ELEARNING THE ENGINE OF THE KNOWLEDGE ECONOMY JULY 6, 2000 “An investment in knowledge pays the best return.” -Benjamin Franklin Brian W Ruttenbur (901) 531-3458 brian.ruttenbur@morgankeegan.com Ginger C Spickler (901) 579-4865 ginger.spickler@morgankeegan.com Sebastian Lurie, Associate Analyst (800) 366-7426 sebastian.lurie@morgankeegan.com Page of 107 MORGAN KEEGAN ELEARNING INDUSTRY REPORT Page of 107 ELEARNING: THE ENGINE OF THE KNOWLEDGE ECONOMY TABLE OF CONTENTS EXECUTIVE SUMMARY SECTION I: INVESTMENT THESIS ELEARNING FOR THE KNOWLEDGE AGE 10 LEARNING IN THE 21ST CENTURY 15 SEEKING PROFITABILITY IN THE ELEARNING INDUSTRY 20 VALUATION AND PERFORMANCE OF THE ELEARNING STOCKS 22 RISK FACTORS 26 KEY TRENDS AND SIGNPOSTS FOR INVESTING IN THE ELEARNING INDUSTRY 28 SECTION II: A TOPOLOGY OF THE ELEARNING INDUSTRY A BRIEF HISTORY: THE FORMATIVE YEARS OF THE ELEARNING INDUSTRY 32 THE BUSINESS MODELS OF ELEARNING 37 SECTION III: THE LEARNING MARKET THE ACADEMIC MARKET 50 THE CORPORATE MARKET 66 THE CONSUMER MARKET 74 SECTION IV: LEARNING TECHNOLOGIES FROM ABACUS TO LMS: THE EVOLUTION OF LEARNING TECHNOLOGIES 78 NEXT ON THE AGENDA FOR ELEARNING? 84 ELEARNING STANDARDS: CREATING A BLUEPRINT FOR THE FUTURE 89 CONCLUSION 98 Page of 107 MORGAN KEEGAN ELEARNING INDUSTRY REPORT Page of 107 EXECUTIVE SUMMARY The following is a summary of the four main sections of the report For more information on any of the topics mentioned in this summary, please refer to the corresponding section in the body of the report Section I: Investment Thesis eLearning will be critical to the success of individuals, organizations, communities and economies in the dawning knowledge economy Much touted are the benefits of the Internet for the various functions of organizations ranging from procurement to marketing to customer service However, the digital age has spawned an overwhelming mass of raw information that is frequently difficult to retrieve and to use We argue that the critical and distinguishing strength of countries, organizations, and individuals lies in their intelligence and knowledge in this new economy Network technology has enabled a proliferation of customized and timely educational tools that optimize investment in human capital: eLearning solutions facilitate the delivery of the right information and skills to the right people at the right time The globalization of the economy, shortage of skilled workers, free agent mentality, new flexible work situations (telecommuting, for example) and numerous other factors have created problems not easily solved by traditional education, spurring the initial growth of the eLearning industry Companies in this space are addressing these problems using technology-based learning resources targeting the academic, corporate, and consumer eLearning solutions facilitate spheres with managed, interactive, just-in-time, current, and userthe delivery of the right centric education tools These factors, and others, set the stage for information and skills to the what we believe are exceptional investment opportunities in the right people at the right time eLearning space Although profitable Internet companies are still few and far between, we think that, with rapid top-line growth and highly scalable business models, select eLearning companies should reward investors with significant returns • Rapid Top-Line Growth: We estimate that expenditures by organizations on education in the United States alone exceed $750 billion and worldwide reach $2 trillion Swelling demand for educational products (particularly U.S products), a shortage of teachers and other learning resources, and the centrality of education in the knowledge economy should drive growth in the education and training industry Revenue growth for eLearning should considerably outstrip revenue growth in all sectors of the education industry as eLearning companies capture an increasing share of the industry total In the corporate space alone, IDC is projecting eLearning revenues to grow from right around $1 billion in 1999 to $11.4 billion in 2003 We expect growth in the academic and consumer markets to be significant as well • Highly Scalable Business Models: We believe that eLearning companies will benefit from the same favorable cost structures that other “e” businesses, in theory, will Whereas traditional education and training providers have high fixed costs in the form of real estate and high G&A expenses, eLearning companies are considerably leaner An eLearning company is also likely to be better able to leverage its content over a larger We believe that the maturation body of learners, as they are generally not reliant on live of the industry should bring instructors for delivery of their services Over time, we expect declining costs and, therefore, that more and more content will be developed in the form of increasing profitability learning objects that can be assembled on the fly into highly customized courses, analogous to a just-in-time inventory system We believe that the maturation of the industry should bring declining costs and, therefore, increasing profitability Page of 107 Given that most of the players are still losing money, traditional profit-based valuation techniques will not be effective in the early stages of the eLearning industry Since first-mover advantage, market share, and the possibility of leveraging costs will be central to determining the winners in this industry, we think revenue-based valuations are most germane However, given the variety of companies competing in the space and the rapid evolution of the space itself, companies will succeed due to a variety of competitive advantages Therefore, treating revenue as a predictor of profitability is an exercise that must be conducted with care and must be tailored to specific companies Section II: A Topology of the eLearning Industry The eLearning industry has emerged only within the last couple of years, and like many new high-growth industries, it is highly fragmented and populated mainly with young, unprofitable start-ups and a few of the more traditional companies in transition to e-companies Many of the younger players are getting financial support from venture capitalists, who We expect that today’s have invested a total of $6 billion in education and training companies since relatively small public 1990 Of this figure, $931 million was invested in the first quarter of 2000 company comp group alone, with 64% going to eLearning companies in particular Given this will grow significantly growing support from the financial community and assuming continued over the years product adoption by customers, we expect that today’s relatively small public company comp group will grow significantly over the years eLearning companies are difficult to categorize because they offer such a wide range of products and services to a number of different target markets, using several different revenue models In broad terms, we divide the industry into three main categories: content, services, and technology However, we have developed a unique “eLearning matrix” which allows a company to also be characterized by which sector of the learning market it serves (academic, corporate or consumer) and by what type of revenue model it employs (contracts, pay-per-use, or ads/sponsors) We also break down the content, services and technology categories into several subcategories, which enable a more detailed look at a company’s business model Section III: The Learning Market Our method of analysis divides the overall learning marketplace into three main categories: academic, corporate and consumer Each of the three categories is characterized by different drivers of growth that, when considered in aggregate, suggest the potential for sizable growth in the overall learning market We believe that each of the three sectors presents a set of unique challenges to the eLearning vendor community in terms of providing the products and services that will truly meet the needs of learners • The Academic Market: In the U.S alone, 76 million people (more than a quarter of the population) are directly or indirectly involved in providing or receiving formal education from the pre-primary level through the upper reaches of higher education Educational expenditures in the U.S are second only in size to healthcare, and Educational expenditures represent 7.3% of the GDP These expenditures have grown by over in the U.S are second 42% since 1991 While efforts have begun in recent years to use only in size to healthcare, technology as an instructional tool, we believe that the academic and represent 7.3% of the world has barely scratched the surface in terms of utilizing the GDP Internet to improve academic performance Growth drivers of the academic market include • • • • a growing student population as a result of both changes in demographics and greater rates of participation in the upper levels of education; public demand for a more effective education system that will prepare students to be competitive in the knowledge economy; a shrinking base of teachers, as expertise is better rewarded in the private sector; and increasing international demand for U.S higher education Page of 107 • The Corporate Market: In 1999, U.S organizations spent more than $62 billion on training-related resources, salaries, and technology Other estimates put government spending on training at $40 billion While the eLearning component of these expenditures totaled only about $1 billion, all indications are that training in the future will be delivered less and less by instructors in a classroom and increasingly by networked technology All areas of the workplace, from the manufacturing line to the boardroom, are beginning to see this type of shift For the same reasons that businesses have come to rely on technology-based systems to manage their human resource and sales efforts, we believe that the task of managing a company’s training initiatives will increasingly fall to learning systems that are integrated into the enterprise framework Some of the key growth drivers for eLearning in the corporate market include • • • • a shrinking labor pool and, at the same time, an increasing demand for skilled labor, particularly in technology-related fields; organizations’ need for learning resources that are both accessible and timely; and globalization of the enterprise demands flexible training programs The Consumer Market: In the consumer market, we include not only “lifelong learners” pursuing avocational learning experiences (gardening or wine selection, for example), but also individual professionals who seek out educational opportunities either because it is mandated for or is conducive to the purpose of career advancement The size of the consumer learning market is much harder to pin down, but we believe that it could eventually prove to be one of the largest growth markets for the following reasons • • Consumers who currently use the Internet for informally researching avocational interests will transition to more formal educational opportunities as the quality of content itself and the method of delivery improves The flexibility of eLearning will draw those requiring and/or desiring professional continuing education Section IV: Learning Technologies We believe that education is one of the last bastions of society that has been largely unchanged by the technological advancements that have revolutionized almost every other facet of life Certainly we have seen technology begin to pop up in the world of education and training in recent years However, in academia, computers are generally utilized as expensive typewriters, and in the corporate training world, computer-based training has generally been limited to stand-alone, linear course modules that typically elicit a groan of boredom from users However, as a result of the ubiquity and growing capabilities of the Internet, we believe that technology will increasingly play a role in learning across all sectors of the market Web-based collaboration tools enable people in far reaches of the world to share an educational experience, while sophisticated learning management systems allow a As a result of the ubiquity and user’s progress and preferred instructional style to be tracked so that growing capabilities of the adjustments can be made to a personalized curriculum in order to Internet, we believe that effectively address learning objectives Technologies such as these technology will increasingly are in use today, but are, we believe, a pale version of the play a role in learning across manifestations of eLearning that we are likely to see in the future all sectors of the market Beyond technologies that are specific to the field of learning, we believe that advancements in the overall capabilities of networked technology (e.g., broadband access, wireless networks, etc.) will serve as a catalyst for acceptance of eLearning technologies on a more widespread basis in all markets Such improvements will make user concerns about the capabilities of the technological medium secondary to actually providing meaningful educational experiences Page of 107 Finally, we believe that the emergence of a set of open, industry-wide eLearning standards will be a critical turning point for the industry as a whole eLearning standards will allow learning content to be easily accessed and reused in various formats and will enable the interoperability of learning technologies from different vendors Virtually no emerging industry has ever experienced dramatic growth without the acceptance of a set of common standards on which all product and service offerings are based We expect that the eLearning industry will be no different Conclusion We believe that the eLearning industry holds much promise for profitable investments over the coming years However, given the immature state of the industry, the wide array of target markets and the difficulty of keeping up with changes in learning technologies, we believe that discrimination is warranted Careful research must be undertaken in order to determine which companies will eventually emerge as winners, and we believe that this report addresses the issues that will be key in making investment decisions Page of 107 SECTION I: INVESTMENT THESIS In this section: • The information age becomes the knowledge age, driving investments in human capital • How eLearning addresses the needs of the knowledge age • The potential for profitable business models in the eLearning industry • Valuing the emerging eLearning industry • Cautionary points regarding investments in eLearning • Our outlook for the industry Page of 107 Learner Related: The main purpose of the movement to develop learning standards is to create a more effective and efficient way for people to learn using technology The learner-related standards focus on creating a connection between the learner and the technology (and its developers) The working and study groups involved in this effort are working to create standards that will aid in characterizing, identifying, and tracking learners, and in profiling their competencies The availability of this information will enable the development of more appropriate instruction for the learner More specifically, the standards will deal with • • • the language used in a “Learner Model” that will maintain a characterization of the learner, including such attributes as knowledge, skills, abilities, learning styles, records, and personal information This will create a sort of electronic learning portfolio that can be used by the learner throughout his lifetime to enhance learning experiences; a means for identifying learners for sign-on and record-keeping purposes; and the components of a user-centered system that will aid in the process of managing life-long learning It will help with goal-setting, planning, execution, tracking, and documentation in order to provide learners with guidance that will help them achieve independence in reaching learning goals, as well as provide documentation of achieved competencies But Don’t Forget the Technical Standards Everything we have discussed thus far has been in relation to learning standards, but also critical to the adoption of industry-wide learning standards are the technical standards on which they will be based The standard that is emerging as the format for the exchange of eLearning information over the Internet is XML (Extensible Markup Language) Whereas HTML (Hypertext Markup Language), the publishing language of the Web, tells a system how to present (format) content on a page, it is unable to tell the system what the content is For example, HTML can’t pick out the name of the author or the price of the course from a Web-based eLearning catalog XML, on the other hand, uses tags that describe the various elements of a page’s content In other words, XML enables the separation of content from its formatting XML could, for example, allow a search of the contents of all the various eLearning catalogs from different vendors, no matter how they were formatted, and XML is key to the return a list of all of the courses on a certain subject, along with their reusability and prices and other information As another, and probably more powerful, customization aspects of example, a piece of content from one course, say a simulation exercise, eLearning can be plucked out and reused in a different course XML is key to the reusability and customization aspects of eLearning We should specify, however, that XML is not unique to the eLearning industry, but rather has been developed by the W3C consortium as a standard that can be adapted by various industries for their particular needs We emphasize that XML is a standard for creating a specified markup language and is not a language itself The key goal of XML is to enable the automation of information exchange, and is particularly suited to business-to-business transactions and integration of data Any entity with a need to exchange data among its members (e.g., a company, a supply chain, or an industry) can establish a common “vocabulary” that is used to tag information Many groups, including the ones involved in the development of eLearning specifications, have already begun this process, creating languages for the exchange of information on everything from genealogy to chemistry Because XML is relatively simple and inexpensive to use (in terms of both programming and implementation), we believe that it will experience adoption levels above those of some of its predecessors that were designed for similar purposes Page 94 of 107 Learning Standards Summary Just to review, we believe that the key benefits of the emerging learning standards are the following • • Tagging material with metadata will make it much easier to find and deploy the appropriate learning material and to track its use Standardization will allow you to use instructional material in any management system • Standardization will enable the granularization of content (its breakdown into smaller learning objects) so that content can be reused in various customized courses • Standards can help make courses richer and more effective by allowing the instructor to track and adjust the courses immediately based on student performance • Standardization can help create a commercial infrastructure for the development, sale and distribution of instructional material throughout the world We believe that each of these issues is critical to the large-scale commercial implementation and acceptance of eLearning Fortunately, learning standards are well on their way to becoming a reality and some vendors are already incorporating the specifications on which they’ll be based into their products The next major hurdle for the industry is to increase the awareness of learning standards among potential customers We believe that customers who understand the significance of standards and the related issue of interoperability will be much more willing buyers of eLearning Page 95 of 107 MORGAN KEEGAN ELEARNING INDUSTRY REPORT Page 96 of 107 CONCLUSION Page 97 of 107 CONCLUSION In this report we have presented an in-depth examination of the eLearning industry with an eye to uncovering the exciting investment opportunities it offers We first argued that with powerful growth in demand for eLearning products and services, exceptional leveraging opportunities, and with thorny issues of valuation notwithstanding, the eLearning space should provide excellent returns for investors We then established a system of classification for companies in this space and divided the public and private players accordingly in terms of the principal markets served, core offerings, and revenue models In the third section we discussed our projections for the academic, corporate, and consumer markets In the final section, we explored the technology behind this industry past, present and future and discussed the crucial issue of industry standards While we believe it is important for investors to have a thorough understanding of all these issues, the bottom line is that we are recommending investments in the eLearning industry because we believe that the learning industry is set for rapid growth and that technology will transform this industry, as it has many others eLearning Addresses the Learning Needs of the 21st Century We believe that eLearning stands at the crossroads of the information economy and the knowledge economy While the Internet generates an unwieldy excess of information, it also enables products that can empower workers, students, and private individuals to harness this information We expect networked technology to transform learning just as it has virtually every other technology • eLearning is not simply a new way to carry out the same old education and training activities that have driven the learning process for centuries, but rather is a fundamentally more efficient and effective way to organize and deliver knowledge resources to businesses and individuals competing in the knowledge economy • For organizations that need to deliver learning resources, eLearning allows scalability, accessibility and timeliness – issues that are critical to global enterprises operating on Internet time • For learners, eLearning provides a learning experience that is personalized, interactive, just-in-time, current and user-centric eLearning Will Experience Powerful Growth We expect that eLearning companies will spearhead the growth of the learning industry that was kicked off during the late 20th century The eLearning industry will be pivotal to the economy and society as the ability to learn becomes the core and defining capacity of organizations and individuals • Comprised of academic, corporate and consumer sectors, the learning market is huge • Growth of the learning industry has occurred because the products and services it offers address the large (and rapidly growing) demand for human capital Human capital is the key to success in the knowledge economy • The for-profit eLearning companies that are targeting these sectors have only cornered a minute portion of the market but capture a rapidly expanding share of this growth industry The information contained herein is based on sources considered to be reliable but is not represented to be complete and its accuracy is not guaranteed The opinions expressed herein reflect the judgment of the author at this date and are subject to change without notice and are not a complete analysis of every material fact respecting any company, industry or security Morgan Keegan & Company, Inc and its officers, directors, shareholders, employees and affiliates and members of their families may make investments in a company or securities mentioned herein before, after or concurrently with the publication of this report Morgan Keegan & Company, Inc may from time to time perform or seek to perform investment banking or other services for, or solicit investment banking or other services from any company, person or entities mentioned herein Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any security Page 98 of 107 PUBLIC COMPANIES MENTIONED IN THIS REPORT NOT ELSEWHERE PRICED (Price as of 7/5/00) 3Com (COMS - $57 9/16) Advantage Learning Systems (ALSI - $16 3/4) Amazon.com (AMZN - $36 1/2) America Online (AOL - $54 3/4) American Education Corp (AEDU - $0.5625) Apollo Group (APOL - $30 3/16) Arel (ARLCF - $10 1/8) Aris (ARSC - $2 7/8) Caliber Learning Network, Inc (CLBR - $4 1/8) Charles Schwab Corp (SCH - $32 11/16) Cinar Corp (CINRE- $7) Cisco Systems (CSCO - $61 7/8) Dell Computer Corp (DELL - $47 7/16) Eduverse.com (EDUV - $0.5001) eKnowledge Group (EKNO - $3) FatBrain.com (FATB - $6 13/16) Futurmedia PLC (FMDAY - $1 1/2) General Electric (GE - $49 13/16) HealthStream (HSTM - $5 13/32) IBM (IBM - $104) Infonautics (INFO - $4 5/8) Intel Corp (INTC - $131 5/8) Lands’ End (LE - $34 7/16) Microsoft Corp (MSFT - $78 1/2) National Computer Systems (NLCS - $48 5/16) Oracle Corp (ORCL - $72 5/16) PLATO (TUTR - $14) Riverdeep (RVDP - $19 3/8) Scientific Learning (SCIL - $21 13/16) Sun Microsystems (SUNW - $86 1/2) Yahoo Inc (YHOO - $120 13/16) Youthline USA, Inc (YLNE - $3) Page 99 of 107 Page 100 of 107 Page 101 of 107 Page 102 of 107 Page 103 of 107 Page 104 of 107 Page 105 of 107 MORGAN KEEGAN ELEARNING INDUSTRY REPORT Page 106 of 107 RESEARCH STAFF David M Guthrie, CFA – Director of Research (901) 529-5430 Geoffrey D Check, CFA – Assistant to the Director (901) 579-3525 CONSUMER SERVICES Retailing John R Lawrence Kevin C Sowers – Associate Analyst (901) 579-4203 (901) 531-3227 Softlines Rick L Snyder Leah M Hollstein – Associate Analyst (901) 531-3261 (901) 531-3397 Leisure and Recreation Robert DeLean William R Renovich – 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David Traywick - Associate Analyst (901) 531-3377 Air Freight/Railroads Arthur W Hatfield Danna E Wright – Associate Analyst (901) 579-4868 (901) 531-3461 www.morgankeegan.com U.S.: 1-800-366-7426 U.K.: 0-800-892-028 Canadian: 1-800-654-4528 MORGAN KEEGAN was founded in 1969 to provide sound investments for investors and to raise capital and provide advisory services to corporations, governments and institutions As a result of the success of this original mission, Morgan Keegan has developed an international business with specific focus in the following industry sectors: consumer, energy, healthcare, transportation services, technology, real estate and financial institutions Morgan Keegan has focused its research, investment banking and trading resources in these sectors and will continue to build depth of service in these sectors for the benefit of investors, corporations and institutions Page 107 of 107 [...]... consider the fact that they are often not reusable outside of a narrow context We believe that the concept of eLearning addresses a number of these issues, and below we will examine in greater detail the primary benefits of eLearning The Benefits of eLearning (or, Everything I Needed to Know I Learned on the Internet) The main benefits of using networked technology for learning are, we believe, fairly... learner, instead of on the abilities of the instructor With eLearning, the the needs of the learner is able to participate in custom-fitted learning experiences that learner, instead of on offer the exact material she needs in the form in which she learns best the abilities of the The instructor, if there is one, goes from being the “sage on the stage” to instructor the “guide on the side.” We believe that... in their old business models to meet the learning needs of the 21st century, the vast majority of companies that fall under the heading of eLearning are relative newcomers to the scene Being a newbie in the world of eLearning has both its ups and downs The vast majority of companies that fall under the heading of eLearning are relative newcomers to the scene • Advantages: Start-up eLearning companies... analysis of how each will fit into the eLearning marketplace Teaching Old Dogs New Tricks Several of the companies that we include in the eLearning group today emerged from the more traditional education and training sectors While the core competency of these companies (educating people) did not change with the advent of the Internet age, their methods of reaching their customers had to if they were to... library of content will be rendered obsolete with the next product needed to make release We believe that only the industry- wide adoption of a set of significant eLearning standards, which create interoperability between tools and content, will purchases when they create this assurance are free from the concern that a certain • Legal Issues: As learning is essentially the transfer of knowledge technology... attempt at generating The larger technology hype Rare (and probably nonexistent) is the “exclusive” companies will play a role in agreement with any major technology company However, we the growth of the eLearning believe that as the players with a clear edge on the competition industry, and we believe it begin to emerge from the pack, we will see select cases of will be through relationships eLearning... model of learning imparts • more responsibility to the learner, resulting in a richer and more dynamic experience Page 16 of 107 If Aristotle Had Been an “eInstructor” We believe that the above attributes certainly make eLearning an exciting proposition for the learner However, the learner is not today (and we believe never will be) alone in the learning process The instructor, whether it be a second... to the Success of eLearning In order for any of the above benefits of eLearning to be realized, however, we believe that a set of eLearning standards must be developed and accepted by the vendor community In order to achieve true sophistication in terms of understanding the objectives of a learner and addressing those objectives with a highly customized program of learning, all of the components of. .. new needs of the learner On the other hand, a CD-ROM is static, requiring a new product to be distributed anytime there is a We believe that change in the material eLearning introduces an entirely new model User-centric: Finally, we believe that eLearning introduces an entirely for learning – one that new model for learning – one that focuses primarily on the needs of the focuses primarily on learner,... have the content and services stocks underperformed technology stocks since the beginning of the year? As we argue in our report, the eLearning technology companies provide the “backbone” of the industry and therefore have been the first group to experience rapid and potentially predictable revenue growth We believe that once the technology backbone is better established this sector will undergo a dramatic ... number of these issues, and below we will examine in greater detail the primary benefits of eLearning The Benefits of eLearning (or, Everything I Needed to Know I Learned on the Internet) The main... INDUSTRY REPORT Page of 107 ELEARNING: THE ENGINE OF THE KNOWLEDGE ECONOMY TABLE OF CONTENTS EXECUTIVE SUMMARY SECTION I: INVESTMENT THESIS ELEARNING FOR THE KNOWLEDGE AGE 10 LEARNING. .. their attempt to leverage the Internet in the learning space There are a multitude of niches to be exploited, and we believe that many of these start-ups have the potential to essentially create