With K12, the largest U.S. operator of taxpayer-funded online schools, the former junk-bond king has figured out how to make money in education. Is that a good thing?
Ten-year-old Asiko Aderin is wearing headphones and staring into a computer screen, looking very much like an underage call center employee. It's a weekday morning—a school day—and this is what school looks like for Asiko and her two brothers, Ayomiro, 11, and Ayodeji, 8. Holed up in the basement of their family's Poconos, Pa., home, they watch lessons on a screen, typing answers to questions as their mother, Sharon Aderin, a former U.S. Army Reserve sergeant, hovers nearby. The children attend Agora Cyber Charter School, managed by K12 (LRN), the largest U.S. operator of taxpayer-funded online schools and part-owned by billionaire Michael Milken.
In a development that would have been unheard of a decade ago, about 200,000 U.S. school children are enrolled in full-time online programs. Eleven years after its founding, K12 has 81,000 students in 27 states and the District of Columbia. If it were a school district, it would be one of the largest in America. K12 expects to generate $500 million in revenue this year—it earned a $21.5 million profit last year—and its stock has doubled in value since the company went public in December 2007. The financial success of K12 has shown that Milken—the 1980s junk-bond king, convicted felon (securities fraud), and health-care philanthropist—has figured out how to profit from public schools. But while online education may have paid off for Milken and other investors, it's less clear that K12 is benefiting its students.
The company says its kids are making impressive gains in academic achievement, but a growing group of critics, including school superintendents and academic researchers, disagrees. They're concerned that online schools fail children and overcharge taxpayers—and that the money-making model that Milken has championed could be embraced more broadly as a way to overhaul public schools at the expense of actual education.
"This isn't going to turn out to be good for education or good for kids," says Diane Ravitch, an education historian and former assistant U.S. Education Secretary under President George H.W. Bush. "When you think about people in isolation, sitting in their basements at home, not having to learn how to deal with people, how to cope with cliques, how to work out problems with other children, how to function in a group, it strikes me this is a hugely dangerous direction for our society."
Some of the nastier elements of socialization, such as drugs, bullying, and early sexual behavior, are why Aderin, a devout Christian, chose an online school for her kids. As part of her fourth grade history lesson, Aderin's daughter, Asiko, volunteers to read off the screen after watching a video about Theodore Roosevelt and the Spanish-American War: "The whole country seemed to crackle with energy," she says, in a quiet monotone. "No one had more energy than Theodore Roosevelt."
K12 manages charter schools, independent entities that operate public schools without bureaucratic constraints such as contracts with teachers' unions. They've become the darlings of would-be education reformers across the political spectrum: Microsoft's (MSFT) Bill Gates, Wall Street hedge fund philanthropists, the Obama Administration, and many Republicans such as Jeb Bush and Mitt Romney. Over the past two decades charters have been promoted as a way to provide less affluent families with an alternative to conventional schools. K12's version is offered entirely online, with students taking classes and earning degrees at home in front of a computer, giving kids along every rural byway access to a charter education, as long as they don't mind getting it through the Web. "Bill Gates has invested [in education] without a real expectation of a return on investment," Michael Moe, an investment banker who helped take K12 public, says, comparing Gates's and Milken's contributions to the field. "Michael Milken believes that the greatest success in education will be tied to the marketplace." Or, as Ron Packard, the former Goldman Sachs (GS) banker and McKinsey consultant who co-founded K12, puts it: "Mike believes that education is a phenomenal investment opportunity." Milken's spokesman, Geoffrey Moore, says: "Mike is an investor but is not involved in the company's management."
The seeds for K12 were planted in the fall of 1999, near the peak of the Internet bubble, when Packard visited the Los Angeles offices of Knowledge Universe, Milken's for-profit education company. Packard wanted to start a business that would offer elementary through high school entirely online. Classes would be beamed directly into students' homes over the Internet. The schools would be operated for a profit. And—perhaps the best part—they would be funded by taxpayer money that usually goes to traditional public schools. Milken, now 64, his brother, Lowell, who is chairman of the family's philanthropic foundation, and Lawrence J. Ellison, the chief executive of Oracle (ORCL), invested $10 million in Packard's startup, named K12. The Milkens have invested a total of about $90 million in the venture, Packard says. Knowledge Universe and other companies controlled by Milken and his brother own 19 percent of K12, a stake worth about $260 million, according to Securities and Exchange Commission filings. Packard says K12 is just beginning its growth trajectory as it pushes to enroll more of America's 50 million schoolchildren.
K12's headquarters are in a nondescript office park in Herndon, Va., along the high-tech corridor near Washington Dulles International Airport. The company has 2,400 employees, including 110 curriculum developers—among them former executives at PBS and the Smithsonian—who design and update the company's online courses. Along with running online public schools, K12 markets directly to homeschooling parents as well as to districts that want to start their own online classes.
One floor of K12's headquarters houses a call center, where 80 employees court students across the country—and the local, state, and federal money that comes with them. An online job posting for a K12 "enrollment sales consultant" says the applicant should "be able to close the sale with a customer" and "meet or exceed team and individual sales goals." Packard says K12's salespeople are paid primarily on salary, but part of their compensation is based on success in enrolling students. The U.S. Education Dept. has moved to ban the tying of recruiter pay to enrollment at for-profit colleges, saying the practice encourages employees to sign up students who might not benefit from the degrees (the ban doesn't apply to charter schools).
Packard dismisses any comparison. Whereas for-profit colleges are paid upfront, K12 is generally paid monthly. Because of initial outlays for computers and materials, Packard says, it loses money if students drop out after several months. "We don't want to be recruiting kids who it's not right for," he continues. "That would be a disaster academically. It would be a disaster for the company economically."
The Education Dept. says there is little valid research comparing online vs. face-to-face instruction for elementary and high school children. K12 did lag behind in a key measure—the percentage of students meeting the federal benchmark for yearly progress toward proficiency on state tests, according to a December 2010 study of companies running for-profit charter schools by researchers at the University of Colorado at Boulder and Western Michigan University in Kalamazoo. Three-quarters of K12 schools failed to show sufficient progress, compared with 45 percent of the physical charter schools in the study. K12's results are "just shocking," says Gary Miron, a Western Michigan University professor, one of the study's authors.
In part, this is a reflection of the backgrounds of K12's students, who tend to be poor and struggling academically, says Packard. The company is growing so fast that more than half its students are new each year, meaning they may take state tests five months after first enrolling, before they've had a chance to benefit from K12 teaching, he says. More than 90 percent achieved proficiency on state tests after seven years with K12, according to company literature. He adds that K12 has invested more than $200 million in technology and curriculum and that the company's schools, which collect money on a per-pupil basis, receive on average only 60 percent of a traditional district's allotment, which saves taxpayers' money.
Still, it's a difficult sell to some education scholars. "The enthusiasts for cyber learning have overstated the potential," says Tom Loveless, an education researcher at the Brookings Institution who did paid consulting for K12 in its early years. "What they keep forgetting is we're not talking about college students here. We're talking about high schoolers and young kids. The idea that parents go to work and leave their kids in front of a computer—it's absurd."
Michael Milken is a product of the traditional public school system—he graduated from Birmingham High in Los Angeles in 1964. After college at the University of California at Berkeley, he joined Drexel Burnham Lambert, where, during the 1980s leveraged-buyout boom, he pioneered the use of high-yield bonds to finance takeovers of companies such as Safeway (SWY). In 1990, Milken pleaded guilty to six felony counts of securities fraud and served a one-year-and-10-month sentence.
Since his release, Milken has become known for high-profile philanthropy, funding prostate cancer and epilepsy research and providing college scholarships through the Milken Family Foundation. He laid out his education philosophy at the annual Milken Institute Global Conference of movers and shakers held May 1-4 at the Beverly Hilton in Los Angeles. There, amid hundreds of CEOs and government officials, Milken released an essay that bemoaned declining U.S. educational performance relative to Asia, and, in an implicit criticism of teachers' unions, complained that instructors are paid based on seniority rather than performance.
To address education and other major problems, Milken wrote, "In each case, the solution is the same: Unleash the energies of entrepreneurial people, and they will change the world."
After Milken agreed to back K12, Packard looked for a partner with education credentials to run K12 with him. He sought out former U.S. Education Secretary William J. Bennett, who had served in the Reagan Administration and had the conservative bona fides to appeal to the initial target market: homeschoolers, many of whom are conservative Christians. In an April interview, Bennett said that he liked the company's "world-class" curriculum, which features a firm grounding in American history and rigorous math instruction. (In 2005, Bennett, who hosts a syndicated radio show, resigned from K12 after making controversial remarks about blacks and abortion that he said were taken out of context.)
Packard says he speaks with Milken by phone as often as once a month. Milken will often call while on trips to China, India, and Indonesia, suggesting that K12 could broaden its international ambitions. "There's no reason why eventually you can't be educating a billion kids online," Packard says.
In Pennsylvania, the first state where K12 won approval to open a cyberschool, online education is both popular and controversial.
Under state law, charter schools, including virtual ones, are entitled to the same amount of local, state, and federal tax money that each student's home district spends, minus funding that traditional schools receive for transportation, capital outlays, and debt service. Of course, online schools don't have to operate cafeterias or gyms, either. K12 says that under Pennsylvania's formula, which is among the nation's most generous for charters, it gets 80 percent of the funding of traditional schools. That came to about $8,000 per student, on average, according to a February state filing.
Charter schools must also be nonprofits under Pennsylvania state law, although the schools' boards can choose a for-profit management company to run them. Agora's volunteer board is made up mostly of parents of children at K12 schools. "It also charges Agora separately for instructional materials and online courses. In the year ended June 30, K12 received $31.6 million from all those sources, Agora reported on its tax form—or 8 percent of K12's revenue. With peak enrollment of 5,500 last year, Agora, the only K12-operated academy in Pennsylvania, can enroll students anywhere in the state.
Pennsylvania Auditor General Jack Wagner issued a report last October saying that Pennsylvania's 11 cyber charter schools may be receiving too much tax money, given their lower costs. Don Bell, superintendent of Pennsylvania's Northern Lebanon School District, says he was able to open an online school for his students for a third of what K12 charges. "I support school choice," Bell says. "I just don't think you need to be ripping off everyone to provide it."
In response, K12 says the state sets funding levels for all charter schools. School districts that say they are spending far less for online instruction "don't care about quality," says Packard. K12 also offers field trips and other face-to-face get-togethers and is introducing physical learning centers that serve about 5 percent of its students nationally.
In a state filing last June, Pennsylvania's Acting Education Secretary Thomas Gluck demanded that Agora improve performance on state tests or risk losing its charter. On the latest round of assessments, for 2009-10, 55 percent of Agora students were considered proficient or above in reading, compared with 72 percent statewide. In math, 47 percent achieved that benchmark, below the 75 percent state average. K12 says Agora has lower test scores in part because 63 percent of its students are eligible for the federal free or reduced-price lunch programs, a measure of poverty, compared with the 39 percent state average. By another state yardstick—students' improvement over each year—the company says Agora ranks among the top schools in the state.
One of Agora's most successful recent graduates points out that K12 attracts students who aren't necessarily suited for independent online work, resulting in heavy turnover: Almost a third of the 7,700 students Agora signed up withdrew last year. "I think cyberschool was the right choice for me," says Darian Kiger, Agora's 2010 valedictorian, who delivered a live speech to the graduating class at an evangelical church and conference center. Kiger, now a 19-year-old freshman at York College in Pennsylvania, says: "I don't think it's the right choice for everybody."
That was the case for one student, Cortnie Ettinger, who left the ninth grade at her high school in the Central Susquehanna Valley in 2007 and enrolled in Agora instead. She eventually stopped logging in to her virtual classes and spent her days watching TV or hanging out in the park. Ettinger, now 19, has since returned to a traditional high school, where she made honor roll last year. Of online education, she says: "I wouldn't recommend it for my kid."
Cyberschool truancy is a common problem, according to many school districts. At least 15 percent of the students enrolled in cyberschools in Pennsylvania's Bangor district end up as virtual truants, Superintendent Patricia Mulroy estimates. As Mulroy puts it: "We pay for them, even though they haven't logged in."
Most of the time, K12 students study on their own, clicking on lessons, doing exercises, taking tests, with teachers available by e-mail and phone for support. For younger kids, this largely independent enterprise means that parents act as classroom monitors—in the company's parlance, they're "learning coaches." This free labor is a boon to K12's business model because it conscripts a corps of committed parents as instructors, cutting out some of the cost of hiring trained teachers, with their union wages and benefits.
Sharon Aderin's two boys also receive up to an hour a week each of speech therapy online, via headset, microphone, and Web conferencing. That means that Agora gets almost $22,000 for each Aderin boy annually from their Stroudsburg school district under state funding rules. (Aderin's daughter used to receive such help but is now receiving only general-education services, for which Agora gets just under $10,000 a year.)
An hour a week of speech services would cost the Stroudsburg district about $1,500 a year, according to Business Administrator Don Jennings. But Agora is receiving "a windfall" when it bills $22,000 a year for students receiving what he described as "very minimal services." (K12 says other children with disabilities can cost two or three times the amount it receives, and the company also delivers special-education services in therapists' offices and at home.) Aderin says she's delighted with the education her children are getting from Agora and notes proudly that they are scoring high on state proficiency tests. But she says she had no idea of the cost to taxpayers.
"Wow," she says. "For that, I could have them in private school. It seems high to me, especially since I'm doing most of the teaching."