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a conversation with diana henriques (web exclusive)
Diana Henriques, a veteran business reporter for The New York Times and a correspondent for FRONTLINE's "Public Schools Inc.," talks about Edison's recent efforts to achieve profitability, the challenges it faces as a business, and how it has responded to its many critics. She spoke with FRONTLINE's Wen Stephenson on June 5, 2003.

Fortune magazine ran an article about six months ago headlined "Why Edison Doesn't Work." Let me just ask you, as a seasoned business reporter who has covered Edison now for a while, does Edison work? And if not, why not?

Well, at the risk of sounding Clintonian, it depends a little bit on what you mean by "work." Why it doesn't work as a profit-making entity -- and, of course, so far it hasn't -- is because they spent too much. They spent a lot of money to grow. In some cases they took on contracts that were not as profitable as they should have been, and invested a lot of capital in getting big in the belief that scale was necessary for profitability.

Edison invented a new category of company. It created this field and others have expected, perhaps, to come into the marketplace in its wake. Well, they may be disappointed...

In the past year, Edison has become a very different sort of company. It has scaled its growth expectations way back. It has endeavored to impose a good bit of financial discipline. It has cut its overhead staff. It has expanded its search for money-making ventures. It has exited a number of contracts that were not productive, that weren't profitable. And they are trying now a slightly different game plan to become a profitable company. I think the jury's out still on whether or not that's going to work. But the sort of sweeping dismissal of it as a failure depends a little on how they're measuring what they are trying to do.

In other words, they are changing the definition of success.

I think, in a way, that's true. Originally, remember, these were different times in the marketplace, different times for public companies. In the late 1990s and early 2000, companies were rewarded for getting big fast. There wasn't as much emphasis or interest in getting profitable. ...

Now among both public investors in the stock market and private investors who invest in companies like this in the form of venture capital, the mood is, "Show me the money. Show me that this can be profitable." And Chris Whittle has said, "Okay, I believe it can be profitable. If profits are what you want, we'll shift gears. We'll scale back our growth plans and emphasize reaching profitability quickly."

They have in fact promised that, on a pro forma basis, they will be profitable in this current fiscal quarter and that they will be able to demonstrate a clear improvement in their financial performance that will be reassuring to all. We haven't seen it yet. ... Their fiscal year closes on the 30th of June, and results would normally be made public some six weeks or so later.

Now, that timing is complicated by this interesting plan that surfaced [in May] for a group of management executives, led by Chris Whittle, to take the company private. To do that they're going to have to get shareholder approval ... and that will entail a number of filings with the market regulators that will give us some information, perhaps, sooner than that. ... Certainly sometime this summer, one way or the other, we will know whether they've met the targets that they've set for Wall Street.

What happens if they don't?

Well, if they don't there would no doubt be some disappointment among speculators and some "I-told-you-so's" among Edison's many critics. I think a wise point of view on Edison's stock price right now, though, would be that big institutional investors were out of this stock a long time ago. This is a speculative stock now, trading between $1 and $2 a share. ... But the big money has already gotten out of this and the big money probably already has been lost. So I wouldn't be surprised if it's a more modest reaction to any shortfall than we saw last year.

There will, of course, be a lot of nay-sayers in the market crowd saying, "Well, Chris Whittle disappoints us again." There are a number of folks who sort of gleefully watch for Whittle to fail completely, and so far he's usually managed to confound them.

But he's still tantalizingly leading them on. He seems to be constantly on the verge of failure.

He apparently thinks that he can pull this off. And if he is able to find a private investor or some venture capital money willing to finance this management buyout, that would suggests that his confidence is not misguided and that there are, in fact, some corners of the investment world that haven't given up completely on the Edison model.

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Reporting on Edison Schools from The New York Times [free registration required]:

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Do you think it's more likely to succeed as a private company than a public one? Why did they go public in the first place? What is the difference for Edison in being a private company versus a public?

... The common wisdom is that companies go public so that they will have greater access to less-expensive capital to enable them to grow. Well, Edison scaled back its growth ambitions. The capital it gets in the marketplace now is extremely expensive. High interest to borrow, and ... if you sell more stock right now at a very low price ... you could sell a million shares and only get a million dollars. So you've given away a big slice of the company for not much money.

So whether they do it in the form of equity or whether they do it in the form of debt, they're paying a lot to get fresh capital now. And some would argue that, as a private company, they will be able to get equity less expensively. ... It would be easier for them to get capital to grow because it would be decisions made by a single venture capitalist or a single investment fund rather than having to make the pitch to a whole, broad spectrum of opinions in the public markets.

In addition, being a public company can be a significant distraction. ... If you're a public company, you've got reporting obligations. You've got analysts who need to be kept informed. You've got to watch your public image. You've got to be concerned with the timing of disclosures. You've got a whole host of regulatory concerns to deal with. Your executives have to be excruciatingly careful about the timing of their stock sales and so forth. It's a complex environment to live in and to navigate in.

And when your stock is almost in free fall and you're in an environment where the public markets are highly skeptical of you and creating your problems for you, it can be even more distracting. You know, aggrieved investors file lawsuits. Well, those lawsuits have to be dealt with by the executives who are otherwise trying to run the company.

So one of the things that they may gain from going private is a chance to get back to business, to get back to what it is they set out to do, rather than trying to deal with the continuing fire storm of public markets and public investors. ...

How much of the market's souring on educational management organizations is due to Edison? In other words, what's at stake in Edison's success or failure? Does the fate of the whole privatization movement, of these kinds of companies, in some way ride on Edison? Does Edison matter in that way?

Edison does matter to them. It matters to other people who have new ideas that they had hoped to use public capital to develop. ... Today it's far less likely that a novel education company or, indeed, a company in any sector ... with a bright idea that needs financing is going to get the same reception in the public markets as it would have five or six years ago, when Edison went public. ...

On the other hand, there's the world of private equity -- that is, the people who invest in private companies and help them grow enough to become public. Apparently there's a perception that they haven't had a lot of choices available to them lately. There's a lot of investment money that's been sitting on the sidelines, looking for good things to invest in, and some of those ideas may be in the education field or in the knowledge services field. So it's unlikely we're going to see a spate of public companies rushing into the marketplace in Edison's footsteps but that merely means that a lot of the more inventive and imaginative and creative work on the business side will be done back in the venture capital world, where it perhaps more appropriately should be done. ...

It's a risky business developing a brand-new industry. You know, one thing that is often said about Edison is that it invented a new category of company. It created this field and others have expected, perhaps, to come into the marketplace in its wake. Well, they may be disappointed to find that they're not as warmly welcomed as they might have been if Edison had been a huge success in the public market. But, you know, Edison is still a large company. They still have a large flow of revenues, a large number of customers, and if someone is persuaded to invest in them in the form of taking them private that would suggest that there may be other people out there willing to invest in other novel ideas in the private marketplace.

So, it's not encouraging but it's not an obituary either. ...

Let's assume they go private. Are those private investors primarily driven by the idea of Edison as a kind of social, almost philanthropic, investment?

Well, not many venture capitalists stay in business for philanthropic reasons.

But Edison certainly did have that appeal.

It did have that appeal. I've been snooping around trying to explore what the potential sources of financing for going private would be, and ... the folks that Edison's talking to seem to be just old-fashioned money-making investors, as opposed to those who are ideologically inspired.

But the interesting thing about Edison is, people do love to talk about it. I mean I've heard anecdotes, second hand, that Whittle would call on some strictly business-like investment managers about making an investment in Edison and the first thing they wanted to talk about was the schools. I mean, there is an intrigue about it that attracts people. After all, you may be a venture capitalist but you may still have kids in school. These are things that people care about. ...

That has always been a high card in Edison's hand. The fact that they are able to approach investors with an idea, with a concept, that is kind of innately intriguing to people, has been one of the reasons, I think, that they've been given as much patience by investors ... and why the company is still around after so many years of not earning a profit.

But the environment that they're in now is different, and I don't think you're going to see folks investing for philanthropic reasons. However, I should say that private investors do have different time horizons. They are often thought of as more patient than public market investors. But they also have higher demands in terms of the rate of return that they want on their money. So they are both more patient and more demanding. And so if Edison does successfully go private, those will be its new investors, the people it will have to satisfy going forward.

How about Chris Whittle? How does he rate as an entrepreneur?

Well, as an entrepreneur, he's really had an amazing run. He generates fresh ideas, things previously unthought of, at a fairly remarkable clip -- or has in the past. I think now he would prefer to be thought of less as an entrepreneur and more as an executor of the idea, you know, as carrying it out, fulfilling ideas rather than just generating them. But certainly, throughout his career he has been widely noticed for his capacity for coming up with startling ideas that, as soon as you hear them, you say, "Well, why didn't someone else think of that?" ...

So it seems he's had to make the transition from entrepreneur to manager. How do you think that's going, or how has it gone? Is he as good a manager as he is an entrepreneur?

I think that he would be the first to tell you, no. I think he's tried to mature into someone who can hire good managers and hang on to them and let them manage. The company's transition over the past year, I think, has been evidence of the fact that he's trying to do that. He's had to shift the company's focus almost 180 degrees from rampant growth to careful husbanding of every dollar. And he seems to have been able to do that with no apparent widespread loss of morale or talent. He has been able to hold on to important executives. He's been able to attract some key new managers from outside the company to help him implement this. ... In many ways, there has been an effort to totally reshape the company culture. They say they watch every dollar, and that's certainly a change.

A lot of the criticism has been that Edison's corporate headquarters is far too expensive. In terms of the way they are controlling costs now, and imposing this financial discipline, how is that affecting the core of what Edison is? Has it had an effect?

They've done a headcount reduction of about 15 percent, certainly not a wholesale slashing but not insignificant. They say they have improved efficiencies in a number of important ways. ... They've had a sort of company-wide awakening about the importance of weighing every dollar. They've told the staff that the assumption should be that they can't sell any more stock in the current environment so every dollar that they spend is a dollar that they have to make. So they're spending, clearly, with a great deal more caution. They're also, though, looking for ways to make money on other things.

This is the interesting strategy that has been emerging in the past six months as Edison has talked to Wall Street. They're looking, for example, at significant expansion in their summer school program. Summer schools are a lot less expensive to run. They don't entail the same up-front investments. And their summer school population is growing remarkably fast. They say they are going to have 44,000 students in summer school this summer, and that's twice what they had last year. So that appears to be an area of expansion that's still within their educational mission but is a lot more profitable than running public schools during the school year. They are also developing after-school programs that districts can buy and that Edison will run. And that's another area that's profitable, doesn't require as much up-front investment, and still is within their core mission. ...

They say they are also looking more aggressively at marketing some of their intellectual properties, some of the software products and online testing products that they use in their own classrooms, selling those to districts that want to use them in their own classrooms without hiring Edison. So those are all things which give them more ways to make money without continuing on this break-neck pace of adding more and more schools every year. ...

Have they ever thought about just being, essentially, consultants? Going in, taking over a troubled school, turning it around, and saying, "Okay, you're on your own now"?

They haven't identified that as a business plan. But you're right, they've found themselves in that position unwillingly a few times. I think their awareness of that may well be what underlies this examination of how to profit from their intellectual property. ... "Okay, if you want to do an Edison-like renovation on your own, we can sell you the tools you need. ... We can give you our teacher-training curriculum. We can give you our benchmarking software so that kids can be tested every day, every week, so you can monitor how they're doing."

This is their patented stuff?

This is their intellectual property. And they're looking for ways to sell it as stand-alone products as opposed to simply applying it in the course of managing a school.

But your question is a very good one. And it's the kind of question that Chris Whittle would love to hear. That would no doubt set him off on a chain of thinking that would have everybody kind of gasping by the end of the day. ...

Another of the criticisms leveled at Edison is that they didn't have a grasp of just how tough the public education business really is. Not just the politics but the whole complexity of running the schools. Were they a bit naïve?

Some people do believe that they were. I think that in some cases the Edison executives would tell you privately that they had no idea how polarizing they would be, how much opposition they would inspire. Certainly the fierceness of the battle in Philadelphia was a surprise to them.

Now, some people -- in fact, people who are Edison backers -- at various times have complained to me in my reporting that Edison needed to have much better relationships with the other stakeholders in the school environment than they were able to develop. Some blame Edison for that, others blame the stakeholders themselves. But that's dodging the question. Edison needs a better rapport with the people who are important in public school politics than it has right now. And it's an interesting question about whether they will be able to achieve that or whether they will simply decide that charter school politics are a lot less difficult to navigate and that's where they will focus in the future. ...

Some of the specific controversies surrounding Edison seem to involve the issue of credibility. There was the SEC settlement which -- fairly or, some would say, unfairly -- called Edison's accounting into question. There is the question of how it calculates the number of schools that it runs. There is the issue of test scores and how it interprets them. There is the question of how much it spends on schools, that it actually spends more on individual schools than the comparable public schools that it competes against. Do you think that Edison, fairly or unfairly, has -- or is perceived to have -- a credibility problem?

Certainly it's no secret that Edison has attracted an enormous amount of criticism on topics like those, and that it has not been effective over the years in managing to quell that criticism. It continually confronts it. So, clearly, you have to say they do have a credibility problem that has dogged them for a number of years. I know it's quite frustrating for them.

One of the problems they face in terms of test score comparisons is that their students are being tested in 23 or so different states. They're not just comparing their kids to the school down the road; they're comparing their kids to all the different kids in all those different states. The way they're structured makes it difficult to make the kind of easy comparisons on test scores that the educational community has led people to expect. There is a big independent Rand study that everyone is waiting for, to try to discover, once you've filtered out for all of the variables that beset Edison, whether it's possible to say whether Edison students do better than comparable students in comparable schools in the same areas. And that's what we're waiting for ... that kind of scrutiny in the form of educational research on their test results.

Edison has always been candid about how it counts its schools [that an elementary and middle school under the same roof are counted as two separate schools]. I mean, people chide them for that ... but they are very up-front about it. They're required to be. They are a public company. But critics say, "Oh, well, you know, they are fudging the number of schools that they have." Well, they're not really. They're telling you how they count schools. And far more useful, and frankly on Wall Street a far more widely used metric for them, is how many students they have. And a student is a student. They count their students the same way you and I do, head by head. ...

The test scores seem to be the biggest conundrum. They have to be able to measure whether they're being effective or not. Their whole value proposition as a company, after all, is that they can do better than the existing public schools.

Right, and so they have to be able to demonstrate that they can. ... As they develop, it may be that they're going to come up with a way of presenting in-state scores, state-by-state comparisons, that will satisfy their critics. But rigorous educational research that will satisfy the most psychometrically oriented of the educational community still has yet to come and will be greatly watched for.

It is, as you point out, critically important to Edison's survival as a company that it be able to demonstrate the success of what it does. The people who work there, on the education side, are fervent in their belief that they are making a difference and that they will, sooner or later, be able to demonstrate that to a skeptical public. That's really what they have to do.

 

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published july 3, 2003

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