The Two Sides of Varsity Group
Varsity Groups is a two sided story. First, we have a tiny (Mrkt Cap: 60m) and fast growing company with a leading position in lucrative and growing industry. Varsity Groups business plan instantly peeked my Peter Lynch instants as an unknown company, with huge growth potential. I first became acquainted with the company after reading a Fooling article about Varsity’s acquisition of Campus Outfitters, but was discouraged by the relative valuation of the stock. Varsity turned up on my screen again recently and I was surprised to see that the stock had fallen from its once lofty peek around $8 and was now trading at a much more intriguing level. Hoping I had stumbled on a buying opportunity, I proceeded to do my own due diligence to see if Varsity warranted my Foolish dollars.
Never before have I been so impressed with a management team’s strategy on some accounts and been so thoroughly disappointed with them on others. This is the crux of my Jeckle and Hyde investment thesis. I’m having trouble sorting out the good from the bad and am wondering if in Varsity’s case, there is more Jeckle than Hyde.
First the good. Offering an online book service to K-12 private schools without the means of running their own campus book stores makes a lot of sense. Granted I went to a public school, where the state supplied us with six year-old texts, I can see how private schools would want to do away with book stores to free up time, space and administration. I also feel that Varsity Group has done a good job in replacing the service. Their core website is intuitive and I found a pre-Calculus math book for a private school in Texas hassle free. I think that this is a good option, especially for parents who do not know what to buy or how to buy it for their children. Private school parents are likely to follow a school’s instructions and pay whatever the school sanctioned website is charging in order to guarantee their children have exactly the right supplies for their first day of classes. I feel that the number of parents with the wherewithal and the inclination to comparison shop online against the urging of the school will me minimal and the addition of higher margin used books is a real plus. I have no qualms with this business model.
Secondly, there is a lot of talk about the fact that Varsity books the majority of its revenues in the third quarter. Time and time again you hear Wall Street analysts bitching about “smoothing out revenue streams.” THIS IS A NON-ISSUE. All that matters is that the company makes money for the year, which it does. Pay no attention to analysts bitching about when or how. In my opinion, analysts get paid way too much to provide services that add very little value, like guessing quarterly EPS. Companies like Varsity make it hard for analysts to do their job, but who cares? I see this as a benefit if it means analysts are less likely to follow the company and I can pick it up at a discount.
Thirdly, still on the good, I love the acquisition of Campus Outfitters. I think that the offering of uniforms can compliment books nicely and make for a package of time and cost savings to the schools that will lead to future contract wins for Varsity. While I like the idea of Campus Outfitters in theory, I find there integration of the two companies lacking. And now for the bad…
The majority of acquisitions are dilutive to earnings in the long term because of one thing, integration. Companies simply fail to do it affectively. If you are going to pay a premium for a company, the some of your parts must be equal to more than both companies separately before the acquisition. I see Varisty failing on this account. The two companies function as separate entities with only a link connecting the two. In order for the acquisition to make sense, Varsity must use Campus to build a product package that makes its website essential. I was hoping to see, when I clicked on my Texas school link, a place to buy a uniform direct to consumer. Parents should be able to place books and a uniform in the same cart; this would increase the purchases of both from the site and keep people from shopping for uniforms with Varisty and books from Amazon. Which brings my nicely to my next gripe about the company.
Though I like Varsity’s acquisition of Campus, I would have much rather seen them vertically integrate and purchase a controlling stake in Baker and Taylor, there book supplier, before it was bought by a private equity firm. This is because the main issue I have with Varsity is cost. Their books are way more expensive than similar e-trailers like Amazon and Ebay’s Half.com. While I feel that parents will generally stick with Varsity, college students probably won’t. That is why I am doubtful about the company’s new push into higher education. The only reason college campus bookstores are able to charge full retail for books is that they are on campus. There is no ordering online, fear of identity theft or wait times for books to arrive in the mail. The minute you force someone to go the online route, tech-savvy college students are likely to shop around. I know I did. The only times I didn’t buy used from Amazon.com and paid anywhere close to full price was when I was in a pinch and needed the book that day. So I went to the campus bookstore. Even if Varsity is able to sign up schools to participate in their eduPartners program, I see students within these schools defecting to other, cheaper online options.
Lastly I just want to point out how badly management is at disclosing info to investors. It has stopped giving updates as to how many schools it is signing up to the program because it is “a bad metric for growth.” But it hasn’t given us any better metric, leaving investors only to worry that the change represents management covering up bad news. I would love to see incremental revenue gains by contract size disclosed and the company said it would consider doling those out in the future. But, until management is more forthright with investors, my dollars are staying in other places in the educational sphere, such as First Marblehead and Blackboard.
I hope this is helpful to someone who is considering this stock and I would love to hear other’s thoughts on the company. I am still on the fence and my value instincts are going nuts as the stock keeps falling. I just wish management would step up to the plate a little.
Oddlot\'s Revenge 