Rosetta Stone's Management and Marketing Woes

One of the hottest new stocks of 2009 has become an investor disappointment in 2010.

Since July 22, shares of Rosetta Stone (RST) have dropped 33 percent. Analysts say the maker of language-learning software has been weighed down by weak sales and the unexpected departures of two senior executives. "People's confidence is a bit shaken," says John W. Hain Jr., an analyst at Barrington Research.

Rosetta Stone Chief Executive Tom Adams acknowledges problems but says the company is still "in a great position." A new product, called Version 4 TOTALe, will be launched on Sept. 14 that offers customers live language instruction over the Internet. "The response has been terrific so far," Adams says of initial product testing.

When the Stock Was a Darling

Rosetta Stone's initial public offering came at a dark time for the stock market. The stock made its debut on Apr. 15, 2009, five weeks after major U.S. indexes hit bottom on Mar. 9. The shares jumped 39.6 percent on their first day of trading. "There was very large demand for the IPO," says Scott Sweet, managing partner of research firm IPO Boutique.

It helped attract attention to the IPO that Rosetta Stone was already a recognizable brand name in the U.S., Sweet says. "This was not only supposedly the easiest and fastest way to learn a foreign language, but [also] the most intuitive and user-friendly," he says.

Shares, initially offered at 18, hit a closing high of 31.67 by May 5, 2009. At 17.24 on Sept. 2, 2010, the stock now trades below its initial offering price.

High-Profile Exits

When Chief Financial Officer Brian Helman announced his Aug. 31 departure in June, citing a desire to move back to Florida, the stock held steady. The company is based in Arlington, Va.

It was the resignation of chief operating officer Eric Eichmann, announced July 22, that coincided with a stock slide. "It causes uncertainty for investors when you have high-level executives walking out," Hain says.

"They both had different reasons for leaving," Adams says, adding that Eichmann's departure was prompted by Adams' plans to reorganize executive roles to focus better on international growth. "The timing of the departures is unfortunate, because we have a big product launch coming up," Adams says.

Adding to investor concerns, Rosetta Stone announced results on Aug. 5 that got poor reviews from investors. Although profits beat estimates of eight analysts surveyed by Bloomberg, quarterly sales of $60.6 million missed estimates by 7.5 percent. The company cited weak sales in the U.S., where unit volume fell 16 percent from a year ago.

Skewered by the Media Market

The reason for poor U.S. sales was not weak consumer demand, Adams says. Rather, it was changes in the advertising market. Rosetta Stone uses cheap advertising—bought at the last minute in the television "spot market"—to drive sales on its website and through call centers. This year, Adams says, the spot market unexpectedly got expensive, and the company cut advertising, hurting sales. "There was something weird going on in the media market," Adams says.

Jeff Van Rhee, an analyst at Craig-Hallum Capital Group, says management should not be so vulnerable to ad market trends. "Their media buying was too unsophisticated," he says. Says Hain: "It sounded like they got caught by surprise."

Rosetta Stone has since hired a new media buyer. "We have some encouraging results from that relationship already," Adams says.

A New Product Coming

Despite the string of bad headlines, there is hope for Rosetta Stone. While U.S. sales slumped 2 percent last quarter, international sales rose 155 percent. Although the company has so far opened direct-marketing offices in Japan, the U.K., South Korea and Germany, Adams sees potential for growth into more countries, where learning English can boost a career. "While language learning here in the U.S. is cake, in the rest of the world it's bread," Adams says.

The launch of a new Internet-based product could also be a "game-changer," says Matthew Kempler, an analyst at Sidoti & Co., who does not own shares.

The product uses Rosetta Stone's usual language instruction approach but adds online games and the chance to interact with native speakers, called "coaches," hired by Rosetta Stone. The product will cost 10 percent to 15 percent more than Rosetta's existing products, which range from about $200 for one level to $600 for a set of all five levels.

By raising prices, Rosetta Stone could bring in higher sales, but Kempler wonders if the new product could also bring in many more customers. Says Kempler: "The question is: Will it help jump-start things?"

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