Varsity: "Booking" Profits

06/25/2004 12:00 am EST


Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

"Amazon isn't the only company making money selling books on-line," says Ian Wyatt, editor of Growth Report. "Varsity Group, which sells to students, has successfully transitioned from a cash burning dotcom to a niche player in the bookselling space."

"Varsity Group (VSTY OTC BB) was founded in late 1997, and began selling books through its Web site to college students at discounted prices. The company's aggressive advertising branding campaign was aimed at college and university students through networks of student representatives on campuses throughout the US. In 2000, Varsity Group began focusing on the development and expansion of its eduPartner program, which today serves as the cornerstone of its business. The eduPartner program offers educational institutions a turn-key solution for selling text books to students.

"With Varsity's new focus on the eduPartner program, the company transitioned from targeting mainly college and university students to focusing on private middle and high-school students. The main benefit of the eduPartner program is that it costs the school minimal, while the benefits in cost savings and increased efficiencies by outsourcing the entire text book procurement process is significant. By outsourcing the book buying process, schools are able to concentrate on what they do best, while allowing a third party to handle the entire book buying and fulfillment process. This win-win makes the Varsity eduPartner solution an easy sell for many private schools that view their existing bookselling process as more of a hassle and a cost than an opportunity.

"For the student or parent purchasing school text books, the process becomes very simple. Varsity creates a customized Web site for each school. The Web site very easy to use, and allows the buyer to easily review and order books that correspond with a student's class schedule, at prices lower then the competition. Varsity Group is not a distributor, and therefore does not maintain a warehouse or fulfillment center. Varsity has partnered with Baker & Taylor, a leading distributor of books, videos, and music products. Baker & Taylor provides order fulfillment and drop shipment services to Varsity. The company's current contract with Baker & Taylor is scheduled to expire in June 2006. We view this as a crucial relationship for Varsity, and failure to renew a contract with Baker & Taylor could be catastrophic to Varsity's core business. It is our understanding that the relationship with Baker & Taylor remains strong, and we have no reason to believe that this contract will not be extended.

"The company has made substantial progress with its eduPartner program since 2000. The eduPartner program has grown from 20 schools during the back-to-school season in 1999 to 210 schools during 2003. This growth has continued into 2004, with Varsity Group reporting that it is the exclusive supplier of text books to roughly 300 educational institutions. In the all-important back-to-school season (quarter ending September 30), Varsity has historically booked 85% of its total annual sales. This seasonality puts a large amount of pressure on the company during its September quarter, as any delay in the delivery of books could result in lost contracts or non-renewal by existing eduPartner clients. Renewal rates are currently very high, in the mid-to-high 90% range. Varsity Group is working to diversify its eduPartner client base by targeting colleges and distance learning education institutions that could result in more year-round sales of books to students. We view this as a long-term area of growth for Varsity.

"Varsity grew its total number of schools to 300 as of May 12, versus 200 at this same time last year, representing growth of 50%. There is a very strong correlation between growth in the total number of schools and the growth of annual revenues. We are pleased to see Varsity's continued success in signing on additional schools over the course of the last year, and believe that this speaks toward the company's strong, value-added offering for educational institutions. Varsity's core target market of private elementary and secondary schools currently numbers roughly 2,500. Roughly 90%, or 270, of the firms 300 educational institution clients are elementary and secondary schools, meaning that Varsity has currently penetrated 11% of this market. We believe there is significant room for future growth within this niche based upon the company's small penetration rate at this time.

"The stock trades at 26-times our 2004 pre-tax EPS estimate, and 17-times our 2005 estimate. With projected top and bottom line growth of at least 55%, we believe the valuation is attractive. Based on the strong fundamentals, we believe shares could trade at 30-times our 2005 pre-tax earnings per share estimate within the next year. We are initiating coverage of Varsity Group with a Buy rating and a 12-month share price target of $10 based on our optimistic outlook for the company's sustained growth in 2004 and 2005."

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