Tutor firm buying Hooked on Phonics

THE BALTIMORE SUN

The company that owns the frequently advertised Sylvan tutoring centers is buying another as-seen-on-TV name: Hooked on Phonics.

Educate Inc., Sylvan Learning Center's parent, said yesterday that it has agreed to pay $13 million for Gateway Learning Corp., which owns the well-known - and sometimes controversial - company whose "Hooked on Phonics worked for me!" slogan became a staple of the airwaves.

It might seem an odd marriage, pairing a tutoring giant with a product company. But Baltimore-based Educate is buying Hooked on Phonics primarily for the brand, and for a new and relatively small part of the company that has nothing to do with infomercials.

Gateway Learning has launched more than 600 "reading centers" in day-care facilities in the past few years, a collaboration in which the day-care teachers use Hooked on Phonics materials to instruct students whose parents pay extra for the service. Most of those locations are through KinderCare, the largest day-care provider in the country.

Educate intends to open similar operations in libraries, community centers and other locations as a way to tap into the market of parents who would like extracurricular education for their children but can't afford - or don't feel they need - the pricey tutoring offered in the Sylvan centers. The company would license programs in day-care facilities but run the other center locations itself.

The infomercial-sales part of Hooked on Phonics, which in the 1990s landed the company in trouble with the Federal Trade Commission for "unsubstantiated claims," will be licensed to a third party. Educate will retain control of the products, which are packages of books, workbooks, tapes, flashcards and CD-ROMs that sell for $150 to $300.

This acquisition is similar to Educate's decision last month to join with educational toy company LeapFrog Enterprises Inc. to open small learning centers in big-box retail stores, most likely Wal-Mart.

"We think we're doing something that really profoundly changes the landscape and the business," said R. Christopher Hoehn-Saric, chairman and chief executive of Educate. "What franchisees have been saying to us is, we have to be able to serve a broader market."

Sylvan is the largest tutoring company in the country, with more than 1,000 franchised and corporate-owned centers in North America, but its services are geared toward relatively affluent people who want remedial help for their children. Six months of instruction costs an average of $2,500.

"They are missing out on a large segment of the population," said Kirsten Edwards, an analyst with ThinkEquity Partners, a San Francisco investment bank. She calls the Hooked on Phonics acquisition a good way to expand while "preserving" the Sylvan brand name.

The Hooked on Phonics centers - like the LeapFrog centers - offer less intensive, lower-priced services than Sylvan, averaging about $125 a month. Hoehn-Saric hopes they will also appeal to parents with younger children; Sylvan is aimed at grades three through 12.

There's another strategy involved as well: Educate wants to have many more locations.

"The No. 1 thing consumers are telling us is, 'Make your service more convenient to us,'" Hoehn-Saric said.

Though Educate is paying $13 million to a group of private investors for the acquisition, it considers the net price $8 million because Gateway Learning has about $5 million in capital. Educate has also agreed to pay an extra $6.6 million if the company meets certain - but undisclosed - performance benchmarks.

The Santa Ana, Calif.-based Gateway Learning employs fewer than 50 people after outsourcing its telemarketing operations last year. It will stay in California, with most of the senior management team remaining.

Hooked on Phonics, founded in the 1980s, has high brand awareness but a rocky past.

Annual sales, which topped $100 million in the mid-1990s, dropped to $50 million in recent years, according to Hoover's Inc. and D&B; Corp., formerly known as Dun & Bradstreet. The company filed for bankruptcy protection in 1995 and was brought back to life as Gateway Learning by Chip Adams of Rosewood Capital, a venture capital investment firm.

At the end of 1994, Hooked on Phonics agreed to settle FTC charges that it did not have adequate evidence to support tje advertising claim that its products quickly teach reading to children with learning disabilities, regardless of the problem.

In July it settled another set of FTC charges that it violated federal law when it sold consumers' personal information to marketers after promising it would not do so.

Gateway Learning declined to comment yesterday, referring calls to Educate. Adams, Gateway's chairman, could not be reached yesterday afternoon.

Analysts said they didn't think the tarnish will stick to the brand, particularly because the direct-sales business will be shunted off to a licensee.

"There's no taint of that in any practical way on what Sylvan's buying," said Trace Urdan, who follows Educate for investment banker Robert W. Baird & Co. "It's a respectable offering."

Robert E. Slavin, director of the Center for Data-Driven Reform in Education at the Johns Hopkins University, said he couldn't speak to Hooked on Phonics' effectiveness, but "it sure has been very effective from a marketing perspective."

"There are gazillions of parents who use it," said Slavin, also chairman of the Success for All Foundation in Towson, a nonprofit that helps struggling schools with programs that primarily focus on reading, writing and language arts. "The research is very strong that beginning reading goes best with phonics."

Educate is a product of the complicated breakup of Sylvan Learning Systems Inc., which until last year owned the tutoring centers and a network of universities around the world.

In 2003, after an unsuccessful gamble on a venture capital fund for Internet education-related businesses, Sylvan Learning Systems decided to sell its kindergarten-through-12th- grade tutoring businesses to focus on higher education. It changed its name to Laureate Education Inc.

The tutoring businesses became Educate Inc., headed by Hoehn-Saric, who was co-chief executive officer of the original company. In addition to running Sylvan, Educate offers publicly funded tutoring in struggling school systems. Hooked on Phonics is also used by some schools.

Laureate and Educate remain in the Inner Harbor East office tower they had occupied when they were the same corporation.

Educate went public in September. Its stock closed at $12.75 yesterday, up 24 cents.

As Educate looks to corner the market on supplemental education services, the number of small-scale competitors is booming. There are more than 1 million tutors in the United States, more than double the number just 10 years ago, estimates the National Tutoring Association. That includes paid professionals and volunteers.

"In every family in the United States," said Thomas Redicks, past president of the tutoring association, "there's a child who needs extra help."

Sun researcher Elizabeth Lukes contributed to this article.

At a glance

Educate Inc.

Revenue, first nine months of 2004: $232 million

Net income, first nine months: $4.5 million

Employees: 10,000

Headquarters: Baltimore

Gateway Learning Corp. (Hooked on Phonics)

Annual sales: $50 million

Employees: Fewer than 50

Headquarters: Santa Ana, Calif.

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