Class Clowns: How The Smartest Investors Lost Billions in Education

ON JULY 9, 2015, Michael Milken’s twenty-year quest to upend education from “cradle to cane”¹ by unleashing the power of free markets came to a practical end when he announced the sale of the last and largest company his ambitious educational venture had backed. Innumerable other deals had preceded this one over the years, but the sale of all U.S. operations of a for-profit early childhood education business left Knowledge Universe—the audacious holding company name of Milken’s educational foray—as little more than a corporate shell with some real estate holdings and intellectual property assets.² According to Lowell Milken, Michael’s brother and one of the original backers of the educational initiative in 1996, Michael was unlikely to redeploy additional capital into the sector.³

Michael Milken, the one-time leader of the now-defunct Drexel Burnham Lambert’s high-yield bond department, has long been a polarizing figure. His legacy as a financier and his ultimate felony conviction have attracted fierce debate. Although his widely praised philanthropic activities since his release from prison in 1993 have been less controversial, they are arguably as revolutionary as his financial innovations.⁴ Milken’s continuing business activities, however, have been mostly under the radar and are the subject of both conspiracy theories and regulatory scrutiny,⁵ due to his well-documented obsession with secrecy and his lifetime ban from the securities industry.

Like much else associated with Milken’s finances, the details of the Knowledge Universe sale were shrouded in mystery, with no terms disclosed. There can be little doubt, however, that the educational ventures collectively had fallen far short of their original broader objective of establishing “the pre-eminent for-profit education and training company in the world.”6 The asset being sold was overwhelmingly comprised of the KinderCare day-care centers that Milken had purchased for more than $1 billion in 2005.⁷ This final transaction, selling a modest, narrowly focused business that had not distinguished itself in either innovation or operating performance, seemed strangely disconnected from the wide-ranging, futuristic vision of education painted in the heady early days of Knowledge Universe.

Even from a financial viewpoint, enough information can be pieced together to confidently conclude that Michael Milken’s unique financial acumen did not translate into financial success for his overall educational investments. In just the day-care center arena, before the KinderCare acquisition, Milken’s Knowledge Universe had begun, in 1998, by spending $100 million for Children’s Discovery Centers; this was followed with the purchase of Aramark’s Children’s World Learning Centers for $265 million in 2003, as well as a number of other smaller acquisitions. Between the KinderCare acquisition and a February 2014 refinancing of the KinderCare deal junk bonds, revenues had remained stagnant at around $1.4 billion, while profitability and cash flow had plummeted. From 2011 to 2013, EBITDA margins were below 5 percent, as compared with almost 15 percent in 2003. With annual capital expenditures typically between $50 and $60 million, in some years (notably 2012), this spending actually exceeded EBITDA—meaning that cash flow was negative even before paying any interest. After the company’s performance necessitated amendments to its loan covenants, the credit ratings agencies downgraded the organization’s outstanding bonds to subterranean levels in 2012.

As S&P noted at the time, the fact that Knowledge Universe was the largest U.S. child-care operator did not detract from the fact that the entire segment is “mature, cyclical and highly competitive.”8 In addition, being “largest” still left Knowledge Universe with less than 5 percent of the overall child-care market. This persistent fragmentation in the face of continuing efforts to consolidate the industry strongly suggested low structural barriers to entry. More generally, there is little reward for being big in an industry in which scale has few economic benefits. Scale matters in sectors in which fixed costs predominate. When costs are overwhelmingly variable, however, any wily local proprietor can give the largest national competitor a run for its money. As we will see in the next chapter, even in industries with such structural infirmities, innovative entrepreneurs can sometimes redraw the traditional dimensions of competition to create sustainable franchises. But a blind desire to be the biggest, without a nuanced understanding of when and how bigness can actually deliver superior performance, is always a recipe for financial disaster.

Given the financial results and the fact that the ultimate buyer of Knowledge Universe was a disciplined private equity investor, it is not surprising that Milken received less than the sum of the original purchase prices paid for the stream of assets swallowed up since the purchase of Children’s Discovery Centers in 1998. A few years before the sale, in 2012, Milken had hired a turnaround expert—former Old Navy CEO Tom Wyatt—who managed to stanch the persistent revenue losses and move EBITDA margins up to high single-digit percentages, but that was too little, too late. Although Milken refused to disclose the purchase price, the private equity buyer was obliged to share all the details to the junk bond investors who were being asked to take on $845 million in debt (almost $300 million more than what was already in place) in the highly leveraged deal. A Milken spokesperson at the time noted that outside investors had placed a $2.25 billion valuation on the business in 2007 and insisted that since then it had “realized substantial gains.”⁹ The numbers told a very different story. The actual purchase price revealed to the new debt holders was $1.465 billion, making it difficult to see how the 2007 investors could have been made whole.¹⁰ Even for Milken, who had been extracting millions in “management fees”—fees that the private equity acquirer’s financing documents insisted were not associated with any actual services—this amount could not have represented an acceptable return for the leveraged risk he undertook over such an extended period.

The breadth of Milken’s aspirations dwarfed even those of Joel Klein at News Corp., who had at least limited his focus to the K–12 realm. At the height of its activity, Knowledge Universe’s investments were organized into six distinct areas, from child care and interactive learning to corporate training and consulting, and most contained multiple distinct investments. The company consistently expressed a genuine belief that these far-flung enterprises were somehow synergistic. Knowledge Universe’s first CEO, Thomas Kalinske, a former toy executive, described the vision of a brand that would encompass child care, educational toys in the early grades, math software in the later grades, SAT prep, and college selection. Kalinske postulated, “Then when they graduate, whatever business they are in, if they need additional training, they think of us.”¹² Under this view, who would be better positioned to provide retirees with “training for a new part-time career”?¹³

As far-fetched as this notion may seem, it attracted a fair amount of breathless praise. Stan Lepeak, then at the META Group consulting firm but later the head of Global Research and Thought Leadership at KPMG, claimed that Knowledge Universe could “easily become a Fortune 100 company.”¹⁴ Kalinske encouraged the impression of inevitable world domination: “Could it be a $5 billion company? Yes. Could it be more than that? Maybe.”¹⁵ One Wall Street analyst described the assets and team as “a potential category killer” poised to “change the face of for-profit education.”¹⁶ Barely two years into its existence, after the investment of only a few hundred million dollars, another analyst pegged the hypothetical market value of Knowledge Universe as $4–$6 billion.¹⁷

All of this big talk distracted from the fact that Knowledge Universe was only modestly capitalized. Milken and his brother had each put in only $125 million. During the course of his career, Milken has often figured out how to control significant endeavors using primarily other people’s money. Here the bigger silent partner was billionaire and Oracle CEO Larry Ellison, who contributed $250 million. Although $500 million is a lot of money, even with leverage it is a tiny fraction of what would be required to break into the Fortune 100 from a standing start. By 2000, more than 100 private equity funds were already at least this size in operation.18 Indeed, strategic logic aside, there had always been a fundamental financial disconnect between the grandiosity of the ambition and the venture’s actual scale.

Milken seemed to revel in the rumors of Knowledge Universe taking over any number of large multibillion-dollar enterprises, such as one of the largest chains of for-profit colleges. He even participated in a bid for Simon & Schuster, the leading educational publisher that ultimately sold to Viacom for $4.6 billion in 1998.¹⁹ The reality was, however, that the venture never had anything like the capital required to lead an acquisition of this scale. The idea may have been that the publicity thereby generated would create enough momentum to attract new capital that would allow Knowledge Universe to fulfill its dreams of world domination. Indeed, much later, in 2007, Milken hired Goldman Sachs and Credit Suisse to raise $1 billion of new equity for Knowledge Universe, though it does not appear that he ever succeeded in attracting anything like that amount.

In the end, the only transaction Knowledge Universe would ever consummate that was even close to $1 billion in size was the 2005 acquisition of KinderCare Learning Centers, which would remain the troubled core of the business. KinderCare was an asset and company that Milken had known well since the 1970s²⁰ and for which he had financed an ill-conceived acquisition spree, including retail clothing and shoe chains, in the mid-1980s.²¹ Before going bankrupt in 1992, its founder pled guilty to secretly pocketing placement fees for pledging company money to Drexel Burnham Lambert junk bond deals.²²

Assessing Knowledge Universe’s smaller investments outside of the child-care arena, whether on Milken’s terms or on a purely financial basis, is complicated by the fact that the organization is so secretive and there were just so many investments. During the course of its history, Knowledge Universe changed names, ownership, and corporate structure repeatedly. For instance, in the years leading up to the KinderCare acquisition, the original partnership appears to have been unwound, with former ambassador to Singapore Steven J. Green stepping in to take Ellison’s place in at least some future investments.²³

The parts of the Milken education portfolio with greatest transparency are those companies in which he invested that went public or were already public. Chapter 2 discussed the fate of K12 Inc., the Milken-backed online charter school operator that went public in 2007. A closer examination of the four earliest public situations in which Milken was involved—the CRT Group, LeapFrog, Nobel Learning, and Nextera—provides a sense of the breadth of his interests and an opportunity to objectively assess his success or failure, at least in these instances (see Figures 4.1–4.4).

In August 1996, Knowledge Universe’s first significant purchase was a relatively large one, consuming fully a third of its cash hoard. CRT Group was a British temporary staffing and training company that specialized in information technology. Spending $169 million for 50.1 percent of a public company that was the UK’s largest private technology-recruitment agency might not seem like an obvious acquisition for Knowledge Universe. However, it apparently fell within their expansive conception of their remit: “We define education as anything that helps people improve, helps train them, or have a new career.”²⁴ The investment reflected a broader effort to capitalize on what Milken saw as an inevitable shortage of high-tech professionals to feed the exploding “human capital industry.”²⁵

In adjacent areas, Milken purchased most of the franchisees of Productivity Point, a Florida facilities-based IT training company; Symmetrix, a Boston consulting firm; and MindQ Publishing, a Virginia computer-based provider of Java training. Some were impressed with the strategy reflected in this eclectic collection of IT training and consulting assets. As tech guru Lepeak explained, “You would have to be an idiot to lose money in the knowledge market over the next few years.”26 Other industry insiders were not so sure. With competitors of both the broad-based entrenched variety, such as “all the major accounting giants,” in addition to well-regarded “specialists occupying every niche,”²⁷ some questioned whether simultaneously attacking every vertical from scratch represented a coherent strategy. Such concerns were largely swept to the side, however, after the infusion of capital into CRT supercharged not only its marketing efforts but also its stock price. Knowledge Universe bought its shares of CRT at 160p; the price tripled over the first two years, reaching a high of 491p by June 1998. Indeed, this very public performance seems to have driven the early perception of Milken’s Midas touch in education, along with outsized valuations of the overall Knowledge Universe portfolio. Ellison himself served as a Knowledge Universe board representative for a time, as did Stephen Bollenbach, the Hilton Hotels CEO and former Disney CFO.

In May 1998, CRT Group announced it would be changing its name to the Spring Group. In the previous year, the company had made eight acquisitions, diversifying into a number of new IT and vocational training and recruiting areas. It had also established an Educational Services division. The name change, it was said, would facilitate “a consistent and coherent message to be communicated” and permit rationalization of the marketing spend being made across what were now “more than 15 different names.”²⁸ But the bloom on the roll-up rose faded quickly. The share price collapsed to just over 100p by December 1998. In May 2000, Milken pushed out CRT’s founder and replaced him with a new CEO, Jon Chait, who quickly set about reversing the diversification strategy.²⁹

Although Chait, a former Manpower executive, announced the planned divestiture of Spring Education, Spring Skills, and Spring Personnel, this move did not halt the share price slide. By December 2000, he had managed to sell two of these three divisions but had to pull one off the market.30 The shares still continued their downward spiral, remaining stubbornly under 100. Chait was replaced as CEO in 2002 by the finance director, Richard Barfield, who lasted until 2006.³¹ Although Barfield turned the business profitable again after consecutive money-losing years, operating margins were rarely above 1 percent during his tenure and the share price fell as low as 39p in June 2006 shortly before his departure. The shares hit an all-time low of 20p in November 2008.³² On August 11, 2009, simultaneous with announcing interim results showing continued double-digit percentage revenue declines, Spring revealed that its board was recommending acceptance of a 62p-per-share offer from Adecco—the largest global staffing company or, as it describes itself, “the world’s leading provider of HR solutions.”³³

This relatively modest deal merited barely a mention by the acquirer, who announced it between two much larger transactions.³⁴ Although the offer represented a 67 percent premium to the share price of 42p before the company revealed the proposal’s existence, the total equity value was about the same as Knowledge Universe had spent for roughly half the company thirteen years earlier. A Milken-controlled entity, which still owned 36 percent of the company (and 60 million of the 72 million shares he had started with thirteen years earlier), had provided an irrevocable commitment to vote for the deal.

The educational toy company LeapFrog was started by a law firm partner who had developed a product using a Texas Instruments chip to help his child learn to read. His original Phonics Desk was first carried in stores during the 1995 Christmas season, and Knowledge Universe made its controlling investment in the product in 1997 for $50 million. In 1999, the company launched its flagship LeapPad product, which became a best-selling toy in the United States for the period35 leading up to its IPO, which was the best performing in 2002.³⁶

Milken’s decision to target a technology-enabled business in the so-called edutainment sector was not surprising given his fascination with both entertainment and futuristic science fiction. His speeches were filled with both Star Trek and Star Wars references, and the Knowledge Universe board was filled not with educators but with media moguls whose loyalty had been earned during the junk bond era.³⁷ Although in 1999 LeapFrog launched an educational division, LeapFrog Schoolhouse, the company was and would remain overwhelmingly a retail toy business. The toy business is a difficult, hit-driven enterprise in which scale in manufacturing, marketing, and distribution matters immensely. The persistently anemic margins and highly seasonal nature of the business (Christmas sales make or break the year) have led even the largest players to diversify into broader entertainment ventures.³⁸ When an upstart introduces an unexpectedly successful product, the scale players are well positioned to quickly flood the market with their own variations on the theme. These structural industry challenges have long made it highly challenging for toy start-ups to attract funding.³⁹

When LeapFrog went public in 2002, it had a hit toy, but it didn’t have scale. Unfortunately, hits are sporadic, whereas the lack of scale is persistent. The public markets focused on the hit, and the offering at $13 per share was wildly successful. After experiencing a more than 20 percent pop in the share price on the first day of trading, Knowledge Universe’s overall stake was valued at more than a half-billion dollars. But not everyone was enamored with the LeapFrog IPO at the time. The Wall Street Journal highlighted a number of unusual aspects to the offering and the governance structure as causes for concern.⁴⁰ First, companies typically sell no more than 20–25 percent of their equity in an IPO—and often much less. The simple notion is that if the owners believe in the growth potential unleashed by the new capital, they should want to retain as much as possible. Selling any more signals to investors a lack of confidence in the business. Knowledge Universe was selling an almost unheard of 75 percent of the company’s equity. Second, the company was issuing low-vote shares to the public so that Knowledge Universe—with ten vote shares—would continue to control the company even after it sold a majority of the equity to the public.

For the first year after the IPO, it felt like the Journal’s cautions were misplaced as the stock soared to almost three times the offering price. The first signs of trouble did not appear until autumn of 2003, when the company missed its numbers. When the company followed up early in 2004 by missing its first-quarter numbers—only a month after providing very different guidance on the coming year’s performance—the stock collapsed back into the teens41 and began a largely uninterrupted decade-long descent. Michael Wood, the founder, chief creative officer, and former CEO, abruptly resigned in 2004.⁴² In September 2015, the New York Stock Exchange notified the company that because the shares had fallen below $1 for more than thirty consecutive trading days, it was potentially subject to delisting.⁴³

Many tech entrepreneurs and investors get rich by selling enough of their stake in a temporarily hot company before it comes crashing down. The fact that Broadcast.com no longer even exists does not make Mark Cuban, who sold the company to Yahoo for $5.7 billion in stock that he hedged, any less a billionaire. Nor does it seem to have done much to harm Cuban’s business or financial reputation. In the case of Milken, however, it does not appear that he was able to translate LeapFrog’s brief early success into significant financial success. In the 2002 IPO, all of the selling shareholders jointly took out barely $5 million. Milken, as part of the unwinding of the original Knowledge Universe partnerships, did distribute the stake in LeapFrog to the individual investors—just before and just after the disastrous 2004 earnings announcement. But at the time, both Ellison and the Milken brothers insisted that they had “no present intention to sell any of their LeapFrog stock.”⁴⁴ In 2015, as pointed out by an activist investor frustrated with the company’s continued decline, Milken and his family still owned almost 4 percent of the shares and controlled almost 40 percent of the vote. That stake, however, was only worth a few million dollars. Milken had sold a few hundred thousand shares near the peak in 2003 for almost $35 per share, but he sold most of his other shares between 2009 and 2011 for an average price of not much more than $5 per share. Although this amount was well above the penny-stock levels the company found itself trading at by 2015, it was still a fraction of the original IPO price.

In February 2016, shareholders got some much-needed good news. A Hong Kong–based “supplier of corded and cordless phones and electronic learning toys” announced the acquisition of LeapFrog for $1 per share. Although this purchase price represented a 75 percent premium to the previous closing price, Milken’s small economic interest in the $72 million deal would still represent only a few million dollars. Collectively, the proceeds of these sales plus the modest value of his remaining stake amounted to less than the $50 million that Knowledge Universe originally invested. Given that the original investment was by an entity only partially owned by Milken, it is conceivable that he personally got back what he put in, but it is inconceivable that he achieved an acceptable return over his holding period, which is now approaching twenty years.

The basic positioning of Nobel was as an affordable alternative to elite private schools for relatively well-heeled middle-class families. A higher student-teacher ratio and a more disciplined cost regime supported the business model. However, new schools typically took eighteen to twenty-four months to achieve profitable enrollment levels, and a burst of openings depressed 1997 profits, when shares fell from $12.50 to $4.50 during the course of the year.

Knowledge Universe seemed to view this decline as a buying opportunity. Unlike the case of CRT, however, new money was not put into the public company to accelerate its growth plan. The Milken vehicle simply purchased 1.28 million shares in the open market beginning in late 1997 and into early 1998, gaining a more than 20 percent stake in the company. One million of these shares were purchased at $5.63 each on January 14, 1998.45 Although the corresponding public filing indicated a potential interest in eventually taking a majority stake in the company, direct communications with Nobel about their interests or intentions were vague beyond generally encouraging a more aggressive new school rollout.⁴⁶

Nobel’s stock popped on the news of the Knowledge Universe purchase, but nothing much else seemed to change. Although Clegg had moved the business from being a child-care company to a predominantly pre-K–8 private school operator, it was still very much a “microcap” (a public company with an equity value of less than $300 million).⁴⁷ What’s more, Clegg ran the business essentially as a family enterprise. Four of his children were on the payroll, including one son eventually positioned as the heir apparent. At the time of the investment, Clegg expressed hope that Knowledge Universe would help with technology in the schools but claimed indifference overall and said he had never even met Milken. “At this stage, I am relatively neutral until I see if there are some benefits,” Clegg asserted five months into the relationship with Knowledge Universe.⁴⁸

Any “synergy” between Knowledge Universe and Nobel never materialized. Over the following years, growth continued, but the company lost focus on the core school business. Indeed, the pace of new general education private school openings slowed. Instead, the company entered the markets for charter schools, schools for special needs children, and summer camps; it also purchased a company that ran pre- and after-school programs.49 These initiatives were accompanied by a significant expansion of Nobel’s geographic footprint. All of this frenetic activity placed significant strains on the company’s capital structure. In the years after Milken’s investment, the shares remained volatile but never exceeded $10 per share and sometimes fell below $5 per share.

In August 2002, Clegg partnered with two small private equity firms to take the company private for $7.75 per share, a 32 percent premium over the $5.85 that it had been trading at.⁵⁰ Although there was speculation that this move came to avoid a Milken takeover of the company, presumably Milken could have simply offered more once Clegg had effectively put the company in play. If the deal had closed, Milken would have achieved a paltry return on his investment. The deal, however, didn’t close. In November, the buyout group informed Nobel that it had been unable to secure the financing needed for the deal.⁵¹ The stock immediately collapsed below $5 once again, and in February 2003, the buyout agreement was formally terminated.⁵²

The company was in a precarious financial position, with its lender threatening to put the company into receivership. The Milken group threatened a proxy fight but settled by making a $5 million loan with warrants to the company and by getting two board seats.⁵³ This loan did not resolve the company’s capital structure challenges, and Milken saw it as a first step to gaining further control, as the agreement also permitted him to buy an additional 10 percent of the company on the open market. Ultimately the company was only able to avoid Milken’s control by accepting help from a “white knight,” Camden Partners which agreed in June 2003 to invest $6 million of new preferred equity in the company—but only if Clegg stepped down.⁵⁴ In July, an entirely new management team, led by George Bernstein, was put in place, and the Clegg family departed the stage.⁵⁵

To Bernstein’s surprise, the company he took over was still facing default. In September 2003, he avoided disaster by getting the company’s three largest shareholders—the Milken Group, Camden Partners, and Allied Capital—to each invest an additional $1 million in preferred equity, which gave Bernstein the breathing room needed to ultimately put a more permanent capital structure in place. By the end of the year, the Milken Group owned just under 30 percent of the common stock; Camden, just under 20 percent; and Allied, just under 10 percent—with each also owning different stakes in the multiplying classes of preferred stock.⁵⁶

Although the stock remained stubbornly under $5 at the end of 2003, Bernstein quickly moved to refocus and stabilize the company. The shares began to rise steadily, ending 2004 at more than $7.50 and reaching $10 early in 2006. The stock reached a high of $14 in February 2007. During this period, Milken liquidated the original Knowledge Universe vehicle used to buy the shares and distributed the holdings to investors. As a result, overall Milken-affiliated entities’ ownership fell, though he and his brother built up their position again—in part by buying out Allied Capital’s holdings. By March 2007, the Milkens once again owned close to 20 percent of the company. News of the Milken brothers’ purchases quickly drove the shares to more than $15 per share for the first time since the 1980s.57 The Milkens continued to buy shares on the open market in 2007 and into 2008.

Throughout the period from the 2003 recapitalization until 2008 Milken’s substantive communications with the company regarding either his intentions or the potential for strategic arrangements with other Knowledge Universe companies were nonexistent. His communications consisted instead of the rare brief note or of high-level conversations. Indeed, Bernstein pressed Joseph Harch, one of Milken’s two initial board appointees, to step down after Harch failed to appear at board meetings.⁵⁸ On Thursday, July 17, 2008, Bernstein got a call from Milken offering to dramatically alter the nature of their previous communications. Milken let Bernstein know that he had purchased another 10 percent of the company at $16 per share and suggested that they get together the following week for a detailed discussion. Milken had purchased the stake at a price above market directly from Ellison, who had not sold his shares since getting them distributed from the original Knowledge Universe partnership.

The threat of a “creeping takeover” by Milken concerned both the board and other major shareholders, who loudly communicated their concerns.⁵⁹ Their worry was that Milken was trying to buy control on the cheap, without allowing the company to explore other, potentially superior proposals. Over the weekend, the board adopted a so-called poison pill to thwart any such effort and to give the company time to organize itself.⁶⁰ On Monday, July 21, after the pill was announced, Bernstein called Milken as promised to schedule their meeting. The call was short, as Milken told him they had nothing left to discuss.

The stock then drifted down below $13 per share. Then, in September 2008, the Milkens made a formal proposal to buy the balance of the company for $17 per share. The proposal came in a letter from Knowledge Learning Corp. (KLC), the entity that owned the U.S. child-care properties. The letter touted the strategic benefits as a feeder for enrollments in Nobel Schools. It also emphasized the benefits of association with Knowledge Universe Education (KUE), KLC’s parent, with its ownership of other K–12 businesses such as GlobalScholar, which was a roll-up of various online businesses serving that market.61

The independent board members established a committee, which decided to run a process to assess what could be achieved from a sale and determine whether any transaction was advisable. Given the company’s progress under Bernstein, some board members felt that selling at all in the midst of the 2008 financial crisis, while stocks were all artificially depressed, made little sense.⁶² Throughout the resulting process, which corresponded with a deepening financial crisis, KLC refused to receive any confidential material about the company so that Milken would maintain flexibility in the disposal of his shares. In addition, KLC repeatedly requested extensions to the date for submitting final definitive proposals. The stock price continued to fall with the market—reaching as low as $11.37 per share—and the process dragged out. Then, in March 2009, Milken publically announced a revised proposal of $13.50 per share,⁶³ which the board quickly rejected.⁶⁴ None of the other strategic or financial parties engaged by Nobel submitted a proposal.

In March 2010, the Nobel board decided to quietly pursue a sale in discussion with a handful of parties that had previously expressed interest and continued to track the company. Although the company had performed relatively well operationally, the recession’s lingering impact and a lack of market enthusiasm for the K–12 sector in general had left the stock floundering below $10 per share since the second half of 2009. This narrow process collapsed in August 2010, after the initially selected “winner” significantly revised its offer downward and none of the other participants were willing to match the original proposal.

Leeds Equity Partners, an education-focused private equity firm, approached the company after the failure of the process and ultimately secured an exclusivity period starting late in 2010. Leeds reached an agreement to buy Nobel in May 2011 at a price of $11.75 per share. Milken had remained enigmatic throughout the 2010 process and the subsequent discussions with Leeds. He ultimately agreed to participate and sign a limited nondisclosure agreement in connection with the 2010 process, but did not submit an indication of interest with the other parties.

Neither the extra fifty cents per share nor the other concessions Milken insisted on before supporting the deal would have any significant impact on the unattractiveness of his investment in Nobel. Although Milken had been associated with Nobel for more than a decade, he had purchased half of the 3.857 million shares he owned at an average price of around $15 per share, representing a loss of close to 20 percent. Even the original million shares he purchased for $5.63 in 1998 would yield him a paltry annual return below 5 percent.65 Adding insult to injury, during four short years of private ownership that followed Milken’s association with the company, the investors made four times their money.⁶⁶ This achievement was not reached by any “synergies” with other Leeds Equity portfolio companies. Rather, Leeds’s main contribution was to leave CEO Bernstein alone to execute his focused strategy of building and operating efficient, locally-based clusters of preschools and K–8 schools.

When Leeds sold in 2015—to private equity firm Investcorp and Bahraini sovereign wealth fund Mumtalakat—the price paid reflected boom M&A market multiples far above what had been achievable in 2011. But Leeds’s success was not simply a function of market timing. Bernstein actually grew the EBITDA of the business by more than 70 percent by growing revenues 33 percent and increasing margins from 10 percent to 13 percent. The growth achieved during these four years came through a balance of modestly priced acquisitions and organic investments. The significant capital deployed in the business still allowed a substantial reduction in the debt level put in place in the initial LBO. The contrast to the period of public ownership is a testament to the potential costs of management distraction in a small-cap company, particularly one with warring shareholders.

The IPO itself had a lukewarm reception. The filing range was first lowered from $13–$15 per share to $10–$12 per share; it was then priced at the bottom end of the range. Shares promptly fell more than 10 percent in the first day of trading.67 Various explanations were offered for the poor performance: the market’s lack of appetite for roll-up stories, Nextera’s minimal exposure to the “hot” Internet and telecommunications niches that were driving the overall IPO boom, and the unorthodox governance structure that could allow Milken to control the business indefinitely through a special class of high-vote shares. Whatever the reasons for the indifferent welcome, none would have necessarily doomed the company if it had proceeded to execute effectively on its articulated strategy.

The key to any successful outcome for Nextera would be the performance of a business called Lexecon, which was both the largest acquisition of Nextera and the least connected strategically to the rest of the roll-up. In the late 1970s, two well-known law professors at the University of Chicago and Andrew Rosenfield, a second-year law student, founded Lexecon to provide litigation support grounded in economic analysis. Over the years, a number of distinguished academics, including more than one Nobel Prize winner, would be associated with Lexecon.⁶⁸ Even as Lexecon grew in its first decade to more than 100 employees, all of its management held either part- or full-time posts at the University of Chicago. By the time of the Nextera acquisition for $60 million, Rosenfield, who once described the business as the “action arm of the Law and Economics movement,” was Lexecon’s chair.⁶⁹ Notably, Lexecon’s principal, Daniel Fischel, was dean of the University of Chicago Law School and had written Payback: The Conspiracy to Destroy Michael Milken and His Financial Revolution, a controversial book defending Milken.

Based on the deal, which was just under half in stock, Rosenfield and Fischel became the largest individual shareholders of Nextera, and, on a pro forma basis, Lexecon would have represented 30 percent of Nextera’s 1997 revenues.⁷⁰ In the month before the IPO, however, Lexecon experienced an unexpected windfall of $50 million when it won a jury trial against plaintiff’s class-action law firm Milberg Weiss for impugning its reputation.⁷¹ The case related to an earlier trial, in which both Milken and Lexecon had been defendants, involving the collapse of a savings and loan controlled by Charles Keating.

Shares of Nextera fell under $5 per share in its first year of trading, and the CEO was soon replaced by Milken’s neighbor, Steven Fink, who was already on the board.72 Although Fink had no particular expertise in consulting, he had undertaken a number of projects for Milken-related businesses.⁷³ With the dot-com boom in full swing in 1999, Fink’s primary focus as CEO was to “refocus the company and convince Wall Street Nextera is an Internet play.”⁷⁴ When the boom became a bust only a year later, a new CEO was brought in⁷⁵ and all of the key operating divisions other than Lexecon were sold in 2001 and 2002 to meet the company’s debt obligations.⁷⁶ In February 2003, with the stock trading in the pennies and Lexecon the only remaining operating asset, Fischel was made CEO of Nextera.

The price that Milken’s vociferous public defender exacted to take the CEO job ultimately required the effective liquidation of the company.⁷⁷ By that time, Fischel had sold the 1.3 million shares he had held at the time of the IPO. The new employment agreement secured by Fischel was remarkable in a number of regards. In a typical professional services business, whether law, consulting, or banking, individual professionals typically keep between 20 and 40 percent of the revenues they generate, with the balance going to cover overhead. Under his deal, Fischel kept 100 percent. In addition, Fischel was entitled to more than a third of a bonus pool pegged at 43 percent of any operating income generated by the Chicago office. On top of all this, he received a $2 million signing bonus and another $5 million for an agreement not to compete for a year (presumably in the event that he decided to leave the sinking ship). The $5 million noncompete took Nextera only to January 1, 2004; it was then obliged to write him and another employee each another $10 million check for an additional five years of noncompetition assurance. This was the straw that broke the camel’s back, as the company had less than $1 million of cash and a mountain of debt.⁷⁸ Nextera had “no viable alternatives” but to sell the last remaining operating asset “to enable us to meet these obligations.”⁷⁹

Fischel and his colleagues at Lexecon would get another bite at the apple as the division was sold for $130 million to a new owner, FTI Consulting, a $1 billion public company that focused more narrowly on corporate finance and restructuring.⁸⁰ None of the sale proceeds would be made available to Nextera shareholders, because the company had almost $100 million in debt and other liabilities to fulfill. There was little question, however, that the transaction would receive shareholder approval, as the Milken group controlled more than 70 percent through a special class of high-vote shares and still held all of the 8.8 million shares with which they had started.

In anticipation of the transaction’s closing on December 1, 2003, NASDAQ sent the company a final delisting notice. The deal left Nextera an empty-shell penny stock, with little more than $30 million in residual operating losses and $17 million in cash. The value of the Milken group’s collective stake was little more than a couple of million dollars. As the New York Times said, the sale transaction “put an end to what began as a big idea: to build a one-stop shop for companies that need advice.”81

All four of these far-flung Milken enterprises shared several characteristics. In each case, somewhere along the line, the company’s ambitions significantly outstripped what was practically achievable, due to some combination of the constraints of industry structure and operating realities, on the one hand, and the needs of domain expertise and execution capability, on the other. At some point, the public market, to a greater or lesser extent, bought into Milken’s expansive vision of each company’s potential role in the broadly defined educational firmament. But Milken took advantage of these moments of market euphoria to only a modest degree. The result is that his financial returns ultimately ranged from the pedestrian to the disastrous, which could reflect either bad market timing on Milken’s part or the conviction of a true believer. Circumstantial evidence indicates that the latter played at least some role in these outcomes.

As public companies, these four situations represented the portion of the secretive Milken edu-world that broke through the surface to be subjected to scrutiny. Although they reflect a small fraction of the investments made by Knowledge Universe, key features are consistent with a slightly messianic and fundamentally misguided world view reflected in Milken’s statements and actions. At the birth of Knowledge Universe in 1996, Milken had shared the overarching investment thesis that “entertainment, technology, telecommunications and education will continue to come together to create a new dynamic in education.”82 However, Milken was not simply predicting that educational products would incorporate innovations in these other sectors. He believed not just in product convergence but also in actual industry convergence. In addition, across the various segments of the “life-long learning” enterprises that make up the “human capital industry,” he genuinely believed that “there’ll be a vertical integration of all of that.”⁸³

More often than not, the investments made by Knowledge Universe underperformed due to lack of focus. The determination to be the biggest overall within a massive, amorphous vertically and horizontally integrated edutainment sector made it difficult to actually achieve relevant scale along the way. Establishing scale only matters within a product niche or geography. Operating K–8 schools efficiently in geographic clusters is a fine business, but combining them with day-care centers and other kinds of schools and programs—at least without a coherent integrated operating strategy—is a distraction. Lexecon has continued to operate successfully within FTI Consulting, but it never made sense for it to be combined with HR or IT consulting. The temporary staffing, IT training, and IT consulting sectors in which CRT played are all distinct businesses, and those that outperform in each business specialize. LeapFrog would never be as big as Hasbro or Mattel in toys or as big as Apple or Samsung in any kind of computer hardware for children; therefore, the only conceivable successful strategy was for it to narrowly define and defend its market segment.

The insurmountable obstacle facing Milken’s ambition to become a titan of the twenty-first century’s trillion-dollar human capital industry was that such an industry does not exist. “Milken is convinced that the fragmented educational-services business will allow for the creation of huge new corporations,” BusinessWeek observed in 1999. “And he intends to be in charge of one of them.”⁸⁴ Even at the time, however, those who actually did run one of the leaders in some segment of the highly regulated and idiosyncratic educational sector found this approach more perplexing than threatening. “What is the core competency, the focus?”⁸⁵ asked John Sperling, the founder and then-CEO of Apollo, which is still the largest for-profit university system.

On the ground, Milken’s approach made it hugely difficult to prioritize opportunities. With a modest bankroll and a desire to dominate a market defined in the hundreds of billions, where to begin and where to end? Joseph Costello, a respected software executive and then-CEO of Cadence Design Systems, joined Milken’s mission in the early days, convinced of “the potential for making a significant contribution to the educational world.”86 He lasted fewer than three months. “They were all over the map,” Costello complained. “[Milken is] like an addicted shopper.”⁸⁷ Part of Costello’s frustration was not just the ad hoc mixture of low- and high-technology initiatives, but also Milken’s tendency to fall back on traditional LBOs of traditional businesses he understood and, in some cases, had financed before. But the ultimate large-scale educational convergence that Milken foresaw required technology to fundamentally disrupt the incumbent players, and he was eager to get in on the ground floor. Many of the investments he pursued involved potentially radical digital business models far removed from providing child care; running bricks-and-mortar elementary schools; selling toys; or providing consulting, staffing, or traditional corporate training.

Knowledge Universe’s digital educational efforts spanned all segments of the educational market. Chapter 2 discussed K12 Inc., but that was not the only effort on the digital side of primary and secondary education. Knowledge Universe also funded a roll-up of businesses under the GlobalScholar brand to compete with SchoolNet and Wireless Generation in the instructional improvement system market. This investment was at least financially successful for Milken, who sold it to his old friend, billionaire Ronald Perelman, for $160 million. Operationally, however, GlobalScholar’s pieces were never effectively integrated, and its offering was never competitive. Perelman publically credits Milken with both his own financial success and that of the U.S. economy more generally. Yet, despite his deep admiration for Milken, Perelman sued Milken for fraud in connection with the GlobalScholar sale, describing the product as “vaporware” that was “not actually functional.”⁸⁸ Perelman lost the suit—the court effectively found he should have known better—and closed the money-losing GlobalScholar.⁸⁹

Milken’s most ambitious early efforts at Knowledge Universe to transform education were aimed at the higher education sector. Almost immediately, Milken focused on the idea of a “‘virtual university’ that would be beamed to students by satellite television or over the Internet.”90 The fate of that project, initially launched under the Knowledge University moniker, highlights a number of the structural challenges to digital business models in general. It also specifically underscores significant practical limits of many pure digital offerings in the educational context.

Knowledge University was born of the notion that the Internet could deliver broad access to the ideas produced at the world’s most prestigious universities. Although the company would burn through hundreds of millions of dollars in a few short years, it would continue to soldier on for more than a decade as it repeatedly changed its name, narrowed its ambitions, and adjusted its business model. Although the carcass of what started as Knowledge University still survives as a tiny subsidiary of another Milken-affiliated company, its effective end came with U.S. attorney Preet Bharara’s December 2012 announcement of a multimillion-dollar fraud settlement.⁹¹ Given Knowledge University’s obsession with affiliating with Nobel Prize winners and top-tier institutions, it is the ultimate irony that its demise came in connection with a scam directed toward career-oriented, low-income students.

Milken’s basic concept for the business was to get prestigious universities to lend their names and faculty to develop courses that would make up an online MBA curriculum. The university would be paid for providing its imprimatur and access to its faculty, but students would not get credit from these institutions. Faculty participation and compensation would be the universities’ responsibility. These courses would be delivered asynchronously, with faculty contributing to curriculum development—in most cases, this contribution appears to have been simply providing a course outline. The final course content and actual class management and instruction were entrusted to paid staff. The initial plan was to sell the product to the corporate market.

The first name change came quickly after it became clear that the prestigious universities whose participation was central to this vision would not lend their names to a Milken-controlled entity. Milken had backed Andrew Rosenfield, a founder of Lexecon and now a lecturer at the University of Chicago Law School, to lead Knowledge University. Although Rosenfield had no experience running an enterprise of this complexity, he had a track record of making academics rich. When Milken bought Lexecon in early 1999, Rosenfield turned around and used the proceeds to buy Knowledge University through a new entity called UNext.com (the .com would eventually be dropped). Milken would retain a 20 percent nonvoting stake in the entity and substantial ongoing informal influence. But minimizing Milken’s association with UNext was a necessary but not sufficient condition to attract the caliber of institution the founders had in mind. As it turned out, the kinds of agreements required to secure their participation would place significant financial burdens on UNext, while reserving complete flexibility for the universities.

Although Rosenfield’s role as a member of the University of Chicago Board of Trustees caused controversy over that institution’s participation—as did the suggestion that a potential generous contribution from Rosenfield’s share of the $50 million Lexecon legal settlement was being used as enticement for their involvement92—it was actually Columbia University Business School that first agreed to be an affiliate. That school’s entrepreneurial dean, Meyer Feldberg, had a personal relationship with Milken and was unapologetic in his view that the deal was as much a “business opportunity” as an “intellectual opportunity” with “huge upside” from the value of the equity in the IPO.”⁹³

For all the focus on the upside, however, Feldberg clearly knew how important the association with a top business school was to Milken and negotiated for months to protect the institution’s downside—both financial and reputational. The dean may have been a friend of Milken’s, but all the evidence suggests Feldberg picked his pocket, which may be why the deal did not seem to engender anything like the level of controversy it had at the University of Chicago. As influential professor of finance Bruce Greenwald said, the arrangement “looked like money for nothing and a chance for some people to make salary supplements for adapting their courses.”⁹⁴

Although the contracts were not public and they varied somewhat among the graduate business schools—Columbia, Stanford, Chicago, London School of Economics, and Carnegie Mellon—each appeared to contain broadly similar provisions based on the template negotiated by Feldberg. On the one hand, the universities got meaningful upfront payments (Columbia reported receiving $2 million and assurances of at least $20 million over a five-year period),⁹⁵ based on a share of ongoing revenues that would be convertible at their option into a collective 20 percent of the company. In addition, the university maintained veto rights over how their logos would be used and even over who other partners would be. On the other hand, beyond being able to claim the association and voluntary assistance from selected faculty in course development, UNext got very little, as all of the agreements were nonexclusive.

A basic problem with many distance-learning models is the extent to which they ignore the central socialization role of most educational experiences. At different levels of instruction, the nature of this role varies but is no less critical to the overarching objective of developing high-functioning citizens. Elementary school introduces children to peers from a broader range of cultures, backgrounds, personalities, and abilities with whom they will need to interact in the real world. In college, students have a heightened level of independence that requires them to master a complex variety of interdependent tasks and human relationships, completely apart from any selected curriculum. The point is not that online learning can have no useful role to play in delivering education; rather, it is that unless the purpose of the enterprise is fully understood, the business is unlikely to be a pedagogical or financial success.

These qualities of an MBA have two broad implications. The first is that if a student does not get into one of the very top programs—with access to a strong network of alumni and high-quality peers who will watch their back as they develop professionally—it is a terrible waste of money. Professor Jeffrey Pfeffer at Stanford has shown how economically unattractive it is to get an MBA from something other than a top fifteen school, particularly when compared with a graduate degree in a specific subject or with just continuing to work.96

The second implication is that an MBA seems like one of the least sensible programs to deliver electronically. Great software can facilitate, replicate, and even enhance human interaction in some contexts, including learning. UNext, however, was spending $1 million per class to develop curriculum in the late 1990s when the technology solutions available were limited and broadband penetration was less than 10 percent. Although UNext marketing materials emphasized interactivity and multimedia capabilities, those capabilities were designed to be “delivered adequately on dial up connections” and were usually supplemented with “textbooks and printed course packs.”⁹⁷ The online courses were being touted as cutting edge for the time. However, when Rosenfield was looking for underwriters to take the company public in 1999, I had the opportunity to view a course as part of a group of bankers at Morgan Stanley. As Rosenfield breathlessly sold the notion that we were watching the “killer app” of the Internet, he clicked on an icon to reveal a short video of an elderly Nobel Prize winner mumbling the basics of the capital asset pricing model. None of us were impressed.

Another critical aspect of the value of an MBA that even Professor Pfeffer concedes can have value is the “signaling” role that a degree from a top school can play for employers. Corporations often view the selectivity of the most elite institutions as a useful form of prescreening, and many only actively recruit from the very best schools. But UNext was associated with such institutions in only the most tenuous way possible, and its students had no access to their faculty or alumni network. Supposedly, UNext students could say they took a course developed in connection with one of these respected institutions, but any credentials received would be from a new entity that UNext named Cardean University, which had no established brand value. Not only did Cardean have no resonance in the job market, but it also did not have the accreditation needed to offer MBAs in the first place. Accrediting bodies generally require several years of review before providing their imprimatur, and UNext was burning cash at a remarkable clip. Although it was able to sell individual courses for a few hundred dollars each in the meantime, this was a far cry from the $25,000–$30,000 they would charge for an MBA. UNext quietly got around this problem by buying the shell of an established correspondence school called ISIM University, which was accredited though not by the more prestigious regional accreditation bodies. UNext soon began offering Cardean MBAs.98

To be fair, the MBA market for students who intend to continue working while taking the courses—usually either because they can’t afford not to or because their employer has sponsored them to do so as part of an internal development initiative—has some important differences from the market for traditional MBAs. UNext initially focused on the corporate part of the market and did succeed in making a few high-profile sales. This market, however, was an even more competitive space in which UNext appeared to be operating at a meaningful disadvantage. On the one hand, all of the top MBA programs—both those affiliated with Cardean and the rest—offered a variety of so-called executive MBA (EMBA) programs that bestow a real MBA from one of these institutions. Although mostly delivered live, these degrees are structured creatively, making use of weekends and short intensive periods of instruction, allowing students to matriculate while being fully employed. On the other hand, pure online MBAs had become an increasingly crowded field, with the established, fully accredited, bricks-and-mortar, for-profit universities already enrolling many thousands in their fully or partially online degree programs. Those programs, as well as a number of others established by public and private nonprofit institutions, were able to heavily leverage their existing staff and infrastructure. Although Cardean was priced far below the traditional EMBA programs, it was priced far above the competing online programs.

Although the existing for-profit higher education industry had obvious structural advantages over UNext, it is worth noting that pure online operations were not the most profitable ventures in the industry. The most successful businesses were those that leveraged their physical regional strength or their scale for delivering targeted degree programs. Although these businesses did build complementary distance and hybrid programs, in the online realm, leaders in particular geographic or subject matter niches were all suddenly able to compete more broadly, putting pressure on pricing and profitability. (The largest online degree program—Apollo’s Phoenix Online—already had almost 20,000 online degree students by the end of 2000.99) In addition, completion rates for online programs—an issue that would be a focus of the future regulatory problems—were far below that of traditional delivery methods.¹⁰⁰ Notably, all of the major online degree programs (except for the very largest) outsourced the learning management system (LMS) on which they delivered their programs. UNext initially followed the sensible model of outsourcing its LMS; however, to secure IBM as its first major high-profile client, it agreed to use IBM’s Lotus LearningSpace platform in a kind of barter transaction. Although this seemed like a win-win, the product was poorly designed for delivering the kind of program envisioned by UNext. Rather than select a more appropriate LMS provider, presumably one that was being successfully used by any of the other online graduate programs, the company decided to spend tens of millions of dollars to design a proprietary LMS.

The UNext approach reflected a variety of faulty assumptions not only about the size and nature of the potential market for its product in general but also about the value to students and employers of the limited association with well-regarded institutions and famous academics. The company even hired Roger Schank, a world-renowned cognitive psychologist who founded the Institute for the Learning Sciences at Northwestern University, to develop the curriculum. After Schank was publicly quoted questioning the company’s actual commitment to education, he was quickly fired.

Many new ventures shift their focus and strategies as they learn more about the market they are serving or trying to redefine. UNext’s most fateful decision, however, was to spend hundreds of millions quickly and commit to a particular model well before it had been able to test the validity of any of its ultimately faulty assumptions. “The whole business model depends on making huge up-front investment,” the company’s president and COO Richard Strubel, a former manufacturing executive, conceded as early as 2001. “I don’t know that anyone will ever do it again, and they certainly won’t do it the way we did it.”¹⁰¹ Although Don Norman, another distinguished academic and Schank’s replacement at UNext, continues to defend the quality of the courses, he conceded that the business model was fundamentally flawed. Recalling a “successful” early pitch to a major global financial institution in the market for online MBA courses, Norman said their human resources executives had surveyed the landscape and declared that UNext courses “were the best.” The bad news came soon thereafter. The institution could “only think of two or three people at the company worldwide to go through [the course].”

From the beginning, UNext was characterized by a remarkable combination of arrogance and naïveté. The arrogance stemmed from a conviction that the association with Nobel Prize winners, world-renowned institutions, and leading academic authorities would almost, of necessity, translate into a large, successful business that could attract endless capital.102 The naïveté extended to almost every area in which domain expertise would be needed to actually build a large, successful business—product, market, regulation, and financing. In the 1999 meeting with Rosenfield, it was not just the pedestrian nature of the product and the narrow market they were targeting that struck the Morgan Stanley bankers. When the hyperconfident Rosenfield, who himself had no public company experience except for working at a subsidiary of the failed Nextera, introduced us to the CFO, whom he proposed would manage the IPO, we were speechless. Not only had Patrick J. Keating, the former finance executive from Carnegie Mellon, never been a public company CFO, but he had also never previously worked at a for-profit institution of any kind.¹⁰³

The Internet boom fed this natural hubris. The NASDAQ peaked in March 2000, just around the time that UNext started to test its first handful of courses with its first handful of corporate clients.¹⁰⁴ By then, a third of all U.S. colleges and universities already offered their own distance-learning courses.¹⁰⁵ Once UNext was up and running with its full MBA, Cardean was still a tiny fraction of the size of, and had a lower level of accreditation than, its for-profit online competitors.¹⁰⁶ Nonetheless, UNext continued to raise new equity from sophisticated investors such as the Pritzker family at valuations that reached as high as $800 million—which would make it, on an inflation-adjusted basis, a unicorn today.¹⁰⁷

In 2001, the last reported outside money came into the company. Thomson Corporation, one of the largest higher education publishers at the time, announced a $38 million investment in connection with a vague “strategic partnership.”108 Around the same time, UNext, which had ballooned to 400 employees, announced its first job cuts. By the fall of that year, UNext reported plans to cut the remaining staff in half¹⁰⁹ and was deep in talks to renegotiate its financial arrangements with “partner” universities.¹¹⁰ But even as it faced challenges in meeting its bills and attracting customers, UNext remained, as The Red Herring reported at the time, “high on hyperbole.”¹¹¹ Rosenfield in particular was fond of referring to the hundreds of thousands of people employed by corporations in Brazil, China, and India as holding the “key to future success,”¹¹² although these would always represent a tiny minority of the company’s modest customer base. In addition, throughout this period of crisis at UNext, Rosenfield kept busy with significant outside business interests. In addition to his continuing association with Lexecon, he worked on establishing a venture capital accelerator with the Pritzkers¹¹³ and later became a founding partner in the Chicago office of investment bank Gleacher & Company, another UNext investor.¹¹⁴

By late 2001, UNext began to significantly shift its focus. It first decided to “lower its brow” and push short, two-hour corporate training courses, leading its hometown business rag to suggest that the “Harvard of the Internet is morphing into something more like DeVry.”¹¹⁵ The following year, the company began to market the MBA directly to consumers online, competing head to head with businesses like not just DeVry but also Apollo and the entire established sector.¹¹⁶ At the time, the market capitalizations of those companies were in the billions, and each had marketing budgets in the hundreds of millions.

The last significant strategic move during Rosenfield’s tenure as CEO was the 2003 launch of an entirely new online nonprofit university called Ellis College, which was part of New York Institute of Technology (NYIT). NYIT is a well-established nonprofit technical training institute, and Ellis College would serve as NYIT’s online arm, enabling them to extend their reach to “serve working adults worldwide with excellence,” according to NYIT president Edward Guiliano.¹¹⁷ NYIT essentially outsourced the bulk of the Ellis operations to UNext. Structured not unlike the earlier deals with the five prestigious business schools, NYIT received a cut of the revenues and stock options in Cardean. In the press announcement, Rosenfield appeared to repudiate the previous business model for which he had raised nearly $200 million: “Students want to be associated with a recognized accredited site-based university via distance” to provide “the best of both worlds.”¹¹⁸

By the time UNext had established this alliance, it no longer referenced any association with the five prestigious business schools that had once been central to its identity.119 Thomson, the educational publisher who had invested in 2001, would also soon negotiate an exit from the unfruitful alliance in which it would sell back its entire stake in the company in return for the promise of no future legal entanglements.¹²⁰ When Rosenfield stepped down a few months later, he pointed to the management of the rapid growth of Ellis College as the new CEO’s primary task.¹²¹

Not until the court filings in the ugly litigation between Cardean Learning Group (UNext officially changed its name to this in 2005) and NYIT were released, five years after the launch of Ellis, did it become clear just how important this venture had been to UNext. NYIT filed suit when it realized that its options were worthless and Cardean had failed to pay the $2 million owed to NYIT. In its countersuit, Cardean conceded that it had staked its entire future on Ellis. “Without a services agreement with Ellis University,” the documents stated, “Cardean will have no business function and cease to exist as a going concern.”¹²² In 2010, Cardean’s few remaining assets were quietly sold for scrap to K12 Inc., another Milken-affiliated company, where they still sit, unbeknownst to most shareholders, in a subsidiary called Capital Education LLC.¹²³

It is striking how different the enterprise begun a decade earlier was from the one that emerged from reading the court filings in the ultimately settled lawsuit. Rosenfield had once bragged to the New York Times that he had spent nearly $100 million on developing courses before receiving a single dollar of tuition¹²⁴ and that he was focused exclusively on developing relationships with high-profile institutions, academics, corporations, and investors. By the end, however, the company had focused on developing relationships with poor working adults dreaming of a better life. How Cardean established and managed those relationships would become an issue not just for NYIT but also for accrediting bodies and federal prosecutors.

In its lawsuit, NYIT complained about privacy breaches of student records, and accreditors cited “substantive and pervasive problems” related to “administrative oversight, integrity,” and “quality issues” more generally.¹²⁵ But the most serious problem that attracted the attention of the federal authorities was Cardean’s illegal use of recruiters to attract poor students eligible for federal loans and grants. The problem was that Cardean paid these recruiters a bounty—a practice clearly banned under federal law as “incentive compensation”—based on how many students they enrolled. Although NYIT was unaware of the activity, it shared in a $4 million government settlement with Cardean for failure to provide oversight.¹²⁶

Cardean was not the only degree-granting online learning venture to end ignominiously over this period. Caliber, the Wharton School’s e-partner, filed for bankruptcy. Fathom, a for-profit online consortium launched in 2000 by Columbia and a dozen university partners, shut down in 2003. A variety of other individual universities announced their own online plans with much fanfare, only to pull the plug as losses mounted.127

In 2008, just as what was left of Cardean was collapsing, along with its relationship to NYIT, a researcher at the University of Prince Edward Island coined the term MOOC, or massive open online courses. There continues to be much debate over the distinguishing features of MOOCs, but the characteristic that most differentiates these courses from the many distance-learning efforts that had preceded them is the emphasis on “openness.” Although even the meaning of this term has been the subject of controversy, it broadly refers to the notion that content should be free or almost free. This idea is consistent with the key tenets of the open educational resource movement, which is the spiritual inspiration for MOOCs. Such was the momentum behind this idea that the New York Times declared 2012 “the Year of the MOOC.”¹²⁸

Given how difficult it was to build a sustainable, pure distance-learning model when charging for the service, the insistence on “free” can only be expected to make it an even harder slog. This does not mean that MOOCs will not be able to provide socially valuable services. A number of nonprofits and public entities, from Khan Academy to edX, have already done so. That said, however, these organizations have not found permanent solutions to the challenges long faced by the for-profit distance-learning market—that is, low completion rates, an often less-than-rich educational experience, an inability to achieve the social objectives of the educational experience, and weak acceptance of the credential by employers and traditional universities. To these long-standing obstacles are now added, of course, increased competition from the nonprofit entities serving the same markets. But these are still relatively early days.

For the for-profit enterprises, however, the huge obstacle to any MOOC business model is the structural tension between the high cost of curriculum creation and the inability to charge for it.129 The two largest for-profit MOOCs—Coursera and Udacity—have attracted high-profile investors and leaders.¹³⁰ Coursera hired former Yale University president Richard Levin, another leader without business operating experience, as CEO. At least his tenure at Yale was more successful than Benno Schmidt’s had been. In addition, the business Levin is running is in the same general domain as his university career—unlike Schmidt, who moved from Yale into K–12 education.

That said, these are very different businesses—one an established long-time leader with prodigious barriers to entry, the other a start-up with new well-financed competitors emerging all the time. The disclosure in 2015 that Levin had been given an $8.5 million payout as an “additional retirement benefit” from Yale on stepping down—more revenues than Coursera had at the time—was a reminder of just how different the businesses are.¹³¹ Despite the fundamental challenges faced by these business models, Udacity has now graduated to “unicorn”-level valuations.¹³²

Both Udacity and Coursera have had to change their revenue model and pursue somewhat different paths, though both charge for certification and various premium services. Udacity has focused on getting corporates to pay for development of nano-degree courses that will pre-certify students for specific jobs at those companies.¹³³ Coursera is also working with corporates, but its aim is to develop “capstone projects” that it hopes will encourage more students to obtain certificates.¹³⁴ Both companies have modest revenues and remain unprofitable.