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Princeton Review's IPO Rates a Solid "F"


Want to have a really bad time? Go to www.review.com, Internet home of The Princeton Review, the company that helps kids study for the Scholastic Aptitude Test. There, you can take a free practice SAT. I promise, it will all come back to you: The raging boredom of having to decipher passages from the world's most convoluted writers; desperation to recall the Pythagorean Theorem; the impulse to pick an answer, any answer, just to get the damn thing over with.

All this was torture enough in high school. But put yourself in the sneakers of today's kids. With new federal legislation, more and more kids will be having to take high-stakes assessment tests as early as the third grade. So it's no wonder that Princeton Review is chasing this fresh opportunity to help kids improve their scores. And now, the New York City company is letting the public in on it. On June 18, it sold 20% of its stock in a $59 million initial public offering run by J.P. Morgan Chase.

I can't bear to disclose my score on the mock SAT (lower even than in 1973, which was plenty low enough). I will, though, give my assessment of Princeton Review's IPO. Although executives are keeping quiet in the wake of the deal, their securities filing spells out the details. And on my proprietary IPO bell curve, it falls in one of those humiliatingly low deciles.

From a start in 1981 with 15 kids studying under then-21-year-old founder John Katzman, Princeton Review has expanded to serve more than 100,000 students in 11 countries. It grew in part by franchising, but lately the company has been buying back those operations. It's also now in books (including a deal with The McGraw-Hill Companies, parent of BusinessWeek), it's in software, and increasingly it's on the Net, where a new venture named Homeroom.com aims to help third- through eighth-graders with the new state assessment tests.

These tests--and the anxiety that accompanies them--open new territory for Princeton Review. But the company is hardly alone in exploiting this opportunity. In fact, it's off to a late start. Educational software maker Lightspan's eduTest.com was founded in 1995 and, while it isn't disclosing sales, now serves more than 1,000 schools. Sales of Princeton Review's fee-based Homeroom.com service began only last August. "To date," the company's filing notes, "these fees have not been significant."

Perhaps Princeton Review will surpass its rivals, but in the meantime it's losing a lot of money. From net income of $1.6 million on revenue of $34 million in 1998, the year it began expanding to aid elementary and secondary school kids, the bottom line has turned red and redder. Last year, including results from its recently acquired franchisees, it lost $15.7 million on revenue of $54 million. This year's first quarter brought a $4.9 million loss, a mega-swing down from 2000's first-quarter profit of $4.4 million. And as far as it can see, the company expects to keep losing money.

So forget about trying to value Princeton Review on a multiple of earnings. Ditto cash flow. Even before capital spending, the company burned $17.6 million in cash last year, and an additional $5.7 million during this year's first quarter. Fortunately, there are ways to estimate the value of Princeton Review on a multiple of sales. First, there are the half-dozen franchisees the company in the past year either has bought or has taken an option to buy. Those prices range from 0.9 times to 1.3 times sales. Then, there are other tutoring stocks (table), such as Sylvan Learning Systems. They trade from 2.0 to 4.9 times sales.

And Princeton Review, what value did it give itself? At its IPO price of $11 a share, it went for 5.3 times sales. Don't ask me what Pythagoras would make of that valuation, but I'll tell you this much: It's way steep. By Robert Barker


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