How Edison Survived
Ohanian Comment: "With a rigorous curriculum, a longer day and a longer year, you don't need to be an education professor to know that should produce better results, but to my surprise, it didn't," said Western Michigan University education professor Gary Miron.
Read on for the financial ties to the Bush brothers.
In the early 1990s media entrepreneur Chris Whittle became the darling of the free-market, antigovernment right by promising that private, for-profit businesses could manage schools better than public boards of education. His Edison Schools, he claimed, would grow into a corporate giant by educating children better and more cheaply than public schools. Teachers' unions were initially skeptical, then increasingly critical as the results came in. But Whittle attracted both enthusiastic investors and support from politicians like Republican Governors George Bush, Tom Ridge and William Weld. After Edison went public in 1999, its stock price doubled in two years.
But by 2002 Edison was on the ropes. Its stock had crashed from $37 to as little as 14 cents. Whittle had long since abandoned his original, controversial goal of building a network of private, for-profit schools, but even the strategy of contracting to privately manage public and charter schools proved flawed. Plagued by local opposition and severely criticized for its educational performance, Edison was hemorrhaging money ($354 million in twelve years), and had lost one-fourth of its contracts.
Edison's collapse would have been a major embarrassment for boosters of educational privatization--that is, if an unlikely white knight hadn't come to the rescue, purchasing the company for $182 million. Edison's savior, ironically, was the Florida Retirement System (FRS)--the pension fund for public employees, roughly half of them teachers, whose union has vigorously criticized both Edison and privatization. The purchase, made by Liberty Partners, an investment firm that made private equity investments exclusively with FRS money, not only put the retirement security of public employees at risk; it financially underwrote the cause of privatization, which public employee unions oppose as a threat to jobs and the pensions of its members. But neither public employees nor their unions had a voice in the matter.
The deal was signed last July but only became public in September, when public employee unions, Florida Democratic legislators and several prominent newspapers criticized the deal, suggesting unsavory political motives. "The politics smells and, more to the point, so does the bottom line," the Palm Beach Post editorialized last October. Florida Governor Jeb Bush is an ardent promoter of privatization and school vouchers, and the Florida Education Association was a leader in fighting his re-election in 2002. Although there is no direct evidence of Governor Bush's personal involvement, a closely linked network of Republican politicians and contributors, pension officials, lobbyists and investment managers had an interest in pleasing the Governor and saving Edison. This web of relationships appears to have facilitated the buyout, in which Liberty Partners betrayed both the principles and the financial interests of the public employees it was supposed to serve.
When Edison manages a public school, it implements a standard curriculum (mostly drawn from widely used programs), lengthens the school day and year, tests students repeatedly, and often provides extras, such as computers. The company is theoretically paid the average per pupil funds spent in public schools. But Edison negotiates contracts in a way that usually gives the company more money per student than in comparable schools, and Edison also shifts many support costs, such as busing, back to public authorities. Critics say Edison also cuts support staff (at times increasing discipline problems), avoids handicapped students and pushes out problem students. Edison's strategy often pushes out experienced teachers; relies heavily on lower-cost, newer teachers whom Edison trains; and increases teacher turnover--raising costs and undercutting teaching.
Edison claims that its established schools produce yearly test-score gains several times better than in public schools. "We're in this to do great things in achievement," Whittle said. "Last year our gains actually improved across the entire system." But several independent studies question those claims. "With a rigorous curriculum, a longer day and a longer year, you don't need to be an education professor to know that should produce better results, but to my surprise, it didn't," said Western Michigan University education professor Gary Miron. "They were doing similarly or slightly worse." Under contract from Edison, the RAND Corporation is now evaluating Edison's performance.
For an enterprise based on cutting overhead, Edison has heavy costs for marketing, highly paid bureaucrats and logistics for a system spread across the country (and four schools in England). Edison kept promising that operating on a larger scale would increase efficiencies, but education research suggests they already have passed the size limit for efficiency gains. "They're losing money while getting a higher amount of money [than public schools] for the services they provide," concludes Henry Levin, director of the National Center for the Study of Privatization in Education at Columbia University. Many districts have canceled Edison contracts, complaining of both excessive costs and inadequate improvements in student performance.
Unions fight privatization as a threat to jobs, wages and unionization, but American Federation of Teachers privatization expert Nancy Van Meter also says, "Our top leadership believes Edison is a diversion. We know what works. We should be talking about what works and not wasting time over something largely irrelevant." Teachers' unions in cities like Peoria, Illinois, argue that tax money would be better spent on reforming public schools than on hiring Edison.
Investors ignored Edison's flaws until the company got a much smaller than expected contract to run schools in Philadelphia in 2002. At the same time, the Securities and Exchange Commission forced Edison to report its income correctly, revealing even worse financial performance. Edison had to borrow at high interest rates, and public scrutiny of its problems made it a hard pitch for even a fabled salesman like Whittle.
In 2002 Whittle retained the Bear Stearns investment firm to look for a private buyer. Only four of seventy-six potential private equity investors made a bid. The winner was Liberty Partners, which paid $112 million for the stock (except for 4 percent Whittle retained) and $70 million in a new loan. But the biggest winner was Whittle: Fortune estimated he could gain $21 million, plus new loans, an extension on old loans, pay that nearly doubled to a minimum of $600,000 a year and a bonus that could be worth nearly triple his base pay.
Liberty Partners is an unusual firm. Many private equity companies use money from rich individuals, including the firm's principal partners, and from institutional investors, like pension funds, to buy public or private companies, spreading the risk among many different investors. But all of Liberty's money--about $1.8 billion--comes from the $92 billion Florida pension fund. So FRS became virtually the sole owner of Edison. In late November of last year, after public criticism of the deal had surfaced, Liberty's eight partners also invested 2 percent of equity, a relatively small share. By nearly any standard, the Florida pension fund's purchase was very large and undiversified, and it fell outside Liberty's standard portfolio and expertise.
While Liberty was bidding for Edison, it was also negotiating renewal of its contract with the Florida State Board of Administration, which oversees the pension fund. An outside consultant to SBA, Alignment Capital, produced a series of scathingly critical reports on Liberty Partners from April 2002 to early July 2003. It recommended, for example, that SBA should "terminate the relationship as soon as possible" if it could not renegotiate terms. Alignment found that Liberty's investments were poorly chosen, were inadequately diversified, and performed badly for the level of risk in its portfolio. Its records were in "shocking...disarray," and its fees "particularly egregious." Alignment recommended that Liberty not invest in both equity and debt of a company.
As the sole trustees of SBA, Governor Bush and two other state elected officials have ultimate responsibility for the retirement system's investment strategies and relationships with its investment managers, like Liberty. Unlike with pension funds in many other states, the beneficiaries--current workers and retirees--have no direct representation or voice. The executive director of SBA is Coleman Stipanovich, whose brother is J.M. "Mac" Stipanovich, a highly influential Republican fundraiser and lobbyist who has been a political strategist for both Jeb Bush and former Florida Secretary of State Katherine Harris (of 2000 presidential election fame) and chief of staff for former Florida Republican Governor Bob Martinez, later Edison's lobbyist in the state.
Last July 14, Liberty formally signed the deal with Edison, which Coleman Stipanovich had known about since March. On July 15 the SBA director for alternative investments wrote to Liberty Partners proposing contract changes: Liberty would limit investments to no more than 20 percent of any company, or $60 million; it would not be allowed to invest in debt and equity; and its general partners would invest 5 percent in any equity. Under those conditions, Liberty could not have bought Edison the day before.
The timing was very curious, but SBA says it was just a "coincidence" that "had nothing to do with Edison." Stipanovich also continued to defend Liberty and its purchase of Edison, even last fall after the Alignment critiques became public. Both he and Governor Bush said it would have been inappropriate for them to intervene in the decision politically. But many Floridians were already upset with risky pension schemes and blamed lack of oversight for Florida's pension fund losing $325 million on Enron stock in 2002--three times the loss of any other pension fund--when its investment manager bought heavily as the stock plummeted. "Pardon the sarcasm," the St. Petersburg Times editorialized after the Edison deal became known last September, "but was there no Enron stock left to buy?"
With its contract up for renewal and under criticism, Liberty had an interest in pleasing Jeb Bush, who had promoted privatization and school vouchers (even though his programs have encountered legal problems, criminal investigations and a state investigation finding serious "lack of accountability"). How better to do that than save the flagship of school privatization?
There were also complex links of contracts and fundraising among many principal figures in the deal that created opportunities for attempted influence. For example, Liberty employed a Philadelphia law firm, Blank Rome, to review the Edison deal. Blank Rome had previously reviewed Edison for the pro-privatization School Reform Commission in Philadelphia. Blank Rome's chairman, David Girard-diCarlo, is a top-level fundraiser for George Bush and close to former Governor Ridge, an Edison advocate. Over the past two years many Blank Rome partners have contributed heavily to both Jeb Bush and George Bush campaign funds, coincidentally on the same days Jeb Bush hosted major fundraising events and as two of the principal partners at Liberty, Peter Bennett and Michael Stakias, made maximum contributions to both Bushes. James Cayne, chairman of Bear Stearns, which found Liberty as Edison's buyer, is also a "Pioneer," the second-highest level of George Bush fundraisers. The links extend beyond fundraising: Last October, after the Edison deal was concluded, Edison was the lead sponsor of a national school choice gala that gave Jeb Bush its "Head of the Class" award. These ties do not in themselves reveal improper influence-peddling, but they suggest a common political interest of all the principal figures and many opportunities for informal conversations.
Liberty, Stipanovich and Whittle maintain that the Edison purchase is a great deal. Edison did report its first quarterly profit last June, and Whittle--who says he has always been optimistic--predicts linear increases in profits and 15-20 percent annual growth in the near future. He claims Edison recently got rid of unprofitable contracts, improved efficiency and expanded profitable tutoring and summer school businesses, which now account for about a third of the 130,000 students Edison "serves." But Edison faces tough competition in the ancillary businesses, and education analyst Jeffrey Silber of investment banker Harris Nesbitt Gerard says Edison's "core business is still unprofitable." Asked what she thought of Liberty's purchase of Edison, Jefferies brokerage education analyst Kirsten Letsinger said, "I probably would have done something else."
"There's nothing you can point to to believe this company will turn around and be profitable, and the assets of public employees are at serious risk," argued Steve Abrecht, director of capital stewardship for the Service Employees International Union (SEIU). "One of the big problems we have is that the people with the most at stake, whose retirement security is vested in this fund, have absolutely no voice in governing the fund."
"With all the possible investments that you could make in our economy where the likelihood of making a significant profit is so much more evident, why would you pick this company?" Abrecht asked. "How do you explain it except that if Edison had collapsed it would have been a huge blow to people who promote privatization of education, not as a business, but out of ideological motivations?"
The SEIU and other unions are campaigning to persuade public pension funds not to invest in companies that privatize public work. "We think it's not in the interest of our members, who are public employees, for their own retirement assets to be used to start up companies that put their jobs at risk," Abrecht said. Union pressure last year discouraged pension-fund investment in a longtime private equity backer of Edison, Leeds Weld, which then announced that it would no longer make risky investments in private school management businesses. Soon CalPERS, the California pension giant, will adopt a policy--similar to those governing public pension funds in New York City, Los Angeles and Ohio--to avoid investments in privatization that threaten the jobs and pensions of public employees. Edison might now be a footnote to history, demonstrating the failure of risky privatization schemes in education, if only the Florida pension fund had done the same.
How Edison Survived