A Power Struggle over PowerSchool
A Power Struggle over PowerSchool
Two operators' thoughts on how a short seller report turned into a buyout offer
Hello!
As announced last week, ETCH was acquired by Whiteboard Advisors. I am looking forward to growing the next evolution of this newsletter, The EdSheet. The first edition of which will land in your inboxes in July - I will cross-post the first few EdSheets here as well to smooth the migration.
But! I have one last ETCH piece for you - a guest collaboration that was written before the acquisition and was too good not to publish. Please note that the writing and production of this post was conducted independently from the Whiteboard team.
The following essay is a rollicking account of the journey PowerSchool went on this spring, told by two neutral-but-well-informed guest authors. Delivered just in time to be read poolside, with a glass of rosé, over the holiday break.
The co-authors of this post are sharing their analysis anonymously, for reasons I agree with. I can confirm that neither is an employee of PowerSchool, Spruce Point, or Bain Capital. Neither risks any direct financial gain or loss from publishing their thoughts.
More importantly, I can confirm that what they’ve written is good. They provide a level of analysis that, sadly, we don’t get to see much of in today’s content landscape. I am willing to vouch for them and hope that you will trust my judgment here, especially after you’ve read the piece.
With that, onto the essay!
Introduction
It’s been a roller coaster for PowerSchool since their Initial Public Offering (IPO) in July 2021. In mid-May 2024, their stock price was essentially flat from their public debut, trading at $18/share.
Investors in both the public and private markets seem eager to change this, with plenty of fireworks over the past 30 days. On April 17th, 2024, Spruce Point Capital, a hedge fund with $273M in assets under management (AUM), released a scathing, 117-page report on the state of PowerSchool’s business.
This report drove a 15%+ decline in stock price over the subsequent 3-week period, though the public market analysts who cover education remained bullish. PowerSchool’s stock price continued to slide until May 8th, when someone leaked that Bain Capital was in talks with PowerSchool to buy them out for a price-per-share “in the mid-20s”, causing the stock price to soar back up. Then, on June 7th, 2024, PowerSchool and Bain confirmed the rumor and announced the take-private transaction at $22.80/share, valuing PowerSchool at $5.6B, a 37% premium to their May 7th, pre-rumor share price.
So who’s right here? Could PowerSchool have weathered a short-seller storm on their own, in an already-fragile EdTech market? Or was Bain Capital’s offer sheet a fortuitous lifeline?
Unfortunately, there is no simple answer. This essay is not about defending a price target or editorializing the outcome. (*cough* A Bain buyout was the correct path. *cough* *cough*.) We are not PowerSchool employees and do not have access to any information that Spruce Point would not have. Prospective private equity buyers like Bain would, in fact, have better access to information than us.
What we do have is experience as EdTech operators. We’ve seen battles like this fought by both our own companies and our competitors. We have a good sense of where short sellers often miss in their research. And where they often shine a helpful spotlight on the creative license companies occasionally take in their reporting.
With that as a preamble, let’s examine the 4 core claims of the Spruce Point report.
The Claims
The disagreement over PowerSchool’s stock price boils down to a simple dynamic: Spruce Point thinks the public markets are ignoring 4 red flags in the PowerSchool business, and that these red flags merit a substantial reduction in the company’s enterprise value. Most public market analysts (and Bain, probably) don’t see anything novel in Spruce Point’s research; that any legitimate risks have already been “priced in” to the company’s stock.
As professionals operating in the thick of the EdTech market, we thought it would be fun to arbitrate these positions, calling out obvious falsehoods, compelling claims, and the incentives driving each side’s narrative.
K12 Funding Environment
The Claim…
It’s no secret that the K12 US education technology market has been turbulent over the last couple of years, and will likely remain so for at least 2 more. Spruce Point believes the impending ESSER cliff will be bad news for PowerSchool, with an average reduction in district Technology budgets of 1.8%. In response to Spruce Point’s analysis, public market analysts offered a wet noodle combination of “management told us revenue will grow” and that technology budget cuts will come from hardware, not software.
Our Thoughts…
The answer lies somewhere in the middle. EdTech has been on a rough ride for the past two years and seems likely to consolidate and retract through 2026. The 2024 ESSER cliff hits in September, which means districts across the country face looming budget shortfalls.
If the ESSER cliff is not priced in, we - EdTech, not just PowerSchool - are in trouble. The 2024 deadline has been known since the day the funding was released, and both schools and vendors should have planned around it.
Fortunately, not a lot of this ESSER money was spent on EdTech and software in the first place (we think of tutoring as its own category, even when delivered virtually), though that doesn’t mean EdTech vendors are totally out of the woods.
Districts all over the country are still cutting software and consolidating vendors, often because they spent ESSER money on new staff and teacher raises that are now unfunded. Districts will do everything they can to avoid cutting back in those areas (and are prevented from cutbacks in some instances). Given this, we expect new business and retention outlooks to remain bearish in 24-25 for most tech vendors.
Furthermore, the 1.8% dip in tech budgets Spruce Point calculated in their report is temporary, based on a one-time spike in budgets during COVID. The education market writ large has actually grown at a 3% CAGR over the past 20 years. There might be some increased risk to the non-LMS products in PowerSchool’s portfolio, but there is no reason this risk should be seen as existential.
In contrast to Spruce Point, we believe that one-stop-shop platform providers, like PowerSchool, have a huge advantage in the short term, as purchasing consolidation is picking up. Districts want to buy their software from fewer vendors, meaning they are hoping to bundle core+supplemental, SIS+LMS, and front+back office product categories.
So, while the macro EdTech procurement environment shows some turbulence ahead, smart operators like PowerSchool will have seen the storm coming and forecasted appropriately.
TAM
The Claim…
Spruce Point points out that PowerSchool’s IPO filing highlights a commissioned 3rd-party study that marks the company’s Total Addressable Market at $25B. This includes $10.5B in US/Canada and an additional $15B in International TAM. In subsequent investor presentations, PowerSchool added $75B in additional TAM for what they call “Personalized Education Opportunity.” Spruce Point thinks this 4x growth in TAM is a gross exaggeration, selling investors a growth stock bill of goods that the company will not be able to deliver.
Our Thoughts…
We agree with Spruce Point that PowerSchool has been marketing an aspirational total addressable market size.
Virtually all of PowerSchool’s growth comes from their core business selling B2B SaaS software to North American K12 districts. Is it conceivable that they use their expertise in learning science to develop personalized learning products to enter the larger “Personalized Education Opportunity” market? Of course! But, we’ve seen no credible evidence from PowerSchool that they have a viable product…let alone a real right-to-win… in this space. Further, outside of a small handful of successful direct-to-consumer education businesses like Duolingo, we don’t see a lot of evidence that any business can credibly attack that market.
If we were wearing Spruce Point’s shoes, we might even have taken this criticism a step further; challenging whether or not to include the full $15B International Market. While several big EdTech companies do have global operations, their international products usually look quite different from their domestic ones and are often the result of acquisitions. We haven’t seen a truly global winner in K12 software or curriculum.
Why? Not only does EdTech face the “normal” barriers to going global in terms of internationalization of the product, building a localized brand, and hitting different price points, but it also faces HUGE cultural differences in how each country approaches education, privacy, and technology. Many of PowerSchool’s core products are deeply rooted in the American system of education and will face significant headwinds moving into new regions.
We think there’s a lot of validity in critiquing how PowerSchool presents their addressable market. That said, we also think there’s room for growth inside the core US/Canada TAM at the business’ current size.
PowerSchool Operational Execution
The Claim…
Spruce Point levels several claims against PowerSchool’s executive turnover, discounted contracts & revenue recognition. Additionally, they take issue with its founding in 1997 and the fact that they have grown through inorganic M&A “pieced together over 25 years.” If Spruce Point were an artist painting a portrait of PowerSchool, they might name their piece something like “Crumbling edifice built on an outdated and perilous foundation.”
Our Thoughts…
Overall, we feel like Spruce Point is excessively critical on this line of attack. PowerSchool has achieved a strong operational track record in executing its vision since Hardeep Gulati joined as CEO in 2015. It’s built a market-leading position and moat in perhaps the most defensible line item in a school’s technology budget - the SIS. The number of EdTech companies (public or private) that have achieved PowerSchool’s level of revenue scale is small.
While they don’t have a perfect track record of M&A, it’s hard to argue that they haven’t created a lot of value and been able to retain customers at a high rate. Acquisitions adding incremental TAM in adjacent product categories (Schoology LMS, SchoolMessenger Communications, and PeopleAdmin HR) have built a robust product ecosystem and solidified their moat. Much like vertical software M&A machines Roper Technology, Constellation Software, and Tyler Technologies, PowerSchool has stayed focused on vertical B2B SaaS segments with very sticky revenue. Bain Capital’s namesake consulting cousin points out that serial acquirers that effectively execute value-creating M&A playbooks “unequivocally perform the best.”
Spruce Point also takes a credibility hit when they try to make the case that “PowerSchool may be forced to give significant discounts to be competitive when seeking deals with large customers.” Anyone with experience in EdTech sales - or, really, experience in any sales function at all - understands the role of volume discounting. The larger the buyer, the lower the price per student. That’s how procurement works for everyone, Spruce!
If we had to take issue with PowerSchool’s executive team, we would have knocked their pitch to investors. Instead of marketing itself as a growth company with a big TAM, we would have re-focused the pitch on being an M&A machine focused on delivering SAAS margins in a sticky, vertical market.
Legal Exposure
The Claim…
Spruce Point’s risk analysis hinges on a couple of key claims. First, that the active class action lawsuit against PowerSchool’s Naviance subsidiary presents an existential risk to the whole business. Second, that PowerSchool’s Intersect product breaks various state SOPIPA laws in the way it enables colleges to “match” with prospective students. They call this collection and sale of student profiles advertising.
The analysts punt on this one and defer any commentary to PowerSchool’s management (who did respond).
Our Thoughts…
With the caveat that we are not lawyers and this is not legal advice, it is hard to see a scenario where either of these legal claims substantially impacts PowerSchool’s business.
The software tool at the center of these claims is an out-of-the-box data analytics tool called Heap. Naviance, like most EdTech companies, uses Heap, or a product similar to Heap, to measure user interactions in their product(s).
The lawsuit claims that Naviance’s implementation of Heap violates student privacy laws. Spruce Point positions this as “spying.”
Whether you believe the lawsuit or PowerSchool, we can look to the past precedent of data privacy lawsuits against companies like Google to see that the outcome is rarely more than a slap on the wrist.
The real legal doomsday scenario that EdTech operators spend their time worrying about is a data breach, such as what happened to Illuminate in 2022. But even that didn’t harm the Illuminate business to the degree Spruce Point posits could happen to PowerSchool.
In sum, we believe legal exposure is the least compelling of Spruce Point’s claims, with very little evidence that the company has a legal risk profile any different than that of other big EdTech companies.
Conclusion
We hope this essay provides more clarity to a rather opaque ownership battle.
The K12 funding environment is currently experiencing a massive shock, but one that will likely favor platforms and incumbents like PowerSchool. PowerSchool inflates its TAM by including international markets and Personalized Education (which is like “AI”, but with a tasteful lemon zest), but there’s a strong case to be made that they can still grow their TAM via acquisition. The company must face at least one lawsuit, but we do not think it will have a lasting impact on the business.
The big loser in this saga is Spruce Point.
But, Spruce Point did nail one thing: PowerSchool’s major investors, Vista Equity and Onex Partners, needed to sell a significant portion of their ownership stake in the company after 8 years of ownership.1 Spruce Point was counting on this move coming via public market sales, and, amidst these stock sales, thought they could drag down the stock price even further with their short report. Despite the amount of neon they used in the styling of their takedown deck, they do not appear to have seen the Neon Swan Bain takeover coming. Their bet looks pretty ugly at this point.
The public market analysts don’t come out of this one completely unscathed either though. Their $26/share (~$6.4B TEV) price target for PowerSchool’s stock now looks way too bullish. Bain is, of course, betting PowerSchool can reach or exceed that value, but only after some Bain-directed operational and strategic changes.
PowerSchool continuing as a publicly traded company was unlikely to make any stakeholders happy. We aren’t saying Bain was right to pay exactly $5.6B to take PowerSchool private, but we are willing to bet that their rationale for doing the deal aligns with many of the points we’ve made in this essay.
This just goes to show that experience in the EdTech investing space matters. Bain Impact, Bain Capital, and Bain Capital Ventures have all made bets on EdTech assets in the last 12 months. Their teams are filled with former operators like us.2 Spruce Point likely spent ~6 months getting to know the EdTech space. We think their diligence efforts came up short.
Note: there are some other familiar EdTech names whose ownership timeline is butting up against the traditional 5-7 PE hold window, might be worth keeping an eye on…
We understand that these teams generally operate autonomously, but we think it is reasonable to say that, at the very least, there are shared cultural values.
