Shorting Education, Against Convention

| About: Capella Education (CPLA)

Capella Education Company (NASDAQ:CPLA) is holding up better than many growth stocks this year. The conventional wisdom is that employees who are laid off, or those who are working fewer hours, will spend time and money to further their eduction. Hopefully this will pay off in the form of higher wages when the economy returns to normal.

While this argument may hold water, I have a hard time using it to justify a multiple of more than 30 times this years earnings in such a difficult market. Add to that the fact that enrollment is expected to increase just 18 to 22% over the next 3 to 5 years and you have a security that could be materially overpriced.

In October, as the market was trading sharply lower, CPLA reached a low just below $35 per share. But after the company announced earnings for the third quarter, the stock shot up dramatically and is now trading in the upper $50’s. What was so exciting about the earnings report? It seems investors were pleased that the company was able to work out the kinks in its new ERP system that has been causing trouble with enrollments in previous quarters. According to Stephen Shank, the CEO, “During the third quarter we made good progress in our recovery from operational challenges impacting new enrollment growth.” But even with the new computer system operating efficiently, there appear to be challenges on the horizon.

Credit Suisse issued a report shortly after the earnings release that attributed the sharp stock ramp at least partially to short covering. Investors may have also been pleased that management took a decent amount of capital to buy back shares (84,000 shares during the third quarter at roughly $50 per share, and another 77,000 shares after the end of the quarter at roughly $40.26 per share). The lower share count is estimated to have added about 1 penny to reported earnings for the quarter. Finally, management stated that they are seeing “no material effect” on enrollment due to the global economic crisis.

I find this statement a bit hard to believe after reading a New York Times article which explained the difficulties that private colleges are having with enrollment this year. Interestingly, a survey of 371 private institutions reflected 2/3 of respondents saying they were greatly concerned about preventing declines in enrollment. It will be difficult for CPLA to completely bypass this trend, although it may survive it better than most.

Stephen Shank has been a solid leader for the company and overseen the transition to a publicly traded entity. He is slated to step down from the CEO position at the beginning of 2009 but will maintain his seat on the board. As of this writing, I have not seen any announcement of a replacement, but I am sure the board is working hard to find a qualified individual. This transition should be watched carefully as it may be difficult to find someone with the same passion, drive, and entrepreneurial spirit as Shank. In the past, many growth companies have experienced transition pains when new leadership has taken the helm.

So it is with the utmost respect for the company, but also the utmost caution on the stock, that I recommend staying away from an investment in CPLA. The company certainly qualifies as a growth company with double digit sales and earnings growth, but the high multiple and uncertain outlook make it a poor candidate for the ZachStocks Growth Model. A short position would likely be profitable over the coming months, but must be managed carefully as volatility will certainly cause major swings in price.


CPLA Notes

Disclosure: Author does not have a position in CPLA.