 plus hotel and other travel costs? In our opinion, INVESTools has an incredible business with very little working capital required and extremely high returns on capital combined with high user satisfaction while targeting the upper quintile of the American population (look at the demographics of the average student). If INVESTools was picking up students that were not qualified, the Company would not have an average account balance of $45,000, which is multiples higher than nearly any other online broker in the US.
The real story here is that INVESTools has a marketing budget of approximately $75,000,000 annually while their next closest competitor on the Brokerage side, optionsXpress (OXPS), spends an estimated $15 million acquiring customers yet has nearly twice the market cap of INVESTools. For November, SWIM overtook OXPS in DARTS and total accounts opened while adding $200mn in client assets while OXPS lost $200mn in client assets. Education is running near a 10% EBITDA margin (which is being held back by spending 30% of sale transaction revenue on marketing) and the online Brokerage business runs at 50% EBITDA margins with top line growth north of 100%. We will leave our estimates out of the picture but Wall Street is looking for approximately $110mn in EBITDA for 2008 or about 10x EV/EBITDA with minimal capex.
It's a business where the value should grow literally daily as long as the churn stays relatively low as it has historically. Everyday approximately 140 new students sign up for INVESTools Education and 120 fully funded brokerage accounts are opened. The Brokerage business has seen its assets increase from $780mn to $2.6 billion in 15 months or growth of 225%. I have hopefully highlighted a variant market view that the products are of high quality on both Education and Brokerage as backed up by Barrons highest point rating ever for the ThinkorSwim Brokerage unit March 2007 and very limited customer complaints relative to paid graduates. Second, both businesses, despite initial appearances, are of high quality in terms of growth, barriers to entry ($75mn customer acquisition and significant "installed base"), and returns on invested capital (INVESTools Education business generated +160% in 2006). Operating margins should continue to increase over time as there high margin high growth brokerage side makes up a greater percentage of revenue.
Neither INVESTools nor its employees are licensed financial advisors. Right! Nor should they be as neither INVESTools nor the Brokerage arm recommends individual securities to buy/sell.
The article is correct that INVESTools is not an accredited educational institution. Why does this matter? Neither is the CFA designation but still thousands of people get the Chartered Financial Analyst [CFA] designation year in and year out. INVESTools is an innovator and their services are designed to be for personal not commercial use.
The article is correct that the coaches do not have years of experience and that they only hire successful traders that have gone through their system. INVESTools is in the business of teaching average people that they can succeed; what better way than having former successful students teach prospective students. I would urge anybody in doubt sign up for the course and use the toolbox; you can get 100% refund within two weeks if you do not think it is worthwhile.
The most dubious claim is that the company is "hiding revenue as a deferred liability...by being too conservative in deferring revenue during prosperous cycles, management can impact-smooth out- future reported revenue by accelerating the recognized product/service as being completed, boosting sales(when needed)." First, 100% of all costs are recognized upfront in the quarter in which the student was acquired yet revenue is deferred as the product/service is delivered and the revenue is non-refundable after 14 days. How would you suggest that management can accelerate delivery of a subscription based (time based) product like the annual toolbox?
We would disagree with the argument that there is much risk due to the net debt of $70mn. On the November conference call, the company stated it could approach 30% adjusted EBITDA margins for the 4Q07 which should be cash flow of $27 million and we think the company will have a net cash position by year end 2008.
Finally the article states:
A review of SEC filings suggests to us, however, that the management never took the workshop or home study courses with the "proven investing formula." For the first six months of FY 2007, the company reported realized losses of about $4.0 million in marketable securities available for investment and subsequently sold!
This statement is incorrect as the filing states the actual number was $4,000 NOT $4,000,000!
Disclosure: Author has a long position in SWIM