Insights From Instructure Preliminary Proxy Statement

On December 23rd, Instructure 1 filed a preliminary proxy statement as part of their process to be acquired by Private Equity firm Thoma Bravo. This document is part of the formal SEC process to disclose relevant details to shareholders of the company prior to a formal shareholder vote on the acquisition agreement (technically called a merger agreement, but it’s an acquisition). There will be a definitive proxy statement after SEC approval and prior to the vote.

This proxy statement gives us one of our last looks into Instructure’s financial plans, assuming the deal goes through, as it will no longer be a publicly-traded company with public filings. And the document is quite interesting, giving indicators on such items such as whether Canvas pricing will go up or not, as well as providing an extensive history of the sales process over the past year.

The Proxy Basics

When the proxy was released, I shared a Twitter thread with the basics, shown below unrolled. Afterwards I’ll analyze some of the details.

1/ Instructure ($INST)’s preliminary proxy statement is out, which is doc describing upcoming shareholder vote on whether to accept the Thoma Bravo acquisition.…#LMS#Canvas#edtech 

2/ Doc has a lot of new details, including total price of deal (adding in stock options, etc): $1.959 billion

3/ Fees that Instructure would owe Thoma Bravo if deal does not go through: $29.3 million if superior bid comes in before Jan 8 (go-shop period) from party who had not already given bid, or $63.5 million otherwise. Instructure would get $136.9m if Bravo walks.

4/ Board of directors unanimous recommendations 1) to approve acquisition (technically called a merger), and 2) to approve executive compensation agreements tied up with acquisition.

5/ Timeline estimated for vote and completion of agreement in Q1 2020.

6/ Extensive “background of the merger” starting p 26, including initial informal offer of $53-$55 / share, subsequently reduced to $49-$51 / share after some due diligence; Bravo initial bid of $50, subsequently reduced to $47.60.

7/ No other bids have come in during go-shop period (thru Jan 8). Bank contacting 24 parties (9 had already been in talks, 15 new) to gauge interest, signed one new confidentiality agreement.

8/ Executives other than CEO Dan Goldsmith getting 6-month severance + 80% bonus package if terminated not for cause; CEO gets 12 months.

9/ Executives (Goldsmith, Kaminsky, Kaminer, DeBellis) and directors full packages (RSU = restricted stock units, basically compensation issued in form of stock); CEO Goldsmith getting $25m – not sure of conditions on $22m of RSUs. [note – see section below for clarification on Goldsmith and Kaminer forfeiting half of their unvested RSUs].

Equity interest of Instructure's executive officers and non-employee directors.

10/ Revenue, earnings (EBITDA), and free cash flow projections from management (p 56):

Management projections of the Canvas business line financials from 2019 - 2033.

11/ Will read in more detail; add blog post with analysis.

Process Details

The proxy is unusually detailed, compared to your typical proxy statement, in its description of the sales process over the past year. The process started January 8, 2019:

On January 8, 2019, a financial sponsor (“Sponsor A”) requested a meeting with Joshua Coates, the Executive Chairman of Instructure. In response to Sponsor A’s inbound inquiry, Mr. Coates had a call with Sponsor A that same day during which Sponsor A expressed an interest in acquiring Instructure for $53.00 to $55.00 per share. On the same day, the Board of Directors held a meeting to discuss Sponsor A’s expression of interest.

What follows on pages 26 – 42 is a description of 40 separate financial sponsors (i.e. private equity firms) in contact with Instructure, with 19 of them signing non-disclosure agreements to get financial information, leading to two formal proposals – one from Thoma Bravo and one from another firm. In addition, there were five industry participants (i.e. other technology firms) contacting Instructure as part of the sales process with none of them making a proposal.

The bids ranged from $47 to $53 per share, with two best-and-final proposals in $47.50 – $47.60 range. It is interesting that prices consistently dropped upon further diligence, and several financial sponsors dropped out due to concerns over bookings trends (likely from the LMS market slowdown and even changes in the overall win rate).

Strategic Plan, With or Without Acquisition

The document makes clear that Instructure’s board had already been making plans to become a “Rule of 40” company, whether the acquisition goes through or not. On September 23rd (p. 30):

Following such presentations, the Board of Directors discussed the timeline for Instructure to achieve profitability, an education focused strategy, cost-realignment plans, and changes that would need to be implemented for Instructure to achieve status as a “Rule of 40” software company with a combined growth rate and profit margin of at least 40%.

What this likely means, in essence, is that Instructure needs to reduce expenses and increase revenue. On November 25th we learn of concerns from financial sponsors on this plan [emphasis added] (p. 37):

On that same day, each of Sponsor E and Sponsor K declined to further pursue a strategic transaction with Instructure. In declining to pursue a transaction, Sponsor E indicated concerns about new bookings performance, the ability of Instructure to increase prices and the consequences of implementing cost reductions. Sponsor K indicated that Instructure did not fit within its investment profile.

Bridge LMS as Schrödinger’s Cat

A lot of the discussion about Instructure over the past year has centered on the fate of the corporate learning Bridge LMS product line, with strong hints provided in November that Bridge would likely be divested, sold, or just shut down. What I find strange in the proxy statement is that there is no view of Bridge, one way or the other. This proxy document is meant to inform shareholders of relevant details before the vote, yet there is no view to show whether Bridge is dead or alive. No inclusion in the management projections of the costs or revenue from a potential Bridge sale or shutdown. I realize that this is a minor part of the Instructure business, but it’s strange to see Bridge disappear from discussions when that topic dominated the earnings call questions over the past four years. By subtraction we can see that Bridge generates roughly $20 million in revenue with losses in the low tens of millions.

Big Paydays for (Mostly) New Executive Team

The size of payouts for the executive team seems remarkable, especially as most of that team was hired in the past year or two to improve the Bridge corporate learning market more than the Canvas academic market. Yet the company’s future is all about Canvas.

Josh Coates with his potential $105 million payday is different. The company started with a project in a class he taught at BYU, he was the first investor, and he was CEO from 2010 – 2018 while taking a $1 salary.

A Bloomberg article today described some of the payout for other executives.

Two weeks after the suitor made a nonbinding offer in January, directors on Instructure’s compensation committee enacted a new policy for rewarding the company’s most senior employees, turning their cash bonuses for 2018 into a package of restricted stock units that was 25% larger, according to the company’s filings. The panel also discontinued cash bonuses through 2022 in favor of new, long-term stock grants for executive officers. And it gave all staff the option of receiving 20% of their base salary in equity.

The shift — which the company says was in the works months before buyers began circling — positioned Chief Executive Officer Dan Goldsmith, Chief Financial Officer Steven Kaminsky and General Counsel Matthew Kaminer to receive more compensation in the form of stock at a time when it could surge in value. Since the policies were adopted Jan. 23, shares of Salt Lake City-based Instructure have outperformed the broader market, gaining 23% as it reached a deal to sell itself. Some of the stock has already vested, and when combined with what’s left, the trio is set to reap a cash windfall of more than $25 million, even as Goldsmith and Kaminer give up half of the unvested portion of their RSUs in light of the accelerated payout.

Matt Kaminer has been with the company for years, as has retiring CFO Steven Kaminsky. CEO Dan Goldsmith joined Instructure a year and a half ago and became CEO on January 1, 2019. CMO Marta DeBellis joined 11 months ago, EVP / Head of Sales Frank Maylett joined five months ago, and the Bloomberg article notes one other payday of relevance.

In May, Instructure hired Goldsmith’s sister as chief strategy officer, awarding her a long-term stock incentive of $3.59 million, according to a filing. The appointment was approved by the audit committee. She reported to Kaminer, not her brother, the person said.

Last-Minute Change to Financial Projections

One other detail that jumps out at me – Instructure changed their financial projections in terms of free cash flow (FCF, how much available money the company will generate each year) on December 3rd, the same day that Instructure was finalizing the agreement with Thoma Bravo. The changes are noted in the document, but the details are buried in a footnote and provided with no explanation of why these numbers changed, increasing forecast FCF up to $7 million per year. This information was not shared with other financial sponsors prior to Instructure signing the agreement with Bravo, at least based on the proxy statement. From the footnotes on p. 55:

Footnotes to management projects, describing changes to Free Cash Flow as of December 3rd.

Overall Thoughts

This proxy document offers considerable detail to the Instructure sales process and insight into the Canvas future (financial projections, efforts to become Rule of 40 company). We’ll have to wait and see, however, what happens in terms of potential new bids during the go-shop period (through January 8, 2020) or in terms of influencing shareholders before the official vote. I would note that while the document describes what happened in terms of interactions with potential acquirers, it does not describe the nature of those interactions. The Praesidium and Rivulet statements described claims that the process has been “designed to result in a sale to management’s chosen buyer at a low price…in order for management to save their jobs and enrich themselves in the years ahead”. The proxy seems to show that the process was not rushed, but it is not clear whether the interactions with financial sponsors were done in a manner leading to a chosen buyer that fit the interests of the executive team. There is much to watch in January and February before the sale is finalized.

What I do not see from Instructure in any official SEC filing or blog post since the sales process became public is a meaningful description of why the Thoma Bravo acquisition might benefit its customers. In the section “Reasons for the Merger” (starting p. 42), Instructure lists:

  • Attractive Value

  • Best Alternative for Maximizing Stockholder Value / Thorough and Well Publicized Sale Process

  • More Attractive Value Than Alternatives

  • Greater Certainty of Value

  • Likelihood of Completion

  • Opportunity to Receive Alternative Proposals and to Terminate the Transaction in Order to Accept a Superior Proposal

In a November press release when Instructure first went public with the sales process, it was all about maximizing shareholder value:

“Consistent with its duties and in response to interest from several parties, our board of directors has determined that it is prudent to undertake a review of alternatives to identify the best way to maximize shareholder value,” said Josh Coates, Chairman of the Board at Instructure.

A December letter to customers , however, comes the closest to addressing customer needs.

Reflecting this year on our goals and path forward revealed that operating in the public spotlight wasn’t fueling innovation and was starting to get in the way of customer success. Partnering with Thoma Bravo opens the opportunity for Instructure to focus even more on accelerated innovation and our customers.

Working with Thoma Bravo over the past weeks, it is apparent that they support our strategy for focus on continued investment in Canvas LMS, expanding our impact in education, positioning Bridge to be more successful, and being a well-run business. As a private company, we will be able to better control our future and execute on these strategic imperatives. That future looks bright and there is much work to do. However, I am more confident and excited than ever for the difference we will make together and the journey ahead.

I realize that the proxy statement is primarily driven by SEC rules, but Instructure is harming its brand by its consistent focus on monetization and shareholder value with no meaningful communication to customers or prospects (I do not consider the letter above meaningful). The academic LMS market deserves better from its market leader.

Disclosure: Instructure is a subscriber to the MindWires LMS Market Analysis data service (as are many of their competitors), and we have a number of investment firms who are also subscribers to the service and pay for in-depth market data and research.

1 Disclosure: Instructure is a subscriber to the MindWires LMS Market Analysis data service (as are many of their competitors), and we have a number of investment firms who are also subscribers to the service and pay for in-depth market data and research.