How to invest in the education tech trend as schools spend billions to close the Covid learning gap

Published Sat, Sep 17 20228:22 AM EDT

Christina Cheddar Berk @in/christina-cheddar-berk-b864404/

Billions in federal aid are being put to work in an attempt to reverse profound learning losses that occurred as remote education became the norm during the pandemic. In a race to catch up, school districts are putting an increased emphasis on assessments to ferret out students' weak spots. There's also a greater recognition of the role technology can play in developing personalized plans to fill in the learning gaps that threaten future success in the classroom. This could accelerate the growth of digital learning companies like PowerSchool , Instructure and others that provide education management systems or tools to assess and improve student performance. "The pandemic has driven an even greater need around personalization," said Ian Chiu, managing director at Owl Ventures, a venture capital firm focused on the education technology market. "Assessment is the first part of that process, especially for those students who have the greatest needs." Sobering data Much attention has been paid to recent results from the National Assessment of Educational Progress that showed two decades of hard-won improvements were wiped away by the pandemic's disruption. The exams are considered the gold standard for gauging the abilities of nine-year-old students in the U.S. Since the 1970s, math scores had only gone up — that is, until this year. From 2020 to 2022, the average math score dropped seven points , providing evidence to back the warnings educators and parents had already been making. Students also lost ground in reading. Average scores fell five points over the same period — the biggest drop in more than 30 years. The declines were widespread, but were most pronounced among the students who had already been struggling prior to the pandemic . Without intervention, the loss of fundamental skills threatens students' progress in higher grades. Some, feeling hopelessly behind, will likely lose interest, and dropout rates could soar. Chronic absenteeism is already a rampant problem that is continuing to worsen, particularly in school districts with low-income students. "There's a whole cohort of students that may be disengaging entirely from the educational system," said Emma Dorn, a senior knowledge expert at McKinsey & Co. "... Children are missing significant amounts of school and that undermines the ability for schools to help them. ... As we think about what are the supports for students, it needs to be holistic support around both the learning, but also around some of those mental health and broader whole-child supports." The federal government has pledged billions to work on solving these problems. In March 2021, $122 billion was approved in the American Rescue Plan Act for the Elementary and Secondary School Emergency Relief, or ESSER III. The funds must by allocated or spent by 2024. Where the money is going Data service provider Burbio has been tracking where the money is going. Large chunks have been earmarked to recruit and retain teachers and other support staff, other funds have been allocated to afterschool programs or intensive tutoring. Billions are going into improve facilities. This includes upgrading or adding HVAC systems, purchasing new furniture and equipment or even adding water bottle filling stations. But money is also flowing into technology, and that trend could accelerate as time goes on. Nearly 70% of school districts have allocated some funding for technology, according to Burbio's analysis of 5,400 ESSER III plans, representing $85 billion in spending. The plans cover districts teaching 75% of K-12 students in the U.S. That tech spending can take many forms, including connectivity improvements or buying devices for students or smart boards for classrooms. In a research report earlier this year, Piper Sandler analyst Arvind Ramnani said schools have already invested in the infrastructure needed to support digital learning. He said the share of schools that have devices for every student has increased more than 3,000 basis points to 88% since the pandemic began. "In our view, significant capital allocations on digital infrastructure is a strong tailwind to K-12 EdTechs as schools are more equipped to effectively deploy digital learning solutions," Ramnani wrote. William Blair analyst Stephen Sheldon wrote in a research note in August, that investors will want to "increase exposure to edtech companies operating in the K-12 space over the next few years given the favorable funding environment and high need for states and school districts to provide better personalized learning solutions to students and better support for teachers." Sheldon, who rates PowerSchool an outperform, said the trend is a tailwind for companies in the space, and it reduces the risk from macro trends such as a recession. As of Friday's close, PowerSchool shares are up more than 10% since January. But the stock is 84% off a 52-week high of $33.46 it set a year ago. A structural shift Hardeep Gulati, the company's CEO, told investors at the Goldman Sachs Communacopia Technology Conference on Thursday that ESSER III funding is helping school districts modernize their infrastructure and it is providing a cushion in a funding environment that is "very stable." Districts that are reaching out for its services for the first time or adding new capabilities are not relying solely on these funds, he said. PowerSchool increased its 2022 forecast in August, when it reported second-quarter results. Revenue is expected to be between $630 million and $634 million, or about 13% to 14% above 2021. Gulati said he expects the trends are structural in nature — not a short-term bump from the stimulus funding — and there will be more digital adoption ahead. "Education has been running on a backward-view mirror and we were pretty much losing the opportunity to even make an impact to a child because you only get to know how the child was doing after a year. So our integrated solution really brings that entire view of the whole child in real time," Gulati said. When dealing with learning losses, it is important for teachers to understand where every student is, McKinsey's Dorn said. Both nonprofits and private companies have done really interesting research on what are the critical building blocks in subjects like math and reading that can help students continue on in their learning, she said. These core concepts provide the support for grasping the other material students will need to learn later. "Instead of teaching everything from kindergarten all the way up, [teachers] can focus on those few scaffolds through some adaptive instructions using products that can help you access some of that grade-level material," Dorn said. What is important to note is that the digital tools cannot replace the role of a teacher, but they can make a teacher more efficient. Amira Learning, one of Owl Venture's portfolio companies, is an example. Chiu said it assists teachers in assessing a student's oral fluency when reading, which can be a very time-consuming task. Children read aloud, and Amira uses artificial intelligence to assess skills and report back to the teacher which students need additional support, and in which specific areas. There also is a need for districts to identify student learning needs at scale, said Jenn Mitchell, senior director of product marketing at Instructure, which is known for its Canvas learning management system. Instructure has been adding analytics so districts can gain insights across schools in a district to identify where action needs to be taken. It also is adding professional development tools, recognizing that there has been a lot of change in the workforce. "The last three years have been incredibly difficult for teachers," said Trenton Goble, vice president of K12 Strategy. "And it's been hard for administrators. There was a lot of tech adoption during that Covid period of time ... so it's more important for us to make sure that we're providing the right kinds of tools." Instructure shares are down about 9% since the start of January. In August, the company raised its 2022 forecast after topping estimates for the second quarter. As districts chose vendors, Dorn said, there has been a lot of discussion about the need for products to provide "instructional coherence." She also said products need to be engaging for students, while also providing evidence that the methods used are effective. "Districts need products that work," she said. "They don't need products that look sexy or that have, you know, exciting front ends, they need products that are actually going to work and support students to improve learning." Piper Sandler's Ramnani told CNBC he expects providers like PowerSchool will have an advantage if they already have an existing relationship with a school district. 2025 and beyond In a best-case scenario, this unprecedented funding will be monitored closely to see which efforts are most successful. Proven programs could then be supported even after the stimulus funding dries up in 2025. Beyond addressing the Covid learning gap, there are other opportunities in the edtech space. UBS recently identified educational services as a long-term investment opportunity, citing as a key factor the rising number of middle class people in emerging markets and the possibility that these individuals will begin to invest more in education and training for themselves and their children. Many of the edtech companies have been looking to expand their business outside the U.S. PowerSchool, for example, said in August that it would accelerate its international expansion over the next six to 12 months. The company is targeting Europe, the Middle East and Africa, Latin America and India. Meanwhile, the ESSER III funds will continue to be allocated through the end of 2024. During its second-quarter earnings call, Instructure CEO Steve Daly said he was confident the funding would be a tailwind for the next couple of years. "In the last budget year that just ended this quarter in Q2, we haven't seen a lot of it yet flow through, so there's still a lot of dry powder, if you will, for the next couple of years we believe," Daly said.