Buy or Sell? Thursday's Winners: K12 (NYSE: LRN), Equinix (Nasdaq: EQIX)

David Sterman's picture

Thursday, September 13, 2012 - 9:30am

by David Sterman

Among the biggest winners in Thursday's early trading are K12 Inc. (NYSE: LRN) and Equinix (Nasdaq: EQIX).

A controversial business model -- with robust growth metrics
Anyone involved in public education has surely been hearing about K12 Inc. This company has developed an academic curriculum -- for home-schooling and charter schools -- that has led to the diversion of government funds away from public schools and toward its private schools. That's been widely opposed among groups that feel that public schools are bound to suffer as they lose incremental funding. The company was even the target of a The New York Times article in December 2011, when the newspaper questioned the company claims of superior academic outcomes. 

K12 and its supporters claim that the company delivers the best of both worlds: A better education at a lower cost. "Evidence suggests, year after year, virtual schools using the K12 curriculum continue to outperform on state test results, academic performance improves with tenure and more students are being accepted to top-tier colleges like Cornell, Princeton, Berkeley, Stanford, Michigan and Duke," note analysts at Barrington Research. Meanwhile, the company, through a higher use of software, claims that its program's costs are roughly 30% to 40% less per student to administer than traditional public K-12 classrooms. 

Even as the debate rages, K12 continues to grow at an impressive clip. On Wednesday evening, Sept. 12, the company released fiscal (June) 2012 results that showed a 36% jump in revenue (to $708 million) and a 30% increase in EBITDA (to $87 million). Various metrics for the fiscal fourth quarter were also handily above consensus forecasts, giving shares a big lift this morning. The company now has more than 100,000 students enrolled -- either in "virtual classrooms" or in its network of charter schools. (We'll have to wait until early October to hear what management expects to generate in the current fiscal year).

Despite Thursday's gain, shares are well off the 52-week high of $37, in part on concerns that regulators are still unsure of the company's claims. (For example, shares had just tumbled more than 10% on Tuesday when reports circulated that Florida was opening an investigation.)

That concern aside, Merrill Lynch sticks with a "buy" rating and a $27 price target, noting that K12 has "significant top-line growth potential without taking into account expansion into new states." 

Equinix's clever move
Would that we could all be called REITs (real estate investment trusts). That's the refrain being said in corporate boardrooms across the land after watching Internet traffic manager Equinix pull off stunning gains on just such a move. The company announced in early July that it was contemplating becoming a REIT -- which reaps huge tax savings -- and its shares went on to surge from the low $160s to above $200 (before a recent pullback). Well , Equinix has just confirmed that the move will take place, spiking its shares more than 8% this morning to around $202.

REITS pay no taxes at the corporate level and instead pass on any tax liabilities to investors, avoiding the dreaded "double taxation" when it comes to investing (when corporate income and then personal capital gains are taxed).

Prior to the early July musings about a REIT conversion, Equinix was valued at $7.8 billion. Now, the company is worth $10 billion. In effect, the shift in its corporate structure has given this stock a quick 28% boost. How long before other companies announce their own REIT conversion plans? 

Action to Take --> K12 is an intriguing business model, but it's wisest to wait and see if Florida more deeply investigates the claims that the company used uncertified teachers in certain classes. The company denies the claim, though you need to let a little time pass to see how this plays out. 

Shares of Equinix have risen from $40 in early 2009 to a recent $210. Analysts have always gushed about this business model, but even they are hard-pressed to justify higher price targets at this point. After all, this stock now trades for more than 50 times projected 2013 profits. Instead of Equinix, it pays to start to look for other companies that hint out loud about a REIT conversion.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.