The Short Case on Strayer Education

Where is the smart money hiding? The absolute easiest slam dunk short of 2008 was the REITs. People were hiding their money in REITs last year during the summer and early fall. It was pretty obvious vacancies would increase, new malls would stop being built, and the massive debt of these companies would be hard to roll over in a tight credit environment. Most importantly, REIT investors get nice dividends that sure looked in jeopardy of not paying. Look at the sector now. Most of the stocks have lost at least 50% of their value since then. I was short SPG, and in my mind, the REITs themselves were layup shorts. I digress.

The point is when every analyst loves a stock or sector and earnings seem to be steamrolling, I usually try to find holes in the story. Enter the education and training services stocks: Strayer (STRA), Apollo (APOL) and American Public Education (APEI). I will focus on STRA as my short candidate.

Strayer Education provides post-secondary education through Strayer University and online. It also runs education loan processing, which was started to administer the Company's student loan portfolio.

So what do I not like about this company, and what do I think the company's fair value is?

1) The Chairman and CEO sold out of 95% of his holdings in the company on December 3rd!

I can understand he might have wanted some extra cash for the holidays but 95% of his holdings in the company. Is he joking? Apparently, he thinks the stock is priced to perfection as I do. How can he be completely upbeat about the company in their latest conference call if he is selling the lion's share of his holdings?

2) Expected growth in earnings per share next year is over 32%. The annual earnings per share growth the past 5 years for STRA is 20%, but suddenly Superman Strayer is going to pick their game up 60% to grow at 32% in 2009 in a recession? Am I missing something? Please spare me that these companies usually do pretty well in a recessionary environment. All these people who lose their job are going to have such an easy time getting loans to go back to school in this tight credit market right? I don't think so.

What do I think is the fair value of the stock? Let's assume that the market prices this stock back to the lower end of its historical P/E ratio to 25 and let's assume new campus openings slow down, there is modest bad debt expense from their loan portfolio, and STRA's growth rate is 20% next year, you have earnings per share of 6.36 and a stock price of $159. Long term, I think the growth rate drastically changes for the education companies. No longer will they be growth stocks but more maturing companies. With that thesis, let's assume a P/E ratio of 18, and growth in earnings per share of 10% from 2010-2013, you have earnings of $9.30 in 2013 and a stock price of $167, 30% lower than today's $218.

My mom always said, "No one is perfect." I usually countered with, "Mom, how do you explain Cindy Crawford then?" She responded, "Even she gets caught without her makeup on." Well, smart money hiding in these stocks will eventually learn that STRA has blemishes too, and the stock will correct hard. I have 60% of my desired short position and plan on dollar cost averaging on strength. Timeframe: medium to long-term.

Here is a link to my portfolio on kaChing.

Disclosure: Short STRA.

Comments

[Nick Waddell:]

Well reasoned argument, Daniel. One doesn't really have to look much beyond the insider sales to be suspicious. Do you think there is anything in Obama's new admin to justify their optimism on growth?

Jan 28 03:13 PM

[Paul Martin:]

As I am sure you are aware, this seems to be a sector bubble. I have been modelling this on kaChing with a few other guys & it does not look good across the board.
Stocks that are overvalued in our opinion include : APOL, COCO, ESI

Good piece

thanks P

Jan 28 11:45 PM

[User 347376:]

If you lower any companies current PE nearly 40%, and then say that they will miss earnings estimates by over 30%, then you will obviously find a compelling short. However, I do not agree with how you came to those estimates.

1) Yes, the CEO did sell 95% of his stake- this is VERY concerning and why I will probably move out of the stock to another education company.

2) All of the education companies have been exceeding earnings estimates... with such a tough job market, many people are going to go back to school to improve their prospects--- yes even in a tough environment. Their job is most important to them... and these companies can help them not only get a job, but also one that pays much better than before at a reasonable price.

With the economy taking a nosedive for the foreseeable future, low-cost secondary education may just be the way of the future and companies like these stand to benefit and this is reflected in the industry's impressive recent results.

Even if it is overvalued, it is too tough a short because it is too easy to get wiped out with so much momentum. Better call would probably be buying a longer term put.

Jan 29 06:48 PM

[SammyBaby:]

And don't forget SLM as a short.

Feb 01 09:24 AM

[msoori:]

I agree with your reasoning. My wife wanted to go to Arts Institute of Atlanta for Interior Design. After seeing how much it costs (over $500/credit hour) we decided to wait it out a bit longer. You can go out and spend $50K on education, but, if at the end of it you dont get a job, you have an expensive piece of paper and no way to pay back the loan.

Feb 01 09:34 AM

[H.J. Huneycutt:]

User,

I look at this from the other direction as you do. Even assuming these companies weren't overvalued by every conceivable measure IMO, I'm not so sure the outlook for them gets better because of an economic downturn. I think the reverse is more likely.

These for-profit universities are extremely expensive and with the economy down, there's absolutely no guarantee that one will find a job after obtaining their degree. Hence, why spend tens of thousands of dollars on a second-rate education when you're not even sure if your investment will ever pay off?

Plus, the other thing to think about - the people attending these universities are normally already employed. They go to the for-profit universities because they are more flexible than traditional universities. As unemployment moves above 10%, people are suddenly going to find themselves with more time and with little need for the flexibility offered by DeVry, Strayer, UofP, etc. In such a scenario, a state school with dramatically lower tuition fees is much more attractive.

Feb 01 02:59 PM

[Nick Waddell:]

Dan,

Strayer down huge today. Good call.

Feb 12 10:32 AM

[Dan Weiss:]

I actually like some education stocks on the long side but LOPE looks like a near no-brainer short at this time based on valuation. Also, APEI looks expensive at these levels. A stock like DV is actually relatively attractive at my opinion based solely on valuation.

Feb 16 01:09 AM

[Xanadu:]

The value of STRA stock will drop like a rock when investors discover the institution is not accredited by the Southern Association of Colleges and Schools (SACS), which evaluates all colleges that have headquarters in Virginia. According to the Virginia Corporation Commission, the headquarters of Strayer University, Inc., is in Arlington, VA. The headquarters of the school's online division is in Newington, VA. Strayer gets around this by claiming that its headquarters is in WashDC, thus not subject to SACS oversight.

Apr 20 05:19 PM