Clearing out More Positions

As we gird our loins for what appears to be an extremely unsteady market -- though whether it will go up or down, I have no idea -- I've taken the opportunity to simplify my investments a little bit.

What does that mean?

Well, in my case, it means selling some of the more vulnerable, long-shot, non-profitable or highly valued companies in my portfolio -- particularly the small positions that I never got the urge to fill out with more cash.

So I've sold a half dozen or so of my smaller holdings in the last few days, a few at more or less break even and most at significant gains (these are primarily stocks that I've held for more than a year, most cases significantly longer).

And as with some of my earlier sell decisions, many of these are more personal than stock-related. I do not have specific news or numbers that make me want to sell these, but they don't fit what I want with my portfolio right now.

So what have I sold?

Myriad Genetic (MYGN) -- I bought this one because of the high growth of the genetic testing business and the promise of their early-stage drugs, but the story has changed somewhat. This has more than doubled for me, almost entirely on the promise of their Alzheimer's drug, Flurizan, that I wasn't all that confident about. That makes me extremely nervous -- many nice news articles and analysts have touted Flurizan as the most promising Alzheimer's drug currently out there, which may be true, but that's kind of like being the best dressed guy at the tractor pull -- Alzheimer's drugs are extraordinarily costly to get through FDA approval, and so far almost none of them have worked at all. I'll take my profits here instead of bucking the odds -- I might be wrong, but this small position isn't worth chewing my fingernails over. If Flurizan takes a big hit and the shares fall hugely on the news, I might reconsider my initial investment thesis and get back in.

Blackboard (BBBB) -- It's lovely to have a monopoly, which is why these shares are up quite nicely for me ... but I wouldn't buy more here, and it's a small position. They have so far had some difficulty in turning their near-monopoly into real profits, though it hasn't been that long since they took out their competitor, and I'm a little bit worried about higher education budgets moving forward. Out they go.

Barrett Business Services (BBSI) -- This one has mostly treaded water for me. I bought it because they had an appealing regional-to-national story unfolding and because they had piles of cash on the books and had recently instituted a dividend. That story still holds, but the difficult undercurrent is that they are still primarily a California staffing business, and they are going to have some serious difficulty making up for all the construction business that's falling by the wayside out West. They may get through this fine, they may not, but I wasn't going to add more to this small position unless it got hit for no good reason ... and if it hits now, I'm afraid it will be for a good reason. I'll keep this one on the watchlist to maybe get back in if the economy really tumbles and puts them on sale.

Akamai (AKAM) -- Oh, how sad I was to see this one go. Again, mostly for personal reasons -- I'm not terribly comfortable holding any significant amount of margin in my accounts right now, and stocks that are richly valued are vulnerable. Akamai is the titan of their industry, but there are lots of little guys nipping at the heels and I'm not confident that their growth is guaranteeed ... or that they will be able to continue to charge relatively high prices. I could certainly be wrong, and I like the company very much, but I would prefer to book my 100%+ gains at this point (even though I missed the chance to sell it all at the top).

Universal Display (PANL) and Harris and Harris (TINY) -- these are both relatively small holdings that I've had in my portfolio for a long time. PANL gave me a nice profit, TINY I'm selling at about the same price I paid for it ages ago. Why? Neither one is going to show a profit for a very long time, so while they may be in an important business segment (Organic LED lighting and display, and nanotech venture capital, respectively) I have no particular confidence that they're going to weather a bad market or become profitable in the near future. Expensive and uncertain seem to me to be the wrong holdings to focus on right now, so I'll move along to shares that I'm more confident in.

So ... for the first time in a long time I'm using no margin and have some cash available. Hopefully, many of the companies I'm most interested in will go on sale soon, but at least I do feel more insulated from some of the shares in my portfolio that had been the most likely to falter on bad company or economic news. I remain significantly overweight foreign companies, now at more than 50%, and have also pared back my long options positions significantly.

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Doubly Pinky Promise from Blackboard (BBBB)

I wrote a while back about Blackboard's patent argument with its customer base, and there has been some interesting recent news on that front.

As a little background, Blackboard (BBBB) is the leading provider of course management software for higher education -- the software that runs online classes, and provides essentially an electronic syllabus and virtual classroom to support traditional classes as well. With an estimated 60-75% market share (depending on who you ask) following their takeover of WebCT, they are in the drivers seat ... and, as near-monopoly operators, they get some of the same kind of negative attention as Microsoft used to get (though from a much smaller group of critics, given their smaller market).

Blackboard faces open source competition just like Microsoft does, as well as other software companies that produce competing products. In the face of that competition, they filed a patent claim a while back for many of the core capabilities of their suite of academic software ... and, in a surprise to many folks, they were granted a very broad patent about a year ago.

The patent flew under the radar for awhile, but about six months later they announced they would enforce the patent by suing a small competitor called Desire2Learn ... and all hell broke loose.

Immediately, the academic IT community panicked and, in a fit of righteous outrage, collaborated to condemn the patent, and the company for enforcing it.

Now, I certainly agree (and I'm far from being a patent lawyer) that there's something a little silly about some parts of the patent that Blackboard was granted -- and from reading the patent and the various blogs and articles about the controversy, there's definitely an argument to be made that Blackboard could certainly prevent a lot of course management systems from propagating if they provide too many services that are similar to the patented offerings of their software -- after all, the basics of delivering course content over the internet are (arguably) not all that different in concept from one software version to another, and the current systems from Blackboard and others seem to me to have all evolved along similar tracks.

But that being said, I would argue that it made sense for Blackboard to try to patent the things that they do uniquely well in order to fend off the competition -- that's just good business. If there was an error there, it was in the patent examiner's office.

And to their credit, Blackboard consistently claimed that they had no intention of doing what was most feared by the academic community: shutting down homegrown and open source course management systems that have similar capabilities to Blackboard's software. But the anger was fierce enough among their customers and potential customers over this, that no one believed them. There's a fair summary of the story as it occurred here.

But now, they've promised ... really promised, in what they say are legally binding documents, that they will not go after open source software producers or users, or those who combine open source and homegrown software to cobble together a system for their students and teachers.

So, will that quell the concerns of the higher education community? Well, as a pledge that got at least some input from Sakai, the leading open source group in this space, and Educause, a group of higher education IT leaders, it will carry at least a little street cred -- but even those groups remain quite concerned that the agreement doesn't go nearly as far as they would like.

A good article from Inside Higher Ed on the pledge and the remaining concerns summarizes the whole thing nicely, and I think there are three important points to take from this whole fight:

One, it's quite possible that the patent will be thrown out upon reexamination (the patent office has agreed, under pressure, to take another look at it -- and if they agree with the contentions of many that this is the equivalent of patenting a chalkboard or whiteboard, it could be significantly redacted or thrown out). If that happens, I expect this to all blow over in fairly short order, and the future will depend on how much better Blackboard's products and salespeople are than their competitors. The bad taste in people's mouths will probably not linger, or will not be strong enough to force decisions that they otherwise wouldn't make (at least in most cases, I expect).

Two, although there has been a backlash among IT professionals in higher education, it's very hard to quantify what that backlash means -- certainly, they're angry about the possibility that collaboration with open source solutions will be squelched ... but they're also worried about the possibility that Blackboard will get royalties on any of its patents, thereby increasing costs for those who use competing commercial products. I've been unable to find any published examples of colleges or universities that have specifically dropped Blackboard or decided not to contract with Blackboard because of the patent dispute, though claims that "we'll definitely take a close look when it comes time to renew" are all over the blogosphere.

In essence Blackboard, at least among members of this somewhat idealistic community, is politically incorrect -- but using them is also arguably the safest route to take while the patent is in litigation. At least, that's my assessment, based on the fact that Blackboard is the only software provider out there that we know will emerge unscathed from the patent fight. (And some more cautious universities might fear being tarred with the liability brush if Blackboard were to renege on the spirit of its pledge and go after users who combine open source and commercial software from Blackboard's competitors.) So its possible that this will lead to some showdowns between University Counsel and the heads of IT Departments ... and I don't like to bet against the lawyers.

And third ... and perhaps most important ... Blackboard did not become the leading provider in this space because of their patent -- the patent award came long after they took the lead, and they got to this point because they produced and sold an innovative product that their customers wanted (and bought out some of their smaller competitors). There's an excellent quote in the article from the Case Western VP for IT Services' blog: "Blackboard should take one more look in the mirror and realize that it is not its patents that will protect its near monopoly share of commercial course management software (full disclosure Case Western Reserve University is an enterprise customer of Blackboard) but rather its ability to demonstrate a true commitment to innovation and responsiveness to the higher education marketplace."

I think that's a great point, and that's what will eventually make the difference for Blackboard -- while the patent is litigated, and reviewed by examiners over the next couple years, will they continue to innovate and create products that schools want and need?

If so, things look good for them and they should be able to leverage their huge customer list by upselling many more of their offerings ... to say nothing of the fact that there is a bias for a high renewal rate because the switching costs are very significant in this business. Even beyond the actual cost of moving all your data from one system to another, the training costs can be quite significant, and measured in more than just dollars -- Blackboard is becoming the industry standard as more and more faculty members learn the software and will resist being forced to learn something different in the future, and as more and more students go through Blackb0ard-equipped high schools and expect a familiar software package in college (and if you've never tried to teach a bunch of baby boomer professors something they don't think they should have to learn, I envy you).

So there are a lot of nice things going for Blackboard -- not only do they have a near monopoly position in a very fast growing market (not only higher education, but K-12 as well, and worldwide), but they are continuing to innovate and use the huge market share of their "academic suite" and course management software to win business in the back end of college and university management -- including financial and registration systems, ID card and meal plan and account system management, and the like.

They also recently released their "outcomes system", and while it's too early to tell if it's any good or will be adopted widely, it's certainly on target: outcomes based learning is absolutely the hottest thing in higher education right now, and assessment and accountability are growing in importance, which means any software that can help colleges move forward with improving assessment of student learning outcomes has at least a wide market to address.

In the end, my investment thesis hasn't really changed -- I wrote about six months ago that I wanted to see how the patent dispute settled down before I bought any more shares, and I've still not decided to pull the trigger and fill out my position, but I'm closer to that point.

I keep coming back to Microsoft -- even when your customers don't like you and smaller competitors have more innovative offerings, sometimes that doesn't matter if the product you offer is the industry standard and you manage to outsell, outbully or outlawyer the competition to keep your market share at stratospheric levels. It's a hard world, and while I think Blackboard has made some mistakes in its interactions with opinion leaders among its customers, the fact remains that they have more customers than anyone else ... and it's hard for those customers to switch, even if they're mad for the moment.

Of course, this is far from a fait accompli -- in the age of Linux and Mozilla, and with fast-changing technology, it may be that the leverage offered by seemingly inpenetrable market share is a thing of the past. Just ask Microsoft about Internet Explorer. We'll see.

full disclosure: I do own shares in Blackboard. I do not own shares of any other company mentioned, though I do teach an online class for a graduate school using a non-Blackboard homegrown course management system.

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Blackboard Toes the Line (BBBB)

Many companies have to answer the question, "Is it more important to make as much money as possible, or to make our customers happy?"

Blackboard (BBBB) has taken a small step toward increasing their earnings while alienating some customers.

You may have already heard this news, but to summarize: Blackboard in January was awarded a patent, no. 6,988,138 by the US Patent and Trademark Office. The patent covers essentially the entirety of their course management system and related software and services, and their decision to begin enforcing that patent against some of their competitors has made a lot of academics very angry, and truly shocked the industry. The AP ran a pretty good story explaining the situation yesterday, and the BBC covered the legal issues quite well a couple weeks ago.

Now, the controversy generally wouldn't matter that much -- academics are an easily angered lot (I should know, being among them), and they often take principled stands. That's fine, and often admirable, but it doesn't often have a huge impact on companies or businesses.

But this time it might matter -- because Blackboard's clients are all academics. And if the fight over this becomes more acrimonious and continues to attract attention, the folks who sway University decisionmaking might have a bad taste in their mouth when it comes to Blackboard ... though this may not end up impacting the company all that negatively in the end (just consider Microsoft -- how many of us hate the company, hate the monopoly, and find the products frustrating ... but have to use them just the same?)

I think it made sense to try to patent this work, especially back in 1999 when BBBB and WebCT, which they later acquired, first filed these patents -- the industry was much newer then, and any edge that could be obtained certainly made sense as all the players feared they would be blown out of the water if one of the major software companies moved into this space.

But it may be hard to prove in court that Blackboard really was the first to invent the very basic networked learning support infrastructure that they've received a patent for. Most of the critics of this patent believe it shoudn't have been granted, as one Motley Fool author argues, and it's entirely possible that they'll lose the patent when their first disputes with their "patent-infringing" competitors hit the courts.

Now, I don't think this is going to be that big a deal, and I expect that the firestorm of controversy within the academic community will simmer down in the coming months as long as Blackboard sticks to a narrow use of their patent to extract royalties from for-profit competitors, or, alternatively, loses their patent.

I actually find the arguments of Blackboard's opponents more compelling in this case, you can read their work at http://noedupatents.org/ and in the Wikipedia article they have quickly constructed explaining -- in great detail and with a pretty exhaustive historical scope -- the "prior art" in this case (all the developments that led to today's course management systems, and that existed prior to BBBB's invention of their own system).

But I didn't buy shares of Blackboard because I though they had patentable ideas, or because they had been granted this patent (as it was granted before I ever bought shares). It never occurred to me that someone might patent the concept of an online course management system.

No, I bought shares in Blackboard because, although still a small cap company, they have a dominant market position, a very well-integrated product, and a set of competitors that, though myriad, are quite weak in comparison. I see BBBB as having a near monopoly on this market, or at least a monopoly on the segment of the market that will always prefer to have a professional, supported suite of products as opposed to a homegrown or self-supported open source solution.

And my sense is that this will not be a threat to that position, at least not in the long term. Blackboard is arguably creating something of a network effect here, with a sea of faculty and administrators around the country who are trained on this product and accustomed to using it. I think it will take more than some moral outrage to make all of these faculty members, especially, accept the idea that they should have to learn an entirely new system and re-do the work they put into creating their current class environments. As this develops, it's more than possible the new faculty members will demand the Blackboard system they're accustomed to from their prior positions, or that the students who grew up with Blackboard as grad students and teaching assistants will expect to have this software available in their professional positions.

I've written before about Blackboard, as I bought shares at around $24 in June and $28 in April,
and I've pretty consistently argued for the opportunity present in these shares as online education grows, faculties age and turn over, and the company takes advantage of their WebCT merger to gain economy of scale and pricing power with their huge market share. Interestingly enough, there was a minor bit of outcry about their merger with WebCT as well, over the past year, as more than one commentator questioned the antitrust issues and many schools feared the impact a monopoly player would have on the market ... but that particular controversy seemed to settle down significantly, as BBBB has continued signing up new clients and building relationships with existing ones.

Universities are extremely reliant on course management software and, increasingly, on online classes ... but that doesn't mean they change fast or happily, as anyone who has worked inside an educational institution can attest. The fact that Blackboard already has the lead position in this market is a huge advantage in itself.

But make no mistake, the controversy is real, and it is certainly possible that some of Blackboard's customers will be angry enough about this move that they could stop buying BBBB's products. There is plenty of talk of a boycott in the academic blogosphere, but as far as I can tell it's just talk so far, and the other options remain riskier, less powerful, or require more of a staff investment ... all things that academic administrators generally shy away from.

I'm still holding my shares and I believe the prospects are good several years out, but I also think there's some chance for a significant short term backlash from angry customers, or a stock dip if and when they lose this patent suit ... if nothing changes in my big picture assessment, I'll watch out for that as a possible buying opportunity.

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Blackboard at bargain prices

I purchased a few more shares of Blackboard (BBBB) today at what I consider a very fair price. My last purchase back in April was at $28.26, so today's buy at $24.26 is about 15% off my initial buy. Average cost is now just above $26.

Clearly, I'm still optimistic about Blackboard -- but why buy now? I am terrible at timing the market, but when stocks decline to attractive levels for no business-related reason I get the itch to fill out my positions. I wrote a week ago that BBBB was almost a buy for me, and it's down about 10% from that point -- that's enough for another nibble.

Today, it was a tossup between Blackboard and Cemex (CX) as to which would get my next purchase. Blackboard won because I am more confident that the shares will recover within the next few months as next year's improved outlook starts to impact the market's valuation, whereas Cemex seems to be getting pummeled both as a Mexican stock and as a resource and infrastructure company -- I wouldn't be surprised to see it dip further just because of the sector it's in, and that would create some wonderful opportunity for a dominant cement company that is taking advantage of the worldwide commercial, infrastructure expansion and a US cement shortage. I may well buy as this decline continues.

But back to Blackboard. This company is in a growing sector that I really like, education, and is a long way from fully addressing its market. They have a lot of potential growth ahead of them, and there are two key factors that I think are significant:

One, college and university faculties are getting older, and there is going to be a significant retirement boom as the baby boomers age and, assuming they can afford to, ease off into retirement, just as we're in the midst of another fairly large generation's college years. This means a couple thing for colleges -- not only is there going to be a shortage of teachers in some areas, but the next generation of younger teachers are generally also more tech-savvy and more comfortable with (and perhaps reliant on) software tools that make managing large classes more palatable.

Blackboard is the market leader in course management software -- larger classes and younger teachers both make the path to BBBB's software more appealing for universities.

Two, colleges are universities are routinely squeezed by budget problems -- and while that may seem to be a problem for a company that relies on contracts with these entities, in truth Blackboard's products are generally designed to bring efficiency to college and university management -- not only in course management software, but in student accounts and all the other IT infrastructure that keeps a college running as a small town or city.

The efficiencies that the microcomputer revolution brought to businesses and allowed for our past 20 years of productivity gains are likely to be translated more and more to the academic environment as accountability, metrics, and assessment are the watchwords of the new guardians of the academic purse. That's good news, in my opinion, for software providers that can help colleges the way Microsoft, Oracle, and others have helped grow productivity in the corporate space.

This is a sector where being the first mover is a huge advantage -- once 5,000 faculty members are trained and online using one kind of software at a big university, there will be massive reluctance to changing that software. With ownership of the two primary commercial course management software systems in Blackboard and WebCT, BBBB has a tremendous tailwind as it fights off any other competitor -- no one can match their customer base, and it's extremely hard to convert customers from one system to another.

And that customer base, newly doubled with the WebCT expansion, also gives them inroads for their infrastructure suite of products -- with more and more colleges online with course management software, being able to provide a compelling product to upsell them on greater course capacity (especially with the legacy WebCT folks, who spent less money than average Blackboard customers), and to upgrade them to student account management, campus-wide transaction and card systems, and other software that can easily interact with the course management stuff is a great spot for a BBBB salesman to be in.

There is competition, and there is always fear of strong competition coming from one of the big guys like Siebel, Microsoft, Oracle or others -- but with first-mover advantage and a near-monopoly at the moment I'm not particularly afraid of even the biggest competitor right now. This is Blackboard's market to lose.

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Blackboard Opportunity (BBBB)

Read a Pearlstein column today in the Washington Post that's definitely worth a read for anyone interested in investing in software or education companies -- Blackboard (BBBB), one of my currently held stocks, has quietly, in Pearlstein's words, become a dominant player in its market.

The article is here: Here in D.C., the Quiet Rise Of a Software Powerhouse

This touches on several of the things that I like about Blackboard, not just because I'm a DC resident and drive by their offices frequently, but because I work in higher education and see firsthand the lock this company has on the marketplace.

It used to be that WebCT and Blackboard had split the market between them -- there are a few other players, and some schools design their own systems or cobble together a mishmash of systems, but there were only two real course management platforms for those who wanted something solid, reliable, and supported, and two companies that could take advantage of that position in course management to get their tendrils into the rest of the computer system that runs every busy university.

And now there is one. WebCT was bought by Blackboard last year -- and while Pearlstein was quite surprised that this was approved by the antitrust police, the fact remains that it sailed through without much concern.

I'm sure this has been said before, but I don't intend to look a gift monopoly in the mouth. I have been looking to fill out my BBBB position over the past couple months but was frustrated to see the price popping on some nice analyst comments ... now, with the rest of the market recovering nicely, Blackboard is headed down. Perhaps this will be my opportunity to add on, or perhaps I'll wait a little longer.

I don't believe this window of opportunity will remain open forever, though -- their difficulty in merging the two systems, converting customers, and building better margins with the new WebCT customers is going to depress earnings this year and possibly even next year, primarily due to the one-time merger costs. But when the company is stabilized and ready to drive growth, the margins should expand pretty dramatically over the coming years as they take advantage of economies of scale, a huge growth in their marketplace (technology use on campuses is growing quickly on one hand, and numbers of students are climbing as well in both traditional and online schools), and near-monopoly pricing power.

This is still a fairly small market compared to those hit by corporate software providers of various stripes, which might be why Blackboard doesn't get that much attention (or it might be, as Pearlstein says, that being located in DC by the education associations isn't as sexy as being in silicon valley) ... but I think the market it is certainly big enough to make this company shine. and I'm hoping to buy some more ... just a few more ticks down, please.

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Blackboard to the Moon (BBBB)

Happy as I am to see Blackboard (BBBB) climbing to new heights today, I'm a little surprised.

Sure, the earnings were a little bit better than expected ... and the commentary was generally positive, but it really has been all along, if you account for the fact that they surprised everyone with the extent of the merger costs and the longer than expected timeframe to integrate and pay for WebCT.

Has the market really shrugged off this year's integration costs and looked to the future already?

It seems hard to believe -- I'm always surprised when the market as a whole takes on a long term perspective and starts getting optimistic about earnings that are 18 months away.

Don't get me wrong, that's why I bought BBBB last month, too, as along with many people I saw the potential for a near-monopoly on a growing business in education software ... but I thought I would have a little more time to build my position before the market embraced Blackboard's future again.

So now I have a little regret that I still sit with just a small introductory position in BBBB -- and watched as those few shares shot up in value by 20% today on what really seemed to be not much in the way of unexpected earnings news ... though the analysts did turn positive and issue some nice remarks about their potential in the out years now that their main competitor is being absorbed.

It's still a long while before their acquisition costs trickle off the books, though, so perhaps I'll have another buying opportunity before the year's out. Regardless, I'm glad I had at least a few shares before the climb began -- another argument for not trying to predict the whims of the market, especially at earnings time, and buying in chunks.

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On the Board (BBBB)

Well, while reading up on Blackboard, Inc. (Nasdaq: BBBB) this afternoon I put in what I thought was a fairly low limit order for a small entry position ... and as a result, I'm now the proud owner of a few shares of BBBB. I picked up my shares today at $28.26, a hair under my $28.30 limit order.

I spent a few paragraphs going over what I liked about BBBB and Pearson (NYSE: PSO) earlier today, so I won't rehash all that. Suffice to say that I think Blackboard's dominant position in academic enterprise software and course management software has them well positioned for several years of excellent growth ... once they have gotten over the speedbump of their WebCT acquisition, the costs of which should be pretty well absorbed by next fiscal year.

That's what I like about Blackboard's business model ... they want to be, in their words, "the operating system for education", a boom market, and they're headed in that direction. What about the numbers?

BBBB is going to have very low or nonexistent earnings this year, depending on whether or not you account for the costs of their WebCT transaction ... so we're not buying them for current earnings, and they don't pay a dividend.

What we're buying is growth. They see 31,000 or so institutions as being their addressable market, including the major categories of U.S. higher education, International educational institutions, and U.S. K-12 schools. They believe that this sector spends $28 Billion a year on IT, so if they can get a growing chunk of that business they'll certainly become a much larger company in the years to come (their market cap today is about $780 million and they had sales of $135 million last year).

They currently have 3,600 clients, many of whom are small customers that are prime candidates for upselling to enterprise-level services, including the 1,400 oof those who were WebCT clients that now have a much richer product menu to choose from. Blackboard says that WebCT's average client contract was worth, $24,000, while the average Blackgoard contract is $45,000 -- that gives them some great room for internal sales growth. And their customers renew at close to a 90% rate, which means excellent potential for ongoing revenue growth.

The acquisition is what's holding Blackboard back right now because of the unexpectedly large accounting costs associated with it -- costs that will keep the acquisition from being accretive for a couple years, and that were the reason for BBBB's recent swoon on their downgraded forecasts (though the combined company will be cash earnings accretive next year). I do like that they used cash and debt for the acquisition and didn't dramatically dilute the existing shareholders -- that's one argument for large management ownership.

BBBB disappointed folks with their downgraded guidance earlier this Winter, but in the long run they see themselves growing quite dramatically. From sales of $135 million in 2005 they're expecting to hit about $170 in 2006 and $220+ in 2007 ... that is close to 40% growth in sales by my reading (that doesn't account for some costs), so this is a very nice underpinning to what should eventually become a capacity for dramatic increases in earnings. This is, after all, a software company -- once the acquisitions costs are digested, earnings should be able to grow substantially as margins build along with sales. They're projected fiscal year GAAP income of .31-38 per share in FY 2007, which would give them still a relatively high forward PE of 75+ ... but they're projecting cash earnings per share, which takes out the accounting costs, of over $1 in 2007, which tells me that's when they think they're really going to be hitting their stride.

I'm glad to be in with a small portion now, but I also think that BBBB could fall significantly from here -- perhaps as much as 20-40%, though I don't guess it will be that severe. If it does and their long term prospects still seem solid, that's when I'd like to fill out my position.

Why might it fall? Well, this is impossible to predict -- but they're going to continue reporting losses for several quarters to come unless they've been seriously sandbagging their projections, and that's quite likely to impact the shares negatively even if we're all expecting losses.

And this is a relatively young company and a small one, acquiring a company that is not that much smaller than themselves. It's certainly possible that they're underestimating the costs they'll incur in the transition or the problems they might have with their 1,400 new customers.

But I look at their projections, which I think are lower than the market might make possible given the boom in education and the dramatic need for the services BBBB offers, and I see a lot to like.

They project growth from FY 2006 to 2007 as follows:

Revenue: 18%
Expenses: 14%
EBIT: 27%
Pro-forma net income: 51%
Pro forma cash net income including taxes: 44%

That's excellent growth, and it shows that they think they'll be able to take good sales growth and transform it into great bottom line growth (assuming you ignore the men behind the curtain, debt payment on their loan for the acquisition, and stock-based compensation -- since this reflects what I think the long term operational performance of the company can be, I'm OK with the pro forma nonsense).

They are diluting shares, but not massively -- they paid for the acquisition with cash and debt, so it looks like we're going to see average share count go up by perhaps 4-5% a year ... not ideal, and I'd like to see that number come down, but not outrageous for a software company.

So, I wouldn't be surprised if I'm buying a little too early here, but I think 2007 and beyond will be extremely strong years for Blackboard -- I'll hold my entry position and hope for some significant declines to present themselves as more lucrative buying opportunities.

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Investing in Education? (BBBB, PSO)

I think one of the most interesting things about investing is finding trends by keeping up on the news in a variety of areas, then thinking of ways to use those trends to make money in the market. One article about higher education in the Washington Post today -- Colleges, Awash in Applications, Turning Away Even Top Students -- brought the swelling ranks of college undergraduates to mind. As someone who works in academia, this is something I think about a fair amount from time to time.

Nearly everyone has ideas about how to invest to benefit from demographic trends, but the one that gets most attention is the graying population as the baby boomers reach retirement (think health care, recreational vehicles, sunbelt real estate, etc.). While I have many investments that hope to take advantage of that, I think a more interesting trend to address at the moment might be the explosive growth in higher education.

This growth is taking place in a few different ways -- the trend we hear a lot about is the boom in distance education, for-profit universities and adult education with people going back to school to give themselves an edge in the workplace. That's certainly a viable trend, and Corinthian Colleges, Apollo Group, Strayer, and many others have been very lucrative investments for many folks.

But traditional schools are also booming and seeing more and more students than ever before. These schools are becoming more selective as they see larger and larger incoming classes, as the Post article above covers in some detail.

Companies that might be effective investments to exploit this trend are the academic publishers and academic services companies. Among publishers, I've looked before at Reed Elsevier (RUK), which I think is probably a solid investment but it's a company that I don't personally like very much for non-investing reasons (I work at a university, and Elsevier is like a leech on our budget). Another British publisher that pays a better dividend and is more leveraged to textbooks both in primary and secondary education is Pearson (PSO). Pearson is just now recovering from some down years, has a very reasonable PE, and pays a nice 3.5% yield, definitely something I'll take a look at.

Among service companies, by far the most impressive one in my mind is Blackboard (BBBB), which I've mentioned before. BBBB is an interesting story -- they produce enterprise software which helps colleges handle the computing demands of managing the accounts and registration details for their burgeoning ranks of students and staff, but the more well-known software they serve is for course management. I've used this both as a teacher and student, and with the increasing size of college classes and the increasing numbers of classes that are taught online or as hybrid online and in-person experiences, demand for this kind of management software is climbing fairly dramatically.

The stock has been an irregular performer of late, and I think this might be a good opportunity to open a position while their earnings are entering a period that the company expects to be fairly poor. BBBB will be digesting their acquisition of WebCT, which was its best competitor, and that's going to significantly impact their reported earnings in 2006, to the extent that the company expects to report a loss for the year.

But the trend is definitely in their favor once this acquisition is fully incorporated -- they will have the lion's share of the market for course management software, and certainly the strongest selling position of any of their competitors (colleges like to go with strong suppliers that lots of other colleges are using, and they don't like change so renewal rates are around 90%). T

here is certainly competition from some other providers, some people fear Microsoft will make a big push in this area, and open source options are available -- but the entrenched leader, which Blackboard is at this point, has a great advantage in this market, even if they're fairly small in the grand scheme of things.

No one wants to be the one who has to tell 4,000 cranky faculty members that they have to learn an entirely new piece of software in order to teach next semester, and as colleges face massive IT challenges not only in hardware replacement and overall migration to Vista but also in handling their thousands of students who are swamping networks by downloading movies and feeding their MySpace and Facebook addictions, the last thing they want is an open source solution that requires significant contributions from IT people who they have a hard time hiring anyway. An out of the box solution like those offered by Blackboard is ideal for this environment.

Beyond the business they're in and the catbird seat they occupy as they watch the renewal money come in, I really like that the company is small (well under $1 billion), the founders are still running the show and are very aggressively trying to build the business, and management still own a large portion of the company (which often is a good sign that their interests are in line with ours). It has been a pretty volatile company in its almost two years of life on the public markets, but the price seems to have stabilized a bit now that their low guidance for this year has been digested, and folks are starting to think about how strong a future Blackboard will be once WebCT is fully on board and they have a stable platform from which to continue growing and adding services and products.

There are certainly other companies that might profit from the expanding ranks of college students -- American Campus Communities (ACC) is a student housing REIT that owns a lot of housing on and near college campuses that can absorb those bodies, but as a REIT it doesn't really stand out from the pack with an average performance and an average 5.5% yield. And I can't think of anything more nervewracking than being a landlord for college students, so I'm not sure I'd want to take on the potential liability headache of this sector for such a small yield.

So today, it's Pearson and Blackboard that are looking like my most likely purchases in the education realm. I'll let you know if I decide to actually make a purchase in either (or something else).

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