Grand Canyon Education's IPO: Credit Issues Hamper Counter-Cyclical Play

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 |  Includes: APEI, APOL, CECO, COCO, CPLA, DV, LOPE, LRN
by: Bill Simpson

On November 15, Bill Simpson wrote an analysis of Grand Canyon Education (NASDAQ:LOPE). In their market debut Thursday, Nov. 20, shares ranged between $9.49 and $11.90 during the session. Earlier that day, the company said it priced 10.5 million shares at $12 a piece, at the low end of a downwardly revised price range.

The text of Mr. Simpson's original writeup follows:

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Grand Canyon Education plans on offering 10.5 million shares at a range of $14-$16. Credit Suisse and Merrill Lynch are leading the deal, BMO, William Blair and Piper Jaffray are co-managing. Post-ipo LOPE will have 43.1 million shares outstanding for a market cap of $646 million on a pricing of $15. The bulk of ipo proceeds will go towards paying a special distribution to corporate directors and pre-ipo shareholders. Very little of the ipo proceeds will find their way to LOPE's balance sheet post-ipo.

Endeavour Capital Fund will own 22% of LOPE post-ipo. Four venture capital firms combined will own approximately 50% of LOPE post-ipo.

From the prospectus:

'We are a regionally accredited provider of online postsecondary education services focused on offering graduate and undergraduate degree programs in our core disciplines of education, business, and healthcare. In addition to our online programs, we offer ground programs at our traditional campus in Phoenix, Arizona and onsite at the facilities of employers.'

This is an online university, focusing on post-graduate degrees in education, business, and healthcare for working professionals. LOPE has increased enrollment from 3,000 students at the end of 2003 to approximately 22,000 students on 9/30/08. 62% of students enrolled were seeking masters degrees, with 92% of students 25 or older.

LOPE began as a campus based college approximately 60 years ago. In February of 2004, investors turned LOPE into a for-profit university and focused on growing the online program. Currently 87% of enrolled students were in the on-line program with just 13% traditional on-campus students.

Tuition - Tuition for a full program would equate to approximately $15,000 for an online master’s program (non-MBA), approximately $47,000 for a full four-year online bachelor’s program, and approximately $62,000 for a full four-year bachelor’s program taken on campus. The eMBA program tuition is $44,000. LOPE raised tuition an average of 5% for the 2008/2009 academic year.

Sector - Approximately 18 million people are enrolled in post-secondary institutions, generating approximately $385 billion in revenues. In the past decade, online post-secondary education has been a nicely growing area as many working adults prefer the flexible schedules of an online, accredited degree-granting institution.

Approximately 70% of LOPE's revenues are derived from tuition financed under federal student financial aid programs. These programs include a myriad of federally funded and/or backed grants and loans.

Recession/Credit issues - We've two competing drivers here. During previous economic slowdowns we've seen post-secondary enrollments from adults (25+) rise as people go back to school to retrain and/or work towards a degree to compete in a slowing competitive economy. This current slowdown, however, is coupled with a freeze in available credit, including private student loans. 40% of full-time post-secondary students receive student loans. With LOPE's eMBA program costing $44,000, student loans are an important component in LOPE's revenues. While a portion of the student loan market is backed by low-interest government backed loans, as tuition costs have risen the private loan market has been an increasingly relied on method of paying for post-secondary education. In 2007, private student loans accounted for over 5% of LOPE's revenue. Also, as credit conditions have tightened, fewer banks are participating in the Federal student loan program itself, making obtaining even these loans potentially more difficult. We've two competing trends here - 1) economic slowdown is generally good for post-secondary education with 2) tight credit making student loans more difficult to obtain. While the education group tends to be a nice counter cyclical play, the current credit issues mitigate somewhat the usual counter-economy trend.

Investigation - The Department of Education has issued subpoenas to LOPE in an apparent investigation into whether LOPE improperly compensated enrollment counselors/managers in violation of Federal regulations. Investigation is still in infancy stage. LOPE is also facing a lawsuit by a former employer relating to incentive based compensation to enrollment counselors/managers.

Competitors - As more brick and mortar universities offer online programs, LOPE's competition includes thousands of on-line programs across the United States. There are, however, a few publicly traded on-line for-profit universities. These include Capella (NASDAQ:CPLA), Apollo (NASDAQ:APOL), Career Education (NASDAQ:CECO), Corinthian College (NASDAQ:COCO), DeVry (NYSE:DV) and ITT (NYSE:ESI). Recent successful ipos K12 (NYSE:LRN) and American Public Education (NASDAQ:APEI) are also on-line education related, although neither is a direct comparable to LOPE. Below we look at how LOPE stacks up financially with those in this group.

Financials

$1 in cash, no appreciable debt.

Revenues have grown strongly while margins remain slim and net profits constrained. LOPE has been very aggressive in student recruiting the past two years and it has been reflected in overall enrollment and revenues. LOPE quadrupled enrollment counselor staff over the past two years.

Revenues in 2005 were $52 million, in 2006 $72 million, in 2007 $99 million and through 3 quarters on pace for $154 million in 2008.

Selling expenses have grown as a percentage of revenue, each of the past 3 years. This can indicate competition for new students has consistently grown, as annually LOPE is paying more as a percentage of revenue to recruit a student, even with the annual tuition increases. Even so, LOPE's revenue increase is impressive and a direct reflection of their success in expanding degree programs and recruiting students to fill these newer programs.

LOPE has been profitable since 2006.

Seasonality - LOPE's strongest quarters are the 3rd and 4th quarter annually. The 3rd quarter marks the beginning of their campus semester while online programs generally begin their academic year in both the 3rd and 4th quarter. 4th quarter annually has had the strongest revenues and margins.

2008 - Note that LOPE will be taking a nearly $9 million charge in the 4th quarter due to ipo related compensation charges. I have folded this out of projections as well as other post-ipo non-recurring charges and dividends. Revenues should be in the $154 million ballpark assuming LOPE has a strong 4th quarter as anticipated. Operational costs are high as instructional costs eat up approximately 32% of revenues and selling (student recruitment) eats up approximately 40% of revenues. Total operating expenses account for 89% of revenues, leaving operating margins for 2008 at a slim 11%. This is actually an improvement over 2007's 8%-9% as LOPE has kept their other non-selling costs in check. Factoring in short term debt/interest income as well as taxes, net margins should be in the 6% ballpark. Earnings per share for 2008 should be in the $0.20-$0.25 range. On a pricing of $15, LOPE would trade 66X's 2008 earnings.

2009
- LOPE will increase revenues 55% in 2008. The big question here is this: Can LOPE continue their massive 2008 revenues growth? I suspect LOPE will not be able to approach 2008 revenue gains as this period coincided with regulatory approval that allowed LOPE to increase enrollments. Lets assume a more muted growth in the 25% range, which may be conservative. However two things should constrain rapid 2009 revenue growth- 1) the slowing economy should constrain tuition increases in 2009 from 2008's record 5% increase; 2) the ongoing credit issues may mute enrollment growth for the foreseeable future. A 25% revenue increase in 2009, would still put LOPE above the sector average. LOPE will never have strong operating margins due to operating expenses. They should be able to increase net margins slightly around the edges however. If we assume a $190-$200 million revenues run rate with slight margin expansion, LOPE should earn approximately $0.35 in 2009. This is a ballpark number and I would not be surprised by a number 10 cents to either side. The problem here is the very high sales expense that is preventing strong bottom line growth. That isn't going to change, so LOPE will most likely filter down revenue growth on a 1:1 level going forward, don't expect an economy of scale here on revenue growth. On a pricing of $15, LOPE would trade 42 X's 2009 earnings.

The online education sector has been a safe port in the 2008 market storm. Comparable companies are performing relatively well with DV upon the year, APOL flat, CPLA down 23%, LRN down 10%, APEI flat, and COCO flat. Only CECO has underperformed the overall market. Even with the potential credit issues hampering growth, this sector has indeed been a counter-cyclical play in 2008 with online education stocks outperforming the market as a whole. **Just as importantly, forward earnings estimates for this group have remained stable throughout 2008, one of the few such groups.

Comparisons:

LOPE - $646 million market cap on a $15 pricing. Growing revenues a very strong 55% in 2008 and coming public 66 X's 2008 earnings.

CPLA - $842 million market cap. Growing revenues 22% in 2008 and trading at 31 X's 2008 earnings.

APOL (which includes the largest U.S. online university, University of Phoenix) - $10.8 billion market cap with 16% revenues growth in 2008 and trading 19 X's 2008 earnings.

APEI (not directly comparable due to focus on military veterans) - $690 million market cap with 53% revenues growth in 2008 and trading 48 X's 2008 earnings.

Conclusion - LOPE is a good candidate to break the ipo drought. Post-secondary education has traditionally been counter-cyclical, enjoying enrollment growth during difficult economic times. We certainly have difficult economic times. Looking at stock performances in 2008 for the on-line education group, they've most certainly heavily outperformed the market as a whole. In addition, LOPE's revenue growth is impressive and, while growth should slow going forward, LOPE looks to outgrow the sector as a whole in 2009. Caution here for the following however: 1) IPOs in 2008 have performed abysmally and in this climate you do not want to pay up for anything; 2) Margins are slim here. They are on par with CPLA, but behind the rest of the group. With strong growth and lower margins, it appears LOPE is 'buying' some of their revenue growth. 3) PE ratio for this current climate appears high. With the revenue growth, a high PE is not a major concern. What is a concern is the market not willing to pay high multiples currently.

Slight recommend here in range. I like the sector here and I like LOPE's growth and prospects. There is enough for caution here and the lower LOPE prices, the more I am interested. Ideally I would like to see a pricing below range or at the low end of the pricing range. Two online education ipos in the past year have each not only held pricing, but are up nearly 100% (APEI) and 15% (LRN). In this ipo market, that is unusual and makes LOPE a good candidate to break the ipo drought and also hold a reasonable pricing.

Disclosure: As of 11/26, tradingipos.com does have a position in LOPE from an average price of $10.60.