The short version of this story is that Blackboard has sold off their Transact business and moved their corporate headquarters out of Washington, DC. Both of these are sensible moves that give them an opportunity to reduce their debt load and get on better financial footing. Not being a debt expert with access to the information to the information that credit rating agencies have, I can't comment at this point on how much this improves their outlook.
That should be the sum total of this post. Unfortunately, because Blackboard handled some of our previous coverage poorly, the news also provides evidence that they weren't entirely forthright with us in previous conversations about the tools they had at their disposal for handling their debt. So I'm obliged to complicate the news with an accountability story. Since I am weary of writing accountability stories after 14 years of writing them, I prefer to turn this story into a lesson about how ed tech companies can handle difficult PR situations better, in the hopes that I will have to write fewer of these stories in the future.
If what you mainly care about is Blackboard's financial health, then you can stop here. If you're interested in learning more about how ed tech companies accidentally get themselves into unnecessary trouble, and how they can minimize their chances of doing so, then read on.
Asking for Trouble
Back in the summer of last year, I got into two consecutive spats with Blackboard, neither of which I saw coming. The first was about our data showing that Instructure Canvas had surpassed Blackboard in US market share. Now, everybody, including Blackboard, knew that those market share lines where moving closer together. Counting methodologies being complex and legitimately debatable, it's possible to have honest disagreements about how close they are or whether they have crossed at any given moment. But we considered this more of a milestone that summed up a long-term trend than a big story in and of itself.
There were a couple of ways that Blackboard could have handled this. One was to play it to the hilt. Being branded—pun intended—as the corporate juggernaut has been a problem for Blackboard for a long time. They could have finally turned the tables on Instructure and portrayed themselves as the scrappy underdog. Or they could have just kept quiet and let the story pass. It would have disappeared down the memory hole in about three days. Instead, they engaged in a strong public pushback against our numbers. That doesn't make them bad people; they have a right to defend themselves as they see fit. But from a purely strategic perspective, their choice had the effect of both prolonging their bad news cycle and provoking responses from us.
In one of those responses, I tried to explain—again—that the market share lines crossing really wasn't news but rather a symbol of the ongoing trend. If you want real potential bad news for Blackboard, I argued—and this is where the danger of prolonging the bad news cycle caused further complications for them—you should look at their debt situation:
The real issue of concern is the potential behavior of their debt and equity owners. I'll come back to the point about Blackboard's total product portfolio in that context....
The second "Blackboard alert" article worth reading is the one by Katherine Doherty and Eliza Ronalds-Hannon at Bloomberg News. This one wasn't a reaction to our piece but rather coincidental timing triggered by the same underlying concerns. I spoke with Doherty, whose beat includes companies with distressed debt.
The debt is the real existential issue. Without it, Blackboard would just be a company that continues to struggle with its flagship product but which would have enough runway to turn itself around over time, one way or another. In the Bloomberg article, Blackboard CEO Bill Ballhaus repeats Miller's reminder that the company sells other products and services. And as we have pointed out repeatedly here on e-Literate, the international markets are an increasingly large percentage of Blackboard's financial picture. The fundamentals of the company may not be great, but they're not dire either. Given time, good leadership, and low debt, a company in this position should be able to right itself.
But because Blackboard has high debt, their situation potentially a lot more volatile. One major reason why the market share milestone matters is that it's an apt metaphor for Blackboard's financial waterline. At their current debt levels, the company can't afford for their market share to continue to drop.
Contract losses have sent Blackboard’s revenue and earnings sliding, according to people with knowledge of the matter, making it harder to carry more than $1.3 billion of rated debt. With some of Blackboard’s bonds selling at deeply distressed levels, Ballhaus is crafting a comeback, and possible options include the sale of its payment processing division, said the people, who asked not to be identified because the discussions are private.
So, I wrote that Bloomberg news reported that Blackboard has debt levels that are high enough to cause potential problems for its business. Elsewhere, we reported that Moody's had made some negative comments about their debt as well. Reporting these things is a little like reporting that the Weather Channel is predicting a high likelihood of heavy snow. It's not something you argue about.
I went on to say that, while the debt situation was serious for Blackboard, it was far from certain doom:
Even in this situation, the results for Blackboard Learn customers won't necessarily be bad, or even noticeable—depending on how the finances are resolved. If Blackboard sells off Transact, gets a good price for it, pays down some debt, and otherwise sticks with the current management's plan, that could buy them some time and some ability to survive further erosion of market share around Learn. If the company's owner, Providence Equity, decides to take more drastic steps, then the potential impact on customers is unpredictable. And Providence's calculations regarding how much drastic action is required must be at least partly driven by their assessment of how close Blackboard is to bottoming out in LMS market share loss.
This story was harder for the company to ignore, but they still had some options. I had said some good things about the company in that post, and some critical things about their competition. Their CEO, Bill Ballhaus, is a turnaround specialist. The Private Equity owners of Blackboard have signaled their trust in him by making him both Chairman and CEO. They had a good story line there. And they were going to have an option to engage with us in person very soon at BbWorld.
So what strategy did they choose?
They pushed back hard. We had two meetings with Blackboard executives, including our meeting with Bill Ballhaus, in which they brought up the debt issue immediately and completely dismissed it as illegitimate. This was what poker players call a "tell." It was so far out of the norm for this sort of analyst/executive meeting that it sent a clear signal of how concerned they were about the coverage. Now, some of that is simply due to the fact that people read what we write and react to it, and they don't always read it carefully. So we know that Blackboard got inbound calls that were triggered by that post. But the tone of the pushback, coupled with the implausibility of the arguments, were highly inconsistent from our experience with this management team.
This instantly changed the story line of BbWorld for us, and not in a way that Blackboard had intended. Here's what I wrote in my follow-up post, entitled "Blackboard's Defenses of Its Finances Are Not Persuasive," about that meeting:
When we were at BbWorld the week before last, Blackboard's executive management pushed back vehemently on our analysis of how their high levels of debt could impact their business decisions. We heard their strong disagreement expressed in our very first meeting of the conference from Chief Learning and Innovation Officer Phill Miller and in our very last meeting from CEO Bill Ballhaus.
We stand by our analysis. In fact, Blackboard's pushback had the opposite of its intended effect. We left BbWorld more convinced that we are right rather than less....
Ballhaus argued to us that the amount of debt that Blackboard is carrying is a strategic choice that he and the private equity investors—he used the pronoun "we"—make together. In particular, he argued, "we" could choose at any time to invest more money in the company, paying down debt in exchange for equity. Further, he argued, it's logical to assume that Providence would do so if needed because "they only make their money if we improve."...
Paying down debt in exchange for equity, called "recapitalization," is a strong vote of confidence by a private equity (PE) owner. First, since debt holders get paid before equity holders in the event of bankruptcy, it increases risk for the PE firm. Second, it would mean a substantial investment of cash, which is partly what PE firms typically try to minimize by requiring the companies that they own to take on substantial debt in the first place. When PE-owned companies find that they are in danger of being unable to make their debt payments—which both Moody's and S&P Global Ratings have said is currently the case with Blackboard—the PE owners can and do employ a number of different strategies that are financially less risky to them in order to address the problem, either instead of or in addition to recapitalizing.
For example, when Cengage Learning found itself with unmanageable debt levels after its acquisition by private equity, they filed for bankruptcy:
“The decisive actions we are taking today will reduce our debt and improve our capital structure to support our long-term business strategy of transitioning from traditional print models to digital educational and research materials,” Michael Hansen, Cengage Learning’s chief executive, said in a statement.
To be crystal clear, I am not suggesting that Blackboard is likely to file for bankruptcy. Providence Equity has other options at its disposal, some of which I will write about in the next section.
Rather, the point is that Ballhaus' claim that we should just assume Providence will see it as being in their interest to recapitalize Blackboard is not credible on its face to anybody with even passing knowledge of how private equity companies work. For example, the tone of the Washington Business Journal article I referenced above, which (obviously) was written by a business reporter, suggests significant skepticism that Providence will not let the company's debt challenges impact their business decisions. The industry experts we typically consult with when writing financial or business stories like this one were even harsher in their evaluations of Blackboard's position. Two literally laughed out loud at it.
I'm pretty sure that wasn't the coverage Blackboard was hoping for.
And it was destined to get worse. Because they were now stuck in a trap of their own making.
What do you do as an analyst when you believe a company has been making misleading statements to you and that there will be evidence supporting your theory of the case in the future? You lay down a marker and wait.
Here's what I wrote:
[I]n fairness, there is an empirical fact of the matter here, and we do not yet have conclusive public evidence that the company's high levels of debt will, in fact, affect their business strategy. So here's what we're going to do:
- I will summarize their position as objectively as I can.
- I will explain why we don't find their position persuasive.
- I will lay out the signs that concrete evidence we will be looking for going forward that will either support or undermine our thesis.
- Phil and I will publish updates as we monitor these signs and, if there is no additional public evidence of our thesis by BbWorld 2019 (or strong evidence emerges that we are wrong before then), then we will publish a mea culpa post....
Here are a few actions Blackboard could take in the future that would indicate Providence Equity has chosen to push Blackboard to solve its own debt problem rather than making it go away with more of Providence's money:
- Sell off one or more parts of the business: A Bloomberg piece written by journalists from their distressed debt desk reports, "With some of Blackboard’s bonds selling at deeply distressed levels, Ballhaus is crafting a comeback, and possible options include the sale of its payment processing division, said the people, who asked not to be identified because the discussions are private." Said payment processing division, Blackboard Transact, is a cash cow for the company. If Blackboard sells off one of its more profitable business units at a time when the company is having trouble making debt payments, that would indicate a choice by Providence Equity to find a way to reduce debt pressure that is less risky for them in terms of cash investment but more risky for Blackboard in terms of long-term health. Particularly since Providence already tried to sell Blackboard once and has now owned the company for well past the normal sell-by date that PE companies like to follow, the sale of Transact might suggest further moves to follow.
- Unload expenses (like office space): The Washington Business Journal article notes, "Blackboard is also interested in unloading its 70,000 square feet of office space at 1111 19th street, with 12,000 square feet already sublet, according to an April post on Tech Office Spaces. It's unclear where Blackboard will go if it succeeds in leasing out its entire footprint. Blackboard stood to benefit from a tax rebate program for companies that agree to sign 50,000 square feet for at least a dozen years, valued at half the company's tenant improvement costs, or a maximum of $5 million over five years." Of course, companies take cost-cutting measures all the time, regardless of their financial health. The business reporter's phrasing suggests that he may be detecting a whiff of desperation in the specifics of this transaction. Since that's his expertise more than ours, we'll be looking for additional confirmation of our thesis, such as if Blackboard were to...
- Significantly restructure with major layoffs: If Blackboard were to move to a smaller office while also laying off employees—beyond those that might leave in a sale of a business division or the slow leak of headcount that the company has been having for a while now—that would certainly be an indicator that Providence is not ready to just give Blackboard the money the company needs to complete a turn-around and is instead pushing them to solve their own financial problems.
I wrote that post on July 31st, 2018. Where are we seven and a half months later?
Last week, Blackboard announced the sale of Transact.
Note that this is not an objectively bad thing for Blackboard. To the contrary, it helps them with their debt problem in a way that has little to no impact on their core customers. The problem is that it also runs against the grain of the story line that Blackboard executives pushed to us aggressively last summer. They turned what should have been a good story for them into a more complicated story.
Also, last January, Blackboard announced they would be moving their headquarters out of Washington, DC to a new space in Reston, VA.
Note that this is also not an objectively bad thing for Blackboard, also a way for them to manage their debt problem without impacting customers, and also in tension with the story they told us last year.
The layoff evidence is less clear. There are plenty of comments on Glassdoor about ongoing layoffs (as well as voluntary talent drain) at the company, but that sort of evidence needs to be taken with a heaping teaspoon of salt. And honestly, I am hoping that I don't see evidence of a major restructuring going forward. I never want to root for people to lose their jobs.
So overall, there is pretty clear evidence that (a) all the debt agencies were not wrong when they said Blackboard had debt issues, (b) we were not wrong when we said that Blackboard could not expect Providence Equity to solve their problems by simply showering them with more money, and (c) Blackboard is taking necessary and reasonable steps to reduce their debt load. In other breaking news, gravity still exists.
I let Blackboard know I would be writing an update to my previous post and gave Mr. Ballhaus an opportunity to revise and extend his previous remarks. Here's what I got back:
Our decision to divest in Transact is consistent with our strategic efforts to simplify our business as we move to a purely SaaS model and enhance focus on our core teaching and learning portfolio. The fact that we have tightened our strategic focus toward our current education clients and are accelerating innovation to benefit them is a stark contrast from our competitors who are looking to grow their business in areas outside of education.
Proceeds of the sale will go toward deleveraging the company and also present potential opportunities to reinvest in the business.
OK. This isn't a bad statement as far as it goes. The last sentence is most directly relevant. The rest is stuff that he wants to get in, which is fine and expected. The truth is that he's heavily constrained in what he can say about the debt management for legal and other reasons. As I said at the top, regarding the substance of the situation, I'm not a financial expert and do not have access to the information that debt agencies do, so I will wait for them to weigh in on how all of this affects Blackboard's financial prognosis. It can't be bad, but I'm not qualified to judge how much they've improved without the benefit of expert input.
Regarding the PR situation, as far as I'm concerned, this was a fairly normal corporate answer. We're back on terra firma. The more interesting question is how companies can avoid getting themselves into this situation in the first place. Blackboard is far from the only company that has gone through this sort of thing with us. And while we occasionally run into CEOs who are simply bad humans, usually these situations arise out of missteps that happen while the people at these companies are under enormous pressure because the companies are working their way through a rough patch. I have been on the inside of a company as an employee in that sort of a situation. It is not easy. External-facing leaders in particular need to cultivate reflexes to deal with these sorts of crisis situations. And make no mistake; an analyst or reporter raising uncomfortable questions about something your company is struggling with definitely feels like a crisis situation.
So what's the right reflex to cultivate?
Executives need to understand the power of honesty as an offensive weapon. Set aside ethics for a moment. I'm talking about it from a purely strategic perspective. Let's look at a couple of examples of how to play this card, starting with Blackboard.
I made the analogy earlier between the debt agencies and the Weather Channel. Let's extend that analogy a bit. I live in Massachusetts. It snows a lot up here. (Or at least, it used to.) But we have very professional road crews who know what they are doing. Most of the time, we can get a dumping of 18 inches at night and still drive on safe roads the next morning. We check the weather, but we don't freak out about it. One way Mr. Ballhaus could have handled the debt conversation would have been to wait for us to bring the topic up—which we would have—and then say something analogous to the following:
It's true; the Weather Channel is predicting snow. I lived for ten years in rural Minnesota. In a house with a very long driveway. I have a truck with a snow plow on it. Here is my shovel. Any questions?
Here's how that looks in business terms:
It's true; the debt agencies are concerned about our debt load. That's one reason why Providence Equity brought me in. I'm a Private Equity turn-around guy. This is pretty much what I do. You guys have been around the block enough to know that I can't talk about the details of how we're going to manage it, but we have strategies in place for strengthening the company's balance sheet while protecting our customers.
Every word of this is either undeniably true or reasonably plausible, and there's not much we could have said in response. It also doesn't make for much of a story. It becomes a "this is one of a number of factors that we're watching" kind of thing. It doesn't become the dominant story line coming out of BbWorld. And it softens the analysts up just a little bit. With a story like debt risk, there's always a lot that we don't know. The flavor of our coverage is influenced by our trust in management to be reasonably honest and open with us. In this context, a little bit of good will goes a long way.
For another example, take the case where Pearson was trying to manage a story I was chasing of their CIO's penchant for repeatedly talking about the company's supposed ambition to build, in his words, the Netflix of education. I was (and still am) pretty sure that isn't what Pearson is trying to do. But because this very high-level person continues to be allowed to publicly declare that they are trying to do this, and because Pearson is a big place where the right hand sometimes doesn't know what the left hand is doing, only somebody who outranks the CIO can definitively put the question to rest. And there is only one person who outranks him: CEO John Fallon. After much discussion with Pearson's PR team and some interviews with a couple of the CIO's peers in other relevant parts of the organization, and very much to my surprise, I was given direct access to Pearson's CEO. So here we go, I thought. This was going to be easy. He could put this story to bed, and I could spend my time writing a story about something good rather than something dumb.
But it so easily could have.
Yeah, Pearson doesn't want to be the Netflix of education, and Albert shouldn't have said that we do. We do think that we need to become an internet-scale digital company, and we do think that the trend toward renting digital assets is one that is relevant to the educational market. That said, we understand that analogies are fraught in education and we don't wish to oversimplify. In fact, we sold off our consumer businesses in part because we want supporting educators in managing those complexities to be the core of what we do. When we talk about efficacy, that's what we mean.
That answer not only would have spiked the "Pearson can't stop talking about being the Netflix of education" story; it also would have turned me toward writing an update to my original efficacy story, complete with reporting on the genuinely good work the company's efficacy team has been doing since then. The Netflix thing would have ended up getting mostly buried as a side note about how difficult and fraught it is for companies to talk about their work.
It wouldn't have mattered if I knew the answer was a strategic attempt to kill or divert the story. As long as it was honest, it would have been fair game. Beyond that, I would much rather write a story about a company that's trying to do the right thing and does it imperfectly than play a game of gotcha with a company because the management is giving answers that I feel I have an obligation to police. When leadership chooses not to play the honesty card, they often accidentally trigger a gotcha game that generally doesn't end well for them and puts them in a worse light than they actually deserve. I wanted to say definitively that Pearson isn't trying to be the Netflix of education because I believe it to be true. I know they are doing good work because I have seen it with my own eyes. I could have written a story about that. But because Mr. Fallon chose not to play the honesty card, the story ended up being about Pearson failing to clearly disavow the Netflix analogy, and I couldn't definitively write what I believe to be true about the company because Mr. Fallon didn't give me the proof that I needed for the story.
I could go on; I have many more examples like these. A positive one is when Instructure's former CEO Josh Coates completely transformed a negative story about the company charging customers for access to their own data. Not only did he admit that the company screwed up in very blunt terms; he changed the policy, encouraged us to call customers and verify that they were satisfied with the changes, and thanked Phil for calling his attention to the problem. There are reasons why we wrote very little negative coverage of Instructure during the Coates years. One is that the leadership team really understood the power of honesty.
The bottom line is that honesty is disarming. Good analysts always try to maintain healthy skepticism, but they also try to be good judges of character. Because good analysis is partly based on knowing how much you trust the particular version of events that a company's management is giving you. In contrast, when leaders give in to the (understandable) temptation to deflect, they look dishonest. I want to be very clear about separating a moment of failing to be honest, which we all have had under pressure from time to time, from being a fundamentally dishonest person, of which I have met relatively few in my life. Analysts (and reporters) have to distinguish between the two based on very little information, and they have the obligation to be skeptical. Also, good analysts have instincts that lead them to poke where it hurts. The reflex of the person being poked will be to protect the sore spot. Effective leaders learn to fight that reflex in the moment. They acknowledge problems that the analyst may have uncovered (to the degree that they can) and turn that moment of vulnerability into an opportunity.