The Edison Project's big mistake.

The Edison Project's big mistake.

The Edison Project's big mistake.

Moneybox
Commentary about business and finance.
Aug. 30 2002 4:45 PM

Edison's Dim Bulbs

Why is the for-profit public-education company struggling?

The theory behind the decade-old Edison Project is that capitalism can work for public schools. Founder Christopher Whittle contends that a privately run, for-profit corporation can educate students better than the government can and still return a profit for investors. Edison took the conceit a step further in 1999 when it went public without ever having turned a profit. Now, Whittle promised, the enterprise would become sufficiently profitable to survive the scrutiny of Wall Street.

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At the time, all sorts of unprofitable companies were going public and receiving outsized valuations. And, it was widely believed that public companies were the optimal mode of organization for everything from opinion magazines to Internet startups. The prevailing orthodoxy asserted that a publicly held company could raise capital efficiently from masses of investors, use its stock as currency to make acquisitions, and attract and motivate employees and executives through incentives like stock options. By relentlessly pursuing the logic of shareholder value, public companies would fulfill their mission and deliver returns to investors.

At many companies, including Edison, that theory hasn't translated into practice. Edison is struggling mightily, and it's hard not to conclude that its public status is partially responsible. Edison's experience calls into question whether a publicly held company can operate public schools and be a viable business.

Despite winning several contracts to run schools—Edison claims that its 150 schools and 85,000 students make it the nation's 35th largest school district—the company has reported mixed educational results and dismal financial ones. As of March 31, 2002, it reported an accumulated deficit of $199.4 million since 1996. And in the first nine months of this fiscal year it reported a $43 million net loss. It sports a market capitalization of just $22 million. But many of Edison's losses and expenses have nothing to do with education—and everything to do with the fact that it is a publicly held company.

While there are great advantages to being public, there are also costs associated with it. Edison holds an annual meeting at the Harvard Club, Webcasts its quarterly results, maintains an investor relations apparatus, pays listing fees to Nasdaq, and racks up accounting and legal bills associated with Securities and Exchange Committee filings. Together, such costs could add up to about $1 million a year.

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This year, Edison has also had to pay lawyers to hammer out an SEC settlement requiring it to restate results and to fend off the inevitable shareholder lawsuits that stemmed from the settlement.

Edison also spends a substantial amount of cash on its 11-person board of directors, which includes such luminaries as former New York City Schools Chancellor Ramon Cortines, former Congressman Floyd Flake, former Massachusetts Gov. (and Edison investor) William Weld, and Kennedy cousin Tim Shriver. Each of the eight outside directors is paid $22,500 per year plus $2,000 for each board meeting and $5,000 for each committee on which he or she serves. Given that the board met 13 times in fiscal 2001, each of the outside directors probably received more than $50,000. Now, public-school boards are notoriously wasteful—I bet your local board has been nailed for ridiculous perks or junkets. Even so, it's demoralizing that Edison has to spend so much money on its board that could have gone into classrooms.

School systems have an extremely low cost of capital, since they can fund school construction by issuing municipal bonds, which bear low-interest rates. A poorly managed public company, by contrast, has a very high cost of capital. When Edison lined up a $40 million line of credit from large institutions earlier this month, it had to issue warrants to the lenders for 10.7 million shares at $1 each. (The stock currently is at 41 cents.) Edison has about 53.7 million shares outstanding. If the stock climbs above a dollar, the banks will swoop in and grab 20 percent of the company for a bargain price.

Then there's executive compensation. Thomas Tocco, the superintendent of the Fort Worth, Texas, Independent School District, which has approximately the same number of students and schools as Edison, is paid $285,000. In 2001, each of Edison's top five executives—Schmidt, Whittle, President Christopher Cerf, Chief Education Officer John Chubb, and Executive Vice President Tonya Hinch—earned at least $295,000 in salaries and bonuses.

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Publicly held companies also offer extra kinds of compensation, such as sweetheart loans, that would be unimaginable in a public-school system. In the 1990s, Schmidt borrowed $1.8 million from the company. As of late last year, Schmidt had made no payments on those loans, and his indebtedness had swelled to $3 million. Whittle owes even more. In 1999 and 2000 he borrowed $7.8 million to exercise options and pay income taxes. As of last September he owed Edison $9.2 million.

Throw in two $100,000 loans to other high-ranking executives, and Edison has diverted $12.4 million in capital to its employees that it could have otherwise have used for operations. Since the loans are largely backed by Edison's broken-down stock, the chances of recouping them look slim. One can imagine a point in the not-so-distant future when that $12.4 million might be the difference between Edison remaining in business or filing for Chapter 11.

Edison also spent $10 million to acquire property on Fifth Avenue in East Harlem, where it intends to build a headquarters, charter school, and new home for the Museum of African Art. But when it bought the land, it had not received the zoning or environmental approvals necessary and had not inked deals with the Museum of African Art or with a charter school operator. The spending on the Harlem property and the unpaid loans roughly equals Edison's market value.

Edison still has hope. In August the company did gain access to $40 million in funds, and it expects to report its first net income in the fourth quarter of this year. And Edison continues to seek out and win new contracts. Even so, the stock market seems to indicate that its prospects are poor.

Edison's busted stock doesn't mean that for-profit management of public schools is doomed. Edison may be doing a better job educating the kids than the public schools they used to attend. That's something I'm not competent to judge and about which reasonable people will likely disagree. Rather, it proves that a publicly held for-profit company can be just as inefficient as a public-school board.