Test Case for Tech Stocks

Test Case for Tech Stocks

Mon. Apr 12, 2004 943 ET

By Ellen McCarthy, Washington Post Staff Writer

During its short, seven year existence, Blackboard Inc. has winked and nodded at speculation that it would attempt to become publicly traded company until last month, when the online learning software maker filed to raise up to $75 million in an initial stock offering.

The reception Blackboard receives could be a harbinger for start-up companies and their financial backers, who have waited four years for a chance to tap the public markets. If Blackboard stock can make a respectable showing at its IPO and in the months following, other local tech firms may be more inclined to test the waters; if it falters, the dry spell may continue.

"I think this matters greatly to the Washington area tech community," said Mark D. Ein, chief executive of Venturehouse Group, a District venture capital firm that does not own Blackboard stock. "I think every entrepreneurial community benefits greatly from its successes."

Blackboard's success is far from a sure thing. The company was profitable in the last two quarters of 2003 after losing money for five years. Some think Blackboard is not the right company to lead the IPO charge for the tech community.

"I've got this book inside me, and it's called 'Lessons From the Bubble,' and there were none," said Frank A. Adams, managing general partner of Timonium-based Grotech Capital Group, and a veteran venture investor in both tech and non-tech companies. "I hope they [Blackboard] do get out and I hope it's wonderful, but I don't understand. As the new wave of IPOs came out, I thought it would be the best companies first. And when I say 'best,' I mean 'profitable.' "

A close look at Blackboard reveals a company that is in many ways far more stable than the dot-com companies that raised billions of dollars in IPOs from 1998 to 2000. In other ways, Blackboard is a product of that exuberant era and has many of its signature traits: venture backing, fast growth and a record of losing money.

"For a company like Blackboard, if you look at the financials, you would see a template that was similar to what you had during the 1990s," said David Menlow, president of IPO Financial Network, a Millburn, N.J., firm that analyzes public offerings.

Blackboard's quick rise, big-name contacts and charming story are likely to "bring people into the fold," Menlow said, but that does not guarantee that investors will buy the stock and hold onto it for years.

"This is not an area that the market has been very comfortable with, so there is going to be extra scrutiny on this one," he said.

Blackboard officials would not comment for this article. Officers of companies that have filed plans for an IPO with the Securities and Exchange Commission usually do not speak publicly about their businesses, to avoid violating SEC disclosure rules. Information about Blackboard comes from the company's registration statement on file with the SEC, interviews with former company officials and outsiders familiar with the company.

Growth by Acquisition

Matthew S. Pittinsky and Michael L. Chasen, college roommates and fraternity brothers, graduated from American University in the early 1990s. Pittinsky, who wanted to teach high school social studies, went on to earn a graduate degree in education from Harvard University. Chasen, a computer-science type, earned an MBA from Georgetown University. Within a few years they both were working in the educational-consulting division of what was then KPMG Peat Marwick LLP, now BearingPoint.

In June 1997, as the Internet gave rise to legions of start-ups, Pittinsky, 24, and Chasen, 25, founded Blackboard Inc.

Pittinsky and Chasen did not, unlike many of the dot-comes then in fashion, want to create online content and learning programs that could replace teachers in classrooms. Blackboard would offer technically challenged college professors a way to put course information -- syllabuses, reference sites, study guides -- on the Web.

Pittinsky and Chasen quickly raised $600,000 from angel investors and within 10 months the company completed its first acquisition: CourseInfo LLC, a small online learning company started by students and faculty at Cornell University.

Less than 18 months after its start, with about 50 customers, Blackboard landed $3.1 million in its first round of venture-capital fundraising. A month later, in December 1998, Blackboard brought in a team of industry veterans to lend gravitas to the company. Among them was Louis C. Pugliese, 42, who shared a single office with Chasen and Pittinsky when he signed on as chief executive.

"It was a crazy place to work -- a lot of young people. One of the jokes was that the first thing you had to do was assemble your desk," said Neal O. Nored, a veteran technology-business strategist who joined Blackboard as a vice president about the same time. Nored left after about a year with the company; Pugliese left within two years. It was a fun work environment, Nored recalled, but the chasm between generations was problematic.

"We had a bunch of young people and old people. . . . They were driven by adding new features and new bells and whistles and I was more driven by making the product rock-solid and reliable," he said. The overriding focus, he said, was on fast growth. "It's the first time I ever heard venture capitalists criticizing a company for not spending enough or hiring fast enough," Nored said.

The company's remarkable growth over the past seven years was driven by acquisitions intended to expand its presence on campus and lengthen its customer list.

In March 2000 Blackboard bought a Richmond-based competitor, MadDuck Technologies LLC, for $2.1 million in cash and stock. Nine months later it acquired two companies that sold systems that allow students to make electronic on-campus purchases and identify themselves for security purposes. The purchases of CampusWide Access Solutions Inc. from AT&T Corp., and CEI SpecialTeams from iCollege Inc., together cost Blackboard $29.5 million in cash and stock, according to SEC documents. In early 2002, Blackboard acquired another online learning competitor, Prometheus, from George Washington University for stock and debt worth $9 million. A year later it paid $4.5 million in cash for the assets of another transaction system, SA Cash.

The acquisitions helped bring Blackboard to about 440 employees and 2,000 customers, including international universities and K-12 schools. Revenue grew to $92.5 million last year from $69.9 million in 2002. Its annual loss shrank to $1.4 million from $41.7 million the previous year.

To keep up that rate of growth, Blackboard may have to keep buying companies, analysts said. That may be the biggest incentive for the IPO: It would give Blackboard access to capital and create a marketable security with which it could pay for more acquisitions.

A March report by industry research firm Eduventures found that the annual growth rate of the industry has fallen to 30 percent from the 50 percent to 90 percent of a few years ago. The reason for the slowdown, said Sean R. Gallagher, a senior analyst at Eduventures Inc., is that educational institutions have already made their initial investments in the technology. About 90 percent of U.S. institutions of higher education have adopted software systems to help professors put course material on the Web, according Market Data Retrieval Inc., which studies the use of technology in colleges.

"That's the saturation and that's why we have our growth rate slowing. It's not a shrinking market," Gallagher said.

Tough Competition

Gallagher, who has tracked Blackboard from its inception, said that while the company's expansion has been impressive, he is skeptical that it will be welcome on Wall Street. "Here you have a company that's going public and they're not even profitable on an annual basis," he said. But, he added, "I think Blackboard wouldn't be growing if it wasn't a high-quality system."

To grow without acquisitions, Blackboard would have to persuade existing customers to buy more applications like the debit-card transaction system or the campus portal software, find new markets or steal customers from competitors. The company says it is pursuing all three strategies.

Specifically, Blackboard is trying to sell to more international universities and K-12 schools. And Blackboard's SEC filing points out that less than 5 percent of its customers use more than two of the five software applications it offers, and the company has already introduced programs to make it easier for colleges to switch from a competitor's system to its own. Blackboard also said it plans to continue buying other companies, though it doesn't specify any targets.

There is fierce competition in the online learning business, but it is dominated by two players -- Blackboard and its closest rival, WebCT Inc. There are also several smaller companies in the market.

"Between them, Blackboard and WebCT have about 80 percent of the academic course management system market in North America, and it's roughly evenly distributed between," said Ronald Yanosky, a research director for higher education at Gartner Inc.

"The users on campus have really taken to it. Students kind of expect to see their course materials on it," said Curt T. Whittaker, associate director of computing services at Southern Oregon University.

Whittaker said Blackboard's service at times fell behind the company's growth. "It just seems that Blackboard has grown pretty quickly and their support structure hasn't always kept up," he said. At one point several years ago it took two months to get a response from the company help desk, Whittaker said. Response times have since improved, he said.

For the most part, customers agree that Blackboard's system is an effective one. According to the company's filing, 91 percent of its clients repurchased software licenses that were up for renewal last year. But there are rumblings of discontent about the cost.

In recent years, customers say, Blackboard has raised prices by as much as 25 percent for software licenses. That has taxed strapped university budgets.

"Blackboard just seems to be growing so quickly and the price has gone up significantly. I don't know how long we can sustain it at this price," James Rutkowski, director of instructional technology at Gettysburg College.

Rutkowski said he would prefer that his college use an open-source system, developed collaboratively by interested users and distributed free.

Such systems, including one developed by the Massachusetts Institute of Technology, University of Michigan, Stanford University and several other schools, are quickly getting the attention of university technology buyers.

"I think any university would be foolish if they didn't look at it," John Lane said of open-source tools . Lane is webmaster at McNeese State University, which uses Blackboard software. "It's going to boil down to increases in price. . . . Any university with a limited budget will have to look their options."

IPO Novices

Blackboard has raised $103 million through five rounds of funding. Among its biggest investors are ICG Holdings Inc., Novak Biddle Venture Partners, Oak Hill Capital Partners (a $1.6 billion Fort Worth fund started in 1999 by oil-fortune heir Robert M. Bass) and Carlyle Group of Washington.

If Blackboard's IPO succeeds, those investors stand to make millions of dollars if they cash out. Because the company has issued warrants and the venture investors control the largest blocks of stock, sales by those investors could dilute other shareholders' stakes and drive down the stock price.

(Kaplan Ventures, the investing arm of Kaplan Inc., a subsidiary of The Washington Post Co., is an investor in Blackboard; Kaplan is also a Blackboard customer.)

Representatives from those investors declined to comment.

Outside venture capitalists make up half of Blackboard's eight-member board.

None of Blackboard's senior managers has been an officer of a company that has gone through an IPO.

At age 42, chief financial officer Peter Q. Repetti is the second-oldest senior executive on Blackboard's team. He was named in a shareholder lawsuit that claimed he and other executives of Rockville-based Manugistics Inc., where he was chief financial officer, made false claims about the company's prospects and traded shares at inflated prices. The suit was settled without Manugistics or Repetti admitting to any of the allegations in the suit.

Pittinsky, the company's chairman, is now 31. Chasen, president and chief executive, is 32.

Paul T. Cook, director of technology investor Munder Capital Management, said he judges the growth and profit prospects of an IPO company before investing, and weighs the experience of senior management.

"We value a CEO who's done this before and has experience," Cook said. "Have they, in the past, taken a company into the public markets? Do they have experience running a very large corporation?" He added that the experience of the company's chief financial officer is also weighed heavily. "The ability to manage the Street is not an easy task -- that's why you want to look for somebody who has done it in the past."

Stephen A. Hoffman, who left Blackboard in March 2003 after two years as its president, and who was paid through last year, said he believes that the company is run well and that Chasen and Pittinsky have learned how to run a successful enterprise.

"There's no question it's a more mature company now than it was three years ago," Hoffman said. "I think a lot of its early years are behind it. It got a lot of the mistakes out of the way."

1April 12, 2004

From news.yahoo.com/news?tmpl=story&u=/washpost/20040412/tc_washpost/a4397_2004apr11