FC - Franklin Covey: All-Access Pass Continues To Drive Growth

2023-05-18 10:28:07 ET

Summary

• Franklin Covey is a small yet profitable company that shows strong growth prospects.
• Their main product, the All-Access pass, continues to drive significant growth and set the company on a solid future path.
• We believe Franklin Covey offers an attractive rate of return of 20% CAGR over the next 2 years.

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Introduction

Franklin Covey (FC) may not be the most well-known public company and has a rather dull-sounding name. When you hear that its main product is the sale of training courses, it may seem like a rather boring investment. However, followers of Peter Lynch may recall that in his book 'One Up On Wall Street,' he mentions some attributes he looks for in a company, as the company doing something dull or having a dull name.

I believe Franklin Covey fits this category quite well; what could be duller than selling training courses? However, upon closer inspection, Franklin Covey has undergone a rather interesting transformation that has driven revenue growth and long-term earnings potential.

Despite this transformation, the shares trade below their values in 2019, presenting an intriguing growth story that I believe is overlooked by the market. Here's why I am bullish on Franklin Covey.

The Story

Franklin Covey is a company engaged in the organizational performance category, with a stated goal to "Enable greatness in people and organizations everywhere." The company focuses on selling training products for both in-person and online formats. Initially, all products were sold individually; however, in 2015, the company came up with the idea of offering all their products for a fixed-price subscription. This led to the launch of the All-Access Pass, which enables customers to access all content through a yearly or multi-year subscription.

Initially, there were concerns that this approach might lead to reduced spending by larger customers and potentially drive away smaller customers who did not want access to all the content. Indeed, Franklin Covey initially reported a fall in earnings. However, as time passed, this change turned out to be a good decision.

Having access to the All-Access Pass enabled customers to utilize the courses they had planned to use, as well as access material they had not previously used or had relied on another training partner for. This allowed companies to evaluate their current training programs and incorporate new material, thereby encouraging customers to expand the number of users they had signed up. As customers are billed on a per-user basis, this growth in users per company helped drive revenue per customer. Additionally, the ability to access all the content encouraged customers to shift from using other companies' training content to using Franklin Covey's, as there was no extra cost involved in switching, resulting in cost savings for customers.

Moreover, the use of the All-Access Pass is also helping to drive revenue from add-ons such as training days. The power of the All-Access Pass is best explained by Franklin Covey's former CEO, Bob Whitman, in the Q1 2020 conference call :

"As to winning a bigger portion of clients' outsourced learning and development budgets, there's a large financial services firm which has now been an All Access passholder for nearly 3 years who, during this period, has expanded their pass from 100 users to more than 8,000 users. Additionally, they're contracting for many dozens of training days, what we refer to add-on services, each year. This client has expanded its passholder population rapidly in 3 short years because of the depth and breadth of content in the All-Access Pass. Each time they encounter a new need in the organization, they consult with their Franklin Covey implementation specialist to determine how that need might best be met through the content and tools in the All-Access Pass, and most often, it can be. As this process has played out again and again, their commitment to All Access Pass has increased significantly." -Bob Whitman

Customer Lifetime Value

All of this leads to a very high lifetime customer value, with the average customer spending over $40,000 in their first year. As customers use Franklin Covey's products more, they add additional users and opt for add-ons such as training days, resulting in the average customer spend on the All-Access Pass rising to over $77,000. Combined with a very high customer retention rate of over 90%, this leads to a substantial lifetime customer value. In fact, during the Q2 2023 earnings call , management stated that the cost of acquiring a new All-Access Pass subscription is not only much lower than the contract's lifetime value, but even lower than a client's first-year All-Access Pass spend.

This makes it extremely compelling for Franklin Covey to increase the number of customers using the All-Access Pass, and that's precisely their plan. All-Access Pass revenue grew by over 15% in Q2 2023, with deferred revenue growing by 22%, which will be booked in future quarters.

Why Does This Opportunity Exist?

Franklin Covey's shift to a subscription model necessitated adjustments in financial accounting and reporting practices. Under this model, customer acquisition costs, such as marketing, implementation specialists, and sales commissions, are recognized in the current period, while the full lifetime value of the customer is spread over future periods. As the All-Access Pass has been growing rapidly, exceeding 29% growth in the financial year 2022, this has impacted EBITDA margins in the short term, with higher upfront expenses and delayed revenue recognition.

However, in the longer term, EBITDA margins are expected to improve. As current customers renew their subscriptions without requiring additional marketing efforts or implementation specialists, the recurring revenue stream contributes to margin improvement. Additionally, the shift towards multi-year subscriptions, which now represent 55% of total subscriptions compared to 32% in 2019, provides further support for margins.

Furthermore, Franklin Covey benefits from licensing content from authors on a fixed amount per year. This allows Franklin Covey to scale those expenses as they expand their subscriber base, boosting EBITDA margins. These factors collectively contribute to Franklin Covey's long-term margin growth potential and forecast EBITDA growth.

Valuation

Franklin Covey generated EBITDA of $42 million in 2022 and is projected to generate $49 million in 2023, $58 million in 2024, and $67 million in 2025, based on the company's guidance provided in the Q2 2023 earnings call . We have confidence in the company's ability to meet this guidance, considering its consistent track record of meeting guidance in the past, and the potential for EBITDA margin expansion.

We value the company based on the EBITDA/EV ratio, which provides a metric that includes both equity and debt. In this calculation, we assign an EV/EBITDA multiple of 11, based on competitors Skillsoft ( SKIL ) and Learning Technologies Group (LTTHF) trading at this multiple.

Assuming a stable share count of 13.9 million shares outstanding, with cash and debt remaining at $60 million and $24.2 million respectively, the valuation is as follows:

This suggests a price of $55.60 per share at the end of the financial year 2025, in 27 months' time (August 31st, 2025). Considering the current share price of $36.87, it indicates a total return of 50.8% for a CAGR of 20%.

Risks To Consider

My bear case revolves around three main issues:

Macroeconomic woes that could result in customers reducing spending on training and add-ons, which would impact nearly all of Franklin Covey's revenue streams. It is believed that the impact this causes would be temporary in nature due to customers' continuous need for employee training. However, despite Franklin Covey's strong balance sheet suggesting it could ride out a recession, a fall in earnings could occur, resulting in a short-term decline in the share price.

The growth of free or nearly free content could lead customers to switch and use this content instead, especially if it reaches a similar standard as Franklin Covey's offerings.

Franklin Covey currently works with larger customers to customize existing content and develop new content to suit their needs. The long-term growth of artificial intelligence technologies raises the concern that customers may be able to easily customize their own content without relying on Franklin Covey. On the other hand, this could potentially help Franklin Covey by making their operations more efficient and aiding in the identification of knowledge gaps in their customers' current training, enabling them to recommend appropriate content from Franklin Covey's library.

Conclusion: Franklin Covey's Undervalued Potential

Franklin Covey is a small but profitable company that has made a shift in its business model, which has helped boost revenue and earnings, unlocking shareholder value. However, it remains overlooked by the market. The fundamentals of the business remain strong, with the All-Access Pass continuing to grow above expectations. I believe it offers an attractive rate of return of 20% CAGR over the next 2.5 years and has the potential to grow even further, despite a poor macroeconomic outlook later in the year. Therefore, I continue to hold and look to add more in the future.

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