Commentary: Chris Whittle's New Ipo Deserves A D

Chris Whittle's ambitious quest to make money running public schools should be about to pay off. After all, the public is clamoring for charter schools and other schemes to improve U.S. education. And the 52-year-old entrepreneur's Edison Schools Inc. has been working on such issues for a decade. But the fine print on Whittle's preliminary prospectus to issue $172.5 million worth of Edison stock--including details about executive compensation and the founder's personal finances--suggests that this deal deserves to flunk.

Edison runs 51 public schools now and plans to have 77 under contract this fall. But President and CEO Whittle has not proved that he can make a profit from privatized public schools. As the prospectus acknowledges: "We are not certain when we will become profitable, if at all." It shows that Edison lost almost $51 million on revenues of $132.8 million in the year ending June 30, including a $22 million charge to reissue stock options. Since inception, it has lost $112 million. Edison needs cash--and fast. So does Whittle, who must repay a personal loan by Aug. 30 or risk losing part of his 15% stake in the company.

The question is when it will start to pay off. On the positive side, the loss per student, before those stock charges, has fallen from $3,927 in 1996 to $603 last year, which suggests that Edison is starting to realize some economies of scale. Whittle won't say how many schools or pupils it needs to break even.

The prospectus cites a need for 20 new principals and 750 teachers this fall alone. And, though there's a teacher shortage, Edison is trying to fill jobs with longer days, fewer holidays, and more pressure to perform than at ordinary public schools.

Some analysts argue that, at best, Edison will be lucky to get a 3% profit margin from school operations. "It's not at all evident that any of these places will make money," says Max B. Sawicky, an economist at the left-leaning Economic Policy Institute. (Teacher unions have been Edison's most vocal critics.)

Edison, which signed its first schools in 1995, was to be Whittle's comeback after he sold debt-plagued Whittle Communications to K-III Communications Corp. in 1994. He persuaded former Yale University President Benno C. Schmidt Jr. to become Edison's first CEO in 1992 with a relatively modest salary that hit $296,636 last year. But the company also gave Schmidt, now chairman, low-interest loans amounting to $1.8 million, which he doesn't have to repay until next year. He also gets $2.5 million if he loses his job, plus up to two years' salary.

SMALL POTATOES? Whittle's base salary last year was the same as Schmidt's, but he has also received more than $1 million from Edison for "professional services" since 1995 as the sole shareholder of WSI Inc. The prospectus also states that the company will offer Whittle a $5.6 million loan to buy 1.45 million shares at $1.50 each and pay any related taxes. Whittle will see many of those shares vest if the IPO commands at least $8 a share. The price sounds low, when you consider that WSI has options to buy 850,000 common shares at $10 each and another million at $20 each. While the company has not yet disclosed how many shares it will sell or when, both Whittle and Schmidt are expected to walk away with millions.

O.K., that's small potatoes in the era of overnight Internet billionaires. What should trouble investors, though, is thefact that both Whittle and WSI have pledged "all of their Direct and indirect interests in Edison to secure personal obligations" for an undisclosed amount to Morgan Guaranty Trust Co. If Whittle doesn't deliver when those debts come due on Aug. 30, the prospectus says, those shares will fall into the bankers' hands. That could give Whittle's bankers a big say in Edison's future.

Perhaps none of this would matter if Edison were clearly about to pay off. The company claims that its students gain an average of five percentage points on standardized tests. The American Federation of Teachers, among others, has challenged such claims with tests that point to more mixed results. Whittle may prove that Edison can pay off. But the brighter students of the markets will find better returns elsewhere.

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