This Hedge Fund Values This “Netflix” Of Coaching And Leadership Services At $90/ Share

It’s been a challenging year for the stock markets, with the S&P 500 down 20% year to date and the Nasdaq Composite off by 30%. However, a few stocks have held up relatively well, and one of those is Franklin Covey. It’s roughly flat for the year.

In a recent interview with ValueWalk, Kevin Daly, founder of Five Corners Partners, highlighted their take on Franklin Covey, which they believe is worth $90 a share. He compared the company to Netflix
NFLX
because it operates on a subscription model and continues to push out new content to customers.

Background on Franklin Covey

Of course, many investors think Franklin Covey makes high-end planners for businesspeople, but that’s not the case anymore. The company sold that business years ago, transforming itself into a leadership and training business built on Stephen Covey’s original studies and books.

The focus now is training courses and related products around Covey’s highly successful project called Seven Habits of Highly Effective People, a book he wrote decades ago that has sold tens of millions of copies. Franklin Covey has grown its brand and offerings around those principles and others.

“They go into companies like United Airlines or Marriott, for the most part, good-sized corporations, and help them enable their employees and the leaders of those businesses,” Daly explains. “Not necessarily going in always at the top, they might come in at the regional or local level, helping them to change the culture of the organization, bringing more accountability, better leaders and outcomes, ultimately resulting in more sales and better customer satisfaction.”

Transition to subscription-based model

Until seven years ago, Franklin Covey primarily sold its products and services on a one-off basis, but over time, it migrated into a business model involving an “all-access pass.” The company’s subscription business model provides all its content for one price in one subscription, making it appeal to companies by allowing them to get all that content on one platform.

“The margins on this are much better for Franklin Covey,” Daly adds. “It also makes the sales of products easier… Close to 40% to 50% of subscriptions are multi-year, which makes the sales cycle a lot easier because now salesmen can focus more on getting new customers instead of re-signing old customers.”

Comparing it to Netflix, Daly says Franklin Covey continues to develop new content and push it out to its customers via its platform.

“In this case, instead of consumers, it’s more business-type customers,” he added. “They’ve seen their top-line sales accelerate and margins and profits accelerate even faster than top line. We think they’ve got several more years of substantial growth on the bottom line, given this transition they’re making to the subscription business.”

Two segments

Kevin’s son Matthew, an analyst at Five Corners, wrote up the fund’s full thesis for Franklin Covey in a recent letter to investors. He broke down the leadership and development industry into two segments: the custom-product approach and the fixed-content approach.

Consulting firms in the first segment build their content and courses from scratch and make them unique to the customer, which pays a one-time, upfront fee of $50,000 to $500,000. The customer then owns the content. Matthew feels this custom approach is best for companies wanting to overhaul their company culture.

On the other hand, Franklin Covey operates under the fixed-content approach. Although the company does some customization in how the content is presented, it’s essentially standard for every customer. For this reason, Franklin Covey is able to operate under a cloud-based subscription model by providing customers yearly access for a certain number of seats.

Customers have access to all of Franklin Covey’s content at once at a much lower price. Franklin Covey’s average package is priced at an annual rate of $46,000. That’s a relative bargain for large corporations seeking transformational changes in their culture and business outcomes.

High marks from customers

Matthew says the users they’ve spoken to and the testimonials or interviews done with human resources people can’t speak highly enough about Franklin Covey. The company has a very good reputation, even among those outside HR who work at companies undergoing its training services.

“They’ve got a team of very high integrity,” he opines. The transition to new CEO Paul Walker, who has been at the company over 20 years, has gone seamlessly. They own a fair amount of stock as individuals in the company. They opportunistically recently bought back a significant amount of stock… Our checks with competitors and customers gave them high marks, the company and its product. I just think they’ve always been straightshooters. Steve Young, the CFO
CFO
, has done a really nice job. The business is great. They don’t try to embellish anything or mislead, and I think they’ve done a nice job of carving out a niche of leadership training and making an important transition to this subscription model that I think will drive a lot of success for them over the next 5+ years.”

One customer of Franklin Covey and LinkedIn Learning offered a comparison of the two companies on Tegus. They see Franklin Covey as the “enterprise version” of leadership training, while LinkedIn is commercial, “‘I want the checklist” kind of stuff.'” The person added that Covey goes much deeper and is more skills-related and “deep on character.”

Another customer felt that what the company offers is almost entirely unique and focused on “human capacity, human capability, becoming the best version of yourself.” With ubiquity on its side, many HR professionals choose Franklin Covey because they’re familiar with its brand.

Why Five Corners Partners likes Franklin Covey

In his report, the fund offers additional reasons they think Franklin Covey is attractive. For example, he said the company saw minimal if any additional churn due to the pandemic, when many companies cut back on expenditures and employees. Additionally, the company’s “All Access Pass” sales grew 16% in fiscal 2020.

57% of North American subscription customers are on multi-year contracts, many of which are in the three-to-five-year range. That’s an increase from 37% in fiscal 2019. Franklin Covey has also been able to grow its annual contract values from $33,000 to $46,000 due to price increases and expansion in existing customer accounts. The company has been able to pass on inflation-related increases in expenses to customers with minimal if any churn.

According to Matthew, Franklin Covey should become a “cash-generating machine.” The company has already spent capital to build out its content library and digital platform, including its recent $20 million acquisition of Strive. He expects most of Franklin Covey’s 90% gross margins in subscription sales to drop to the bottom line. The result is an average incremental adjusted EBTIDA margin of more than 40% over the last three years.

Determining valuation

As Franklin Covey enjoys an increasingly negative net working capital situation, its free cash flow should receive a boost. Its deferred revenue should grow faster than all its current assets. Further, as an asset-light business with improving margins, Franklin Covey’s return on invested capital has been increasing over the last four years.

Customers’ upfront subscription payments finance further growth for Franklin Covey. In turn, its return on invested capital should improve dramatically from the high single digits to more than 20%.

Matthew expects Franklin Covey to conservatively reach $4.40 a share in levered free cash flow by fiscal 2026 while continuing to grow this metric at about 20%. This assumes top-line growth in the low double digits and continued margin appreciation.

Due to the recurring cash flows, unit economics, and high retention rates, the fund thinks Franklin Covey could command software-like multiples of three to four times sales or 20 times EBITDA. Conservatively, he thinks the company can trade at 17 times its $65 million in free cash flow he estimates for fiscal 2026.

Adding the $210 million in net cash the analyst estimates will be on the balance sheet in 2026 and assuming fewer than 15 million outstanding shares, he conservatively estimates Franklin Covey’s valuation at $90 a share for a 20% compound annual rate of return.

Michelle Jones contributed to this report.