June 23, 2008

Nine Page Report

Investools’ Announcement Creates

Investment Opportunities In Online Financial Sector

By Michael Markowski

          I.                   Introduction

Investools, (NASDAQ:SWIM:$8.23) the leader in the Investor Education Industry  made a surprise announcement that sent its shares and the shares of TheRetirementSolution.com (OTCBB:TRES $0.11) tumbling to new 52 week lows.  At first blush the announcement appeared to be a huge negative for the Investor Education Industry and the industry’s two publicly traded companies.  However, after doing my research I have concluded that the shares of both companies are a “buy.”  Before I get into the nitty-gritty on why, let me disclose that I have been very bullish on this industry (See my articles “From Supporting Role to Romantic Lead” and “Cyber Gains” in Equities Magazines’ September 2007 and March 2008 issues respectively) and that I currently hold shares in both companies.  

II.                Investools Announcement and the Repercussions

Investools (NASDAQ:SWIM) in its May 14, 2008 press release reiterated the recently announced change to its business strategy and business model (initially announced on May 1, 2008) stating that it is de-emphasizing its investor education business and will no longer operate it as a profit center.  On its May 1, 2008, announcement, Investools shares fell from $12.48 to as low as $6.90.  Investools shares had previously reached an all time high of $18.23 in December of 2008.    

The company also indicated that it will change its name to Think or Swim Group (TOS) and will move its investor education business from Salt Lake City, Utah to Chicago, which is the headquarters for TOS, the online broker that it acquired in 2007.  The company also announced that it intends on using its investor education business as a marketing tool to generate new customers for TOS. 

I believe this move is evidence that the management of Think or Swim (TOS), the online broker that the company acquired in 2007, has taken control of Investools.   Before going into more detail as to why Investools is exiting the Investor Education Industry, I would like to cover why Investools shares were able to go up almost 100 fold from $0.20, in 2002, to over $18.00 in 2007 and why I still believe investments in the Investor Education Industry could continue to provide these kinds of returns over the next five to fifteen years. 

III.             Origins of Investools and Industry

Prior to 2002, Investools was a company, which was experiencing flat revenue growth.  Its cumulative losses or deficit for 2001 and 2002 were $85 million.  The Company then made a strategic decision to enter into relationships with third party marketing partners.  These partners agreed to pay for all of the advertising and marketing costs so that customers or students could be acquired.  It was a simple arrangement.  The partners would dedicate their capital to go out and get the students and Investools was responsible for educating them.  Under this arrangement Investools was not required to expend any monies for customer acquisitions.  For taking the risk in acquiring the students the marketing partners got between 40% and 50% of the revenue and Investools got between 50% and 60%.  

Due to the nature of those businesses participating in the Investor Education Industry , especially those, which primarily offer intense two or three day courses instead of courses ranging over weeks at a time, the foundation to develop very lucrative and profitable partnering relationships was born.  The reason why the relationship was a win-win for both the company and its partners is because neither the company nor its third party marketing partners had to make any capital expenditures or enter into any long term leases to teach the students who purchased courses.  They collected the tuition and rented hotel rooms to teach the one to three day courses.  The business model was brilliant.  It was unique and efficient.  Due to its great cash flow dynamics educating investors is an even better business than selling illegal drugs on a street corner.       

With no need for capital to support aggressive selling and marketing activities and due to the boom in new hotels across the USA, Investools and its partners were poised to capitalize on the growing dissatisfaction with traditional brokers by the investment public.  Enron’s collapse with over 20 brokerage firms having a “buy” recommendation on its stock was the straw that broke the camels back.  The seeds for un-interruptible growth had been planted.  Between 2002 and 2006, Investools’ revenue grew five fold from $56 million to $252 million.  Investools’ partners were also happy.  In 2002 alone, Investools paid its partners $48 million according to its SEC filings.  

In 2006, Investools decided to change its business model for two reasons.  Firstly, it wanted to decrease its dependence on its third party marketing partners because it was paying them over 40% of all the revenue that they were generating.  This is not the first nor will it be the last time that someone will attempt to kill the goose that lays the golden eggs.  The second is that it found that it had significant referral power with all of the thousands of its graduates. 

One of the biggest reasons why I am very bullish on the Investor Education Industry stems from discussions that I have had with numerous players in the industry.  In every single discussion that I have with individuals who work in the industry I learned that a powerful bond develops between the student and the instructor who enlightens the student on how to invest.  Therefore, the instructor has significant credibility with his or her graduates and can easily refer them to providers of financial services.

Up to 2006, Investools was referring its students to specialty online brokers such as Options Express Holdings (NASDAQ:OXPS) before it acquired Think or Swim (TOS), which is Options Express’s main rival.  For referring the customers to the brokers Investools was paid a small referral fee.  The problem that Investools had with these arrangements is that it was doing all the work and getting very little of the action.  It was not able to fully leverage the relationships or referral power that it had with its students. 

The commissions that the online brokers generated from the students, that Investools’ were referring generated revenue and profits for the brokers that dwarfed what Investools was receiving from them in referral fees.  This is because SEC rules and regulations do not allow brokers to share their commissions with non-brokers under any circumstances.

To fully leverage the referral power, Investools made a decision to purchase the privately held Think or Swim online brokerage firm in late 2006.  The acquisition was paid for with cash, which Investools borrowed from J.P. Morgan Chase, and stock in March of 2007.

By the middle of 2007, Investools’ business model had completely changed.  It now offered on line brokerage services.  It was utilizing a lot of its own capital or cash flow to advertise and market its investor education products and services.  It appeared as though the merger was a marriage made in heaven.  The results that TOS has been getting since the merger was completed have been nothing short of spectacular.  The metrics below were pulled from Investools’ press release for its first quarter ended March 31, 2008: 

            -- Record brokerage revenue of $42 million, up 109%.

            -- New accounts opened of 24,800, up 46%.

            -- New accounts funded of 10,550, up 30%.

            -- Funded accounts totaled 66,950 as of March 31, 2008, up 124%.

            -- Retail DARTs of 45,400, up 199%.

            -- Active Trader DARTs of 41,900, up 102%.

            -- Total client assets $2.69 billion, up 89%.

Additionally, since the combination, the metrics for TOS brokerage customers have steadily climbed to an average of 177 trades per year per customer.  This compares to 40 trades per year per customer for Options Express Holdings, its nearest competitor and approximately 12 trades per year for online brokers such as Ameritrade and Etrade.

IV.              The possible logic behind a change in Investools’ strategy

Investools’ May Day announcement shocked investors.   I have been tracking and monitoring the company over the years for friends, family, StockDiagnostics.com subscribers and most recently Equities Magazine readers.  I decided to dig deep into what was going on with them and the Investor Education Industry because I could not see the logic in their change in strategy. 

What is perplexing to me is why a leader in an industry (Investor Education) such as Investools would abandon such a lucrative and fast growing market, particularly since this segment represents +70% of its 2007 total revenue.  Investools in its announcement on May 1, 2008, did state that it believed that the economy was having some negative impact on its investor education business. Interestingly, this “decrease in their sales” explanation also coincides with the significant change in the sales and marketing strategy, which it implemented after it purchased TOS in 2007.   

I also found that Investools’ laying the blame for the downturn of their investor education business metrics on the Investor Education Industry as the reason for their exit from the industry was suspect at best.  This is especially since its CEO Lee Barba indicated, in an interview with Equities Magazine that was published in its April 2008 issue, that all was well with Investools and the industry.    

My hunch is that Investools is exiting the Investor Education Industry because with its purchase of online broker Think or Swim in 2007 it now must operate as a broker dealer.   Owning an online broker dealer hampers or severely restricts the company’s ability to compete with other non-broker investor education providers for two reasons:

1.      Broker dealers, which is now what Investools has become, have to abide by securities laws and regulations in conducting their advertising and marketing activities.  The laws and regulations that brokers are subject to are much stricter and different than the laws that stand alone investor education companies have to abide by.  Investools learned about this the hard way as it only recently announced that the SEC had launched an investigation on several of its instructors.  Conversely, non-broker or stand alone investor education providers are not subject to securities laws and regulations.  They are protected by the 1^st Amendment of the U.S. Constitution (Freedom of Speech) and brokers are not.  It’s just that simple.       

2.      Third party marketing partners are not allowed to share in the commissions generated by the customers that they send to brokers.  Thus, Investools has no way of motivating its marketing partners who were instrumental in its growth from $56 million in revenue in 2002 to $252 million in 2006.  Attempting to continue to grow its education business without having access to these partners would have been difficult at best.  This was probably behind their decision to kill the golden goose

Another contributing factor to Investools’ decision may have been that its new advertising and marketing strategy that it implemented after it purchased TOS was not successful.  Investools had no experience in advertising and marketing campaigns and yet according to Lee Barba, its CEO, the company was spending more on television advertising than Merrill Lynch.  After relying on third party marketing partners to increase its annualized revenue by almost $200 million between 2002 and 2006, it decided to forge ahead on its own.  I believe that this change in its marketing and advertising strategy contributed to the downturn in Investools’ education business.           

If one uses simple logic an understanding of Investools’ ejection of its investor education business makes sense.  If a company has two businesses and one of them is firing on all eight cylinders and the other is firing on four, it’s a simple decision.  The decision was even made easier for Investools when they came to the conclusion that having to abide by securities laws and regulations severely hampered their ability to grow and maintain their investor education business.  It was easy for Investools’ management to lay blame on the industry and the economy as their reason for a quick exit from the Investor Education Industry. 

V.                 Current status of Investor Education Industry

In doing my due diligence on the state of the industry for this report I checked with several other stock market investor education providers.  Due to Investools’ expenditures on a major television advertising campaign, the reduction of its prices and subsequent downturn of its margins and the increase in its customer acquisition costs, I expected to find that the industry was in a state of disarray.  Instead I found that the industry players that I talked to said that competition within the industry had intensified, but at the same time each expected to report record results for 2008.  Expected record results by a multiple number of participants in an industry indicate that it is vibrant and growing. 

All of the metrics for Investools’ competitors, which I communicated with, including prices, profit margins, customer acquisition costs and even the commission splits with third party advertising and marketing partners, remain stable.  Based on the others in the industry that I communicated with there does not appear to be any slowdown in the growth of the Investor Education Industry. 

Most importantly, as viewed in a longer term frame, the investor education services space has barely been penetrated in the last seven years.  There are less than one million individuals who have attended investor education seminars and courses as given by Investools and all its competitors since 2002. The US market alone is made up of a potential 20 million online investors and 90 million mutual fund investors.  Also, the dynamics driving long-term secular growth in the Investor Education Industry are quite powerful.  Underlying these dynamics are the demographics of the post world war baby boomers:

·        There is a significant transfer of wealth underway.  Every minute of every day someone is inheriting wealth.

·        Millions are retiring with 401Ks and IRAs.  Over the next 10 years many who have never invested before will have portfolios, which will require management.    

·        The continuing erosion in the credibility of the traditional broker especially since a lot of their clients were sold pools of sub-prime mortgages.

·        The continued under performance of mutual funds and money managers.  More than 80% of the mutual funds under perform the stock market. 

With these powerful dynamics and the demographics driving them I just could not conclude that the industry was running out of steam.  It is just not logical for an industry that has been significantly under-penetrated to experience any type of downturn whatsoever regardless of what is going on in the economy.  It would be like saying that the software industry, which has grown steadily for the past 30 years, was going to be affected by the economy when it was in its infancy.  Thus, I give little credence to Investools’ announcement that the economy is having a significant impact on the Investor Education Industry.

VI.              TheRetirementSolution.com is well positioned to become the new leader in the Investor Education Industry

Investools’ decision to exit the Investor Education Industry opens the door wide for TheRetirementSolution.com (TRES).  Its shares currently trade for pennies on the Over The Counter Bulletin Board under the stock symbol TRES.  After Investools made its May 2008, announcements, TRES shares tumbled to new all time lows.  The following are the reasons why I believe that TheRetirementSolution.com is best positioned to become the leader in the Investor Education Industry:

1)                  CEO Nick Maturo, who is totally fluent in English, French and Italian, spent 20 years with Philip Morris/Kraft Foods.  He was the CIO of Kraft Foods International when he retired in early 2000.  For most of his career with Kraft, Maturo lived in the US, Canada, Switzerland and Italy.  With Maturo, and his management experience with Kraft and in conducting business globally, the company is well positioned for growth worldwide. 

2)                  Maturo also has significant experience in the Investor Education Industry.  He was the CEO of EduTrades, another investor education company between 2002 and 2006.  During his five year tenure, EduTrade’s revenue grew from $2 million to over $100 million.  Maturo’s experience in this industry should not be underestimated.  His current post as CEO of TRES is not the case where a highly experienced and seasoned executive from an S&P 500 company is coming into a new industry and will have to get his feet wet before he gets traction.  Maturo’s pedigree and his contacts within the industry should not be underestimated.  They give him a significant advantage in negotiating partner deals and in making acquisitions.  The Investor Education Industry is becoming increasingly fragmented as new providers enter the industry.  There will be many opportunities to make acquisitions, which could result in hyper growth for TRES. 

3)                  TRES’ management team has seven key individuals who have worked with Maturo over the years.  Each has more than five years of experience in the Investor Education Industry.  They are all under 40 years old.  All of them have either previously worked for Maturo when he was at Edutrades or have been instrumental in the growth of Investools and the Investor Education Industry.  They rank among the other founders of the Investor Education Industry. 

4)                  TRES’ principals and managers have significant equity stakes.  On January 16, 2008, TRES announced that it had acquired two companies.  The majority of the acquisition prices were paid with stock.  No cash was paid.  The result is that the seven principals who were the founders and principals of these two companies now control approximately 33% of TRES’ outstanding shares.     

5)                  TRES recently made two acquisitions that will enable it to grow.  The two companies, Razor Data LLC and Investment Tools & Training LLC., which TRES acquired in January 2008 were both generating earnings and had combined cash flows, which were in excess of $3 million according to their pro forma filings, which were filed with the SEC.  Do not misconstrue these acquisitions as your typical reverse mergers, which are generally done so that private development stage companies can get access to capital.  These acquisitions were not development stage businesses.  They have businesses or business models that are already firing on all cylinders.  The principals of the acquired companies only agreed to be acquired because of the confidence that they had in Maturo and his leadership abilities.  He had gained their respect and confidence because one of the key principals worked directly under his leadership at Edutrades as its Director of Marketing.  During these years Razor Data was a dedicated services provider to Edutrades, since it began operations in 2002.

6)                  TRES has state of the art investor education products and on-line services.   In its January 2008, acquisition of Investment Tools & Training (ITT), TRES gained “Investview” which it believes is representative of the next generation of investor education products and on-line investor services.  Investview, with its on-line “toolbox” product, was developed by ITT and was launched in October 2007.   

7)                  TRES is now the only “pure play” publicly traded company in the Investor Education Industry.  It now becomes the only option for individual and institutional investors who want to make an investment in the growing and vastly under penetrated Investors Education Industry.  It is also the only option for those privately held companies who are interested in partnering with TRES or being acquired for stock in a public company.   

8)                  TRES is well positioned to attract institutional investors.   Investools has 118 institutional shareholders who hold 68% of its shares.  I believe that these institutional shareholders are savvy, extremely sophisticated and are very knowledgeable about the Investor Education Industry.  Many of them began accumulating shares at prices well below $10 and before Investools became profitable in 2007.  My recollection is that institutions began to purchase Investools shares when it was still trading on the Over The Counter Bulletin Board.   This should not be underestimated since most Institutional investors typically require a company to be profitable and trading at over $10 per share before they begin to purchase shares.   Thus, I believe that Institutional investors are good candidates to invest in TRES.  I also believe that they will not wait for significant profitability before they begin to purchase shares.  They made their bets on Investools because of their strong belief in the demographics of the Investor Education Industry and are likely to soon start placing their bets on TRES. 

9)                  TRES is well positioned to attract Investools’ marketing partners.  Like Investools, TRES also utilizes third party marketing partners.  Now that Investools is exiting the Investor Education Industry its marketing partners will be looking for alternatives.  However, there are few entities that have the infrastructure in place to educate the mass quantity of students that can be brought in by Investools’ partners.  TRES is one of those few logical alternatives because its management team has the experience with high volume fulfillment.  Maturo led a team that ramped Edutrades investor education business from $2 million to over $100 million between 2002 and 2006.  Should TRES be successful in landing Investools’ partners, its revenue and profits could scale rapidly.  For example, after linking up with its partners in 2002, Investools’ revenue grew from $56 million to $252 million in 2006. 

10)              TRES is uniquely positioned to capture Investools’ key personnel.    Investools’ announced that it is moving its investor education business from Salt Lake City to Chicago.  TRES’ investor education business is headquartered in Salt Lake City.  The fact that both Investools’ and TRES’ investor education businesses are located in Salt Lake City is no coincidence.  The roots of the Investor Education Industry stem from Salt Lake City, where it was founded.  This geographical edge gives TRES a huge advantage over all of its competitors in the Investor Education Industry when it comes to having access to additional highly capable human resources.

Based on these 10 reasons and one other reason that I would like to discuss, I am recommending that the shares be purchased at $0.50 or below. The eleventh reason why TRES is currently a buy is because it has been misperceived by the investment public who think that it is a start up or development stage company.  This is because Financial Statements for its fourth quarter and 10K for its year ending March 31, 2008, have not yet been filed.  The SEC requires that the reports be filed by July 15, 2008.  Because of its recent acquisitions, which were closed on January 16, 2008, during its fourth quarter, the reports should show significant year over year and quarter over quarter comparative increases in revenue, earnings and cash flow when compared to its previous fiscal year.  Until the Financial Statements are filed on or before July 15^th TRES will continue to be perceived as a development stage company which has heavy losses.  However, this is far from the truth.  TRES did file a special 8K report with the SEC, which discloses some financial data on the acquisitions.  The data that was filed in its 8K in March of 2008, has not yet been incorporated into the company’s regular SEC filings.  I believe that TRES shares will become much more visible and liquid when the investment public becomes aware that it is an operating company instead of a development stage company. 

VII.            Now that Investools is an online broker its shares are also a buy  

My instincts tell me that the sudden and sharp decline in Investools’ share price, on its May 1, 2008, announcement, from $12.48 to as low as $6.90 can be attributed to a readjustment in its perceived upside potential by its institutional investors.  My bet is that these investors invested because of their belief in the long term potential of the Investor Education Industry.  Now they find themselves owning an online brokerage business instead of an investor education business. 

I believe that Investools’ share price is down because the long term potential of its online brokerage business pales in comparison to the long term potential of its investor education business.  The trading of its shares in a narrow range of $7.65 to $8.31 since May 5^th indicates that its shares are most likely being accumulated by institutions at approximately $8.00 per share.  Since the sudden drop of its shares their subsequent price action has been good.  This indicates that some of its current institutional investors are selling and that current or new institutional investors are buying.  What likely is happening is that its shares are being recycled by institutional investors.  Those who believe in the potential of the online brokerage industry are purchasing shares and those institutions who do not are selling shares.  When all those that don’t want to own the shares of an online broker have sold, Investools shares will most likely begin to move up.  Therefore, even though Investools is exiting the Investor Education Industry, I believe that Investools shares are currently a buy under $10.00 for the following reasons:

• Investools’ Price to Cash Flow (P/FC) multiple of 8 is significantly lower than that of its potential suitors including OptionsXpress Holdings, Charles Schwab and Ameritrade.  With Free Cash Flow of $1.00 per share over the last 12 months and a share price of $8.00, Investools’ shares are currently trading at eight times their free cash flow.  Even if the other brokers paid a 50% premium or $12.00 per share to acquire Investools, which is $4.00 more than its most recent share price of $8.00 the acquisition P/FC multiple would still be at a significant discount when compared to the rest of the online brokers.        

• Investools has the best customer metrics in the online brokerage industry.  There is little doubt in my mind that Investools’ assimilation into an online broker Think or Swim (TOS) and its metrics are being monitored by the other much larger online brokers such as Schwab, Etrade, Ameritrade and Options Express.  While its dynamic metrics of 177 average trades per year per customer may not be sustainable over the long haul because of the drying up of its original investor education student referral pipeline, its metrics will likely remain among the highest of the industry. Also, the metrics are not the only item of significant interest.  For the past two years Think or Swim has ranked in either first or second place in Barron’s annual survey which ranks the top 20 online brokers.  

• Investools, for its 12 months ended March 31, 2008, generated record Free Cash Flow of $69 million.  Its previous record for annualized Free Cash Flow was $53 million for a 12 months ended.  I have found from my research at StockDiagnostics.com that Free Cash Flow is a good predictor of earnings gains and increasing share price in future quarters.   

• Investools has an intangible asset that a suitor would find attractive.  The company has a state of the art financial information delivery system, which provides historical statistical data.  I suspect that this information system (much more than ongoing education) is the primary driver of high number of trades per customer per year.  I believe that if a suitor purchased Investools and made its system available to their entire customer base the result would be a significant increase in the number of trades per year per customer for the combined enterprise. 

Because of the four reasons that I have stated above it is likely that Investools will be acquired by one of its competitors if its shares do not go back to at least $12 within 12 months.   I believe that its shares are a good buy at under $10.00. 

Mr. Markowski and/or family members currently hold shares in both Investools (NASDAQ:SWIM) and TheRetirementSolution.com (OTCBB:TRES).   StockDiagnostics.com, Inc., a company that Mr. Markowski founded, currently has a business relationship with TheRetirementSolution.com, Inc.   StockDiagnostics.com currently provides stock portfolio recommendations to TRES subscribers, which are based on StockDiagnostics.com’s proprietary cash flow algorithms.

To contact:

Michael Markowski

800-747-6189