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In a May 2008 press release, Investools announced a change to its business strategy and business model, stating that it’s de-emphasizing its investor education business and will no longer operate as a profit center. Its shares fell from $12.48 to as low as $6.90 (they’d previously reached an all-time high of $18.23 in December 2008). The company announced its intention to use its investor education business as a marketing tool to generate new customers.

I believe this move is evidence that the online broker 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 15 years.

Origins of Investools and Industry
Prior to 2002, Investools was a company that 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 the rest.

The foundation to develop very lucrative and profitable partnering relationships was born. The reason the relationship was a win-win for both the company and its partners was 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 courses. The business model was unique, efficient, and yielded great cash flow dynamics.

With no need for capital to support aggressive selling and marketing activities, and due to the boom in new hotels across the U.S., Investools and its partners were poised to capitalize on the growing dissatisfaction with traditional brokers by the investing public. 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.

In 2006, Investools decided to change its business model for two reasons. First, 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. The second is that it found that it had significant referral power with its thousands of its graduates. A powerful bond develops between the student and the instructors. Therefore, the instructor has significant credibility with his or her graduates and can easily refer them to providers of financial services.

Up until it acquired thinkorswim in 2006, Investools was referring its students to specialty online brokers such as Options Express Holdings (NASDAQ: OXPS). For referring the customers to the brokers, Investools was paid a small referral fee. But Investools was doing all the work and getting very little of the action.

The commissions that the online brokers generated from the students that Investools’ were referring generated revenue and profits for the brokers, which dwarfed what Investools was receiving 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 thinkorswim online brokerage firm in late 2006. The acquisition was paid for with cash that Investools borrowed from JPMorgan Chase and stock in March of 2007.

By mid- 2007, Investools’ business model had completely changed. It now offered online brokerage services. It was using a lot of its own capital 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 thinkorswim had been getting since the merger had been spectacular. The metrics below were pulled from Investools’ press release for its 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 thinkorswim 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 and approximately 12 trades per year for online brokers such as TD Ameritrade and E*Trade.

The Logic Behind the Strategy
Investools’ May announcement shocked investors. I have been tracking and monitoring the company over the years for friends, family, StockDiagnostics.com subscribers, and EQUITIES 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 the change in strategy.

What’s perplexing to me is why Investools would abandon such a lucrative and fast-growing market, particularly since this segment represented over 70% of its 2007 revenue. In its announcement on May 1, 2008, Investools 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 that it implemented after it purchased thinkorswim 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, which was suspect at best.

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 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 that 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 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 the long-term, 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 U.S. 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 baby boomers:

• There is a significant transfer of wealth underway.
• Millions are retiring with 401Ks and IRAs. Over the next 10 years, many who have never invested before will have portfolios that will require management.
• There is continuing erosion in the credibility of the traditional broker.
• 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. Thus, I give little credence to Investools’ announcement that the industry is being significantly impacted by the economy.

My hunch is that Investools is exiting the investor education industry for three reasons. The first is because of their purchase of thinkorswim. Owning an online broker hampers or severely restricts their ability to compete with other non-broker investor education providers for several reasons:

1. Broker dealers have to abide by securities laws and regulations in conducting their advertising and marketing activities, which are different and much stricter than the laws that standalone 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 standalone investor education providers are not subject to securities laws and regulations—they are protected by the First Amendment, 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.
   
   
3. Investools’ new advertising and marketing strategy that it implemented after it purchased thinkorwim in 2007 was failing. Investools had no experience in advertising and marketing campaigns, and yet according to CEO Lee Barba, the company was spending more on television advertising than Merrill Lynch. After relying on third party marketing partners to grow its sales from $56 million in 2002 to $252 million in 2006, it decided to forge ahead on its own. I believe that this change in strategy resulted in the downturn in Investools’ education business.

If one uses simple logic, 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.

Investools’ decision to exit the investor education industry opens the door wide open for other players in the investor education industry. TheRetirementSolution.com. Its shares currently trade for pennies.

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 fluent in English, French, and Italian, spent 20 years with Philip Morris/Kraft Foods. For most of his career with Kraft, Maturo lived in the U.S., Canada, Switzerland, and Italy. He was the CIO of Kraft Foods International when he retired in early 2000. 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 that time, EduTrade’s revenue grew from $2 million to over $100 million. He has experience—and contacts—in the industry. Maturo’s contacts give him a significant advantage in negotiating partner deals and in making acquisitions. The investor education industry is fragmented and there will be many opportunities to make acquisitions.
   
   
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 and 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 that were in excess of $3 million according to their pro forma filings, which were filed with the SEC. 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 online 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 underpenetrated investor 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. They made their bets on Investools because of their strong belief in the demographics of the investor education.
   
   
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.
   
   
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 an advantage over all of its competitors when it comes to having access to highly capable human resources.

• 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. 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 this system available to its entire customer base the result would be a significant increase in the number of trades per year per customer.

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.

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.