PowerSchool Holdings: Acquiring Capabilities

In February 2022, I concluded that shares of PowerSchool Holdings, Inc. (NYSE:PWSC) showed some power. Shares had done quite alright since the business went public in the summer of 2021, as the business has seen accelerated sales growth, unleashed by the pandemic, with margins looking quite alright.

Despite the growth and reduced expectations (read a lower share price), the lower price was not compelling enough for me to initiate a position yet.

A Recap Of IPO Day

The idea behind PowerSchool is that the adoption of technology has been lagging in the education sector. Addressing this problem, and taking advantage of the opportunity, the company pioneered cloud-based software for the so-called K12 education market.

The company served some 12,000 customers across 100 countries at the time of the public offering, with the software platform including reporting functions, compliance, special education, funding, and attendance functions, among others. Since its founding in 2015, the company has seen strong growth, albeit aided by dealmaking efforts.

In fact, the software is so widespread that the company claimed to serve 45 million students across the U.S. and Canada at the time of the offering, a number which by now has risen to more than 50 million students across the globe, with average prices per student being very reasonable at $12 and change per annum.

The company went public at $18 per share, which translates into a $3.5 billion equity valuation, a number which rose to $4.3 billion if we factor in net debt. This was applied to a business which posted sales of $365 million in 2019, on which an $8 million operating loss was reported, albeit hurt by amortization charges to some extent.

Revenues rose by 19% to $435 million in 2020 with operating profits reported at $22 million, again after amortization charges (which again were not quantified).

With resulting valuations coming in at 9 times sales and 60 times annualized operating profits, the fundamental valuation support was thin. Given this high valuation, some debt being apparent on the balance sheet, competitive forces at work, and some bad reviews regarding the quality of the software appearing online, I found it easy to not get involved.

Following the IPO shares rallied to the $35 mark in September, aided by a 41% increase in second quarter sales to $145 million on which operating profits of $16 million were reported. Third quarter sales grew by 29% to $149 million, as operating losses came in at $2 million.

With the share count increasing to 198 million shares and shares trading at $15 early in 2022, the market value had fallen to $3.0 billion, as net debt was down to $650 million, for a $3.65 billion enterprise valuation. At those valuations, shares were trading at 6 times sales and a still hefty 22-23 times EBITDA multiple. Realistic earnings power was still rather limited, resulting in a high multiple on that front.

Coming To Life

A $15 stock in February of last year has traded at lows of $12 during the summer of 2022 but actually has seen a decent rally during the second half of last year in which shares rallied to a high of $25. Following some setbacks, shares fell back to the teens again, now trading at $20 per share.

In February of this year, the company reported its 2022 results with sales growing by 13% to $631 million on which the company reported a meager operating profit of $6 million. This came after a $57 million amortization charge, for realistic operating earnings of $63 million. Net debt had already come down to the $600 million mark as an adjusted earnings number of $196 million worked down to a reasonable leverage number around 3 times.

Moreover, the 2023 guidance was quite solid with revenues seen up to $688-$694 million and EBITDA set to increase to $222-$227 million. In May, the company posted first quarter results as a nearly 7% increase in first quarter sales to $159.5 million felt a bit underwhelming. The company posted flattish operating results, after accounting for a $31 million amortization charge. In the absence of that, the company posted realistic operating profits of around $30 million, with EBITDA reported at $49 million.

At this rate, the company is posting realistic operating earnings at $120 million, and based on the full-year guidance to as much as $150 million. With net debt reported at around $670 million, a realistic interest expense over time might fall to $40 million (now trending at $60 million here). This might yield pre-tax profits of $80-$110 million which after taxes works down to earnings of $60-$85 million, for earnings of roughly $0.30-$0.40 per share.

With 200 million shares now supporting a $4.0 billion equity valuation at $20 per share and the companies commanding a $4.7 billion enterprise valuation, expectations have risen a bit again to nearly 7 times sales.

Making A Substantial Deal

In July, the company announced its next deal. The company has reached a deal to acquire K12-communicaiton tools provider SchoolMessenger in a $300 million deal, with the deal tag being equal to 6-7% of its own enterprise value. SchoolMessenger is strong in its communication platform, which provides reliable mass communication and emergency messaging services.

Unfortunately, no other financial details are announced, as pro forma net debt will increase to $970 million, pushing up leverage ratios to around 4 times here.

Concluding Thought

With PowerSchool Holdings, Inc. shares having risen a bit over the past year and first quarter sales growth being rather underwhelming, I am not too impressed right now. Based on the realistic earnings power of $0.30-$0.40 per share, the company trades at an earnings multiple of 50 times, or more, which together with higher pro forma leverage makes me certainly cautious from a valuation perspective.

Given this observation, I am happy to learn more about the impact of the deal, but fail to see the imminent appeal for PowerSchool Holdings, Inc. shares here based on the combination of slower growth, a high earnings multiple, and high leverage ratios.

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