Playing For-Profit Education Stocks: The Government's Bet On The U.S. Economy

by: Alpha Bet

Is the for-profit education industry a critical economic catalyst or another potential sub-prime showdown? True success of these companies imply that the number of jobs, and specifically the number of jobs that require a highly trained and skilled work-force is growing. This growth in jobs injects additional capital into the economy, requiring companies to expand in order to meet growing demand. In order expand, companies have to hire more workers, which in-turn drives additional university enrollment. That's a pretty straightforward "circle of success" [we'll call it] concept that most people can agree on. However, that is where the agreement typically ends and where much of the debate with respect to job growth in the US economy begins.

The problem is that there is a great divide between many of our government and business leaders on where this cycle of events actually begins. Does a more educated workforce attract new jobs? Or do companies need incentives to move jobs to, and create jobs in the US, at which point the enhanced workforce can then expand to meet growing demand? It's simply the old chicken or the egg adage, and maybe there is no right or wrong answer, who knows. What you should know is that as the debate rages on, the US government is placing huge bets on the educated workforce [came first] side of the argument, indirectly investing billions of dollars per year in the for-profit education industry each year. That's $32 billion in the 2009-2010 school year to be exact.

The Government's Political Position

The government's political position on the for-profit education industry has become very apparent in recent months. Federal and state lawmakers have begun to crack down on this group of educators as a result of low student employment rates, questionable educational standards, predatory recruiting tactics and most importantly incredibly high student loan default rates. Below are a couple of quick facts from Iowa senator Tom Harkin's website regarding the HELP committee's investigation into for-profit colleges:

•Between 2008 and 2009, over a million students started attending schools owned by the companies examined by the Committee. By mid-2010, fully half (54 percent) of those students had left school without a degree or certificate. For Associates-degree students, 63 percent left without a degree.

•Most for-profit colleges charge much higher tuition than comparable programs at community colleges and flagship State public universities. The investigation found Associate degree and certificate programs averaged four times the cost of degree programs at comparable community colleges. Bachelor's degree programs averaged 20 percent more than the cost of analogous programs at flagship public universities despite the credits being largely non-transferrable.

• Students who attended a for-profit college accounted for 47 percent of all Federal student loan defaults in 2008 and 2009. More than 1 in 5 students enrolling in a for-profit college-22 percent-default within 3 years of entering repayment on their student loans.

• The investigation also documented that many companies recruiting tactics misled prospective students with regard to the cost of the program, the graduation rates of other students, the job placement of other students, and the transferability of the credit.

Although the government has begun to look for ways to hold these for-profit schools accountable for graduating students, rising costs and as a result debt burdens, as well as their recruiting tactics, the industry has also been able to maintain an admirable political position against additional government regulation. These schools argue that they are the only postsecondary education option for their target market, which mostly consists of minority and low-income students, and that over-regulation would not only inhibit the ability of these students to obtain an education, it would also limit their chances of getting ahead in society and would ultimately steal their right to experience the American dream.

The Government's Financial Position

The government's financial position on the for-profit education industry has proven to be much more generous than their political position. As previously mentioned, the US government indirectly invested $32 billion into these schools during the 2009-2010 school year. How did they do this? While for-profit colleges only enroll between 10 and 13 percent of total students, they receive 25 percent of all federal financial aid. Of those 10 to 13 percent at for-profit colleges, 96 percent take federal student loans. With for-profit schools getting such a large portion of the federal aid, and with almost all for-profit students using government aid to pay tuition, the final HELP committee report estimated that the 15 publicly traded for-profit universities received 86 percent of their revenue from federal loans and grants. That is, the government indirectly contributed over $30 billion of revenue in 2009-2010 to these schools.

Of course those figures are a couple of years old now, so with the tightening regulations, you'd expect those numbers to begin to fall right? Not exactly.

Over the last couple of weeks, for-profit college stocks have received a boost as a result of a report from the Congressional Budget Office that stated the Pell Grant program, which gives need-based grants to low-income students, will have a surplus in 2013 and 2014. Many experts had expected a deficit and eventual budget cuts. Pell Grants accounted for around $7.5 billion of the total $32 billion in federal aid that went to for-profit schools in '09-'10.

The Government's Plan

Although the government is indirectly investing billions in these for-profit schools, they're more concerned with their investment in the students at these schools. The hope is that a well-trained and educated workforce will help to facilitate growth of the US job market, and ultimately spur overall economic expansion and prosperity. There is no doubt that there are great intentions with this approach, and the potential return of this investment would certainly mean success for the United States, making the success of for-profit universities a serious economic growth catalyst. But what about the potential risks?

Over the last 20 years, for-profit enrollments have increased 225 percent or to about 2.4 million students in 2010-2011, which equates to about 12 percent of total postsecondary students. As the government continues to invest, and as community colleges continue to meet enrollment capacities, for-profit enrollments will continue to grow, which seems to be potentially leading to a situation that is strikingly similar to the housing bubble and subsequent burst of just a few years ago. With rapidly increasing asset prices (tuition), and even faster growing amounts of debt (student loans), it's easy to see the similarities. Even more concerning is the concentration of growth in postsecondary education in the for-profit segment, a segment that may very well represent the "sub-prime" portion of the college education industry. As previously discussed, this segment of educators focuses on the minority and low-income pool of students, which in-turn has led to incredibly high loan default rates for students at these universities. With continued expansion in this segment, a coinciding growth in jobs will be a necessity in order to avoid a catastrophic burst in the student loan bubble, which would lead to a rapid loss economic value.

How Should You Play The Situation

The for-profit education industry seems to be a potentially oversold, undervalued industry. This group of stocks has been beat down by low employment rates, questionable standards and recruiting tactics, incredibly high student loan default rates and just generally bad reputations. The consensus outlook for these stocks has not been great for some time now, but as with many great value opportunities, that is normally the case.

With close to 52 week low prices and with many of the stocks trading 60, 70 and even 80 percent off their all-time highs, now may be a good time to considering jumping into this industry, especially given the government's continued investment in the industry and the recent news regarding the government aid surplus for the next couple of years.

Just a few days ago, DeVry (NYSE:DV) reported a beat of their Q4 2012 earnings estimate, lifting the stock about 15% on the day. Their better than expected earnings also lifted the industry as a whole, with competitors ITT Educational Services (NYSE:ESI) also jumping around 15%, Strayer Education (NASDAQ:STRA) adding around 10% and Apollo Group (NASDAQ:APOL) which is better known as University of Phoenix moving up about 5%. Despite these recent pops, I believe there is still some upside in these stocks, although I would wait for a pull back or the slight market correction that many are predicting to take place in the near future, before jumping in. Other names in this industry include Capella (NASDAQ:CPLA), Grand Canyon Education (NASDAQ:LOPE) and Kaplan (WPO) which is owned by The Washington Post.

I won't say that this industry is not without significant risk and you'll obviously want to follow school enrollment announcements and job growth very closely, but with companies like Apple (NASDAQ:AAPL) and Lenovo (OTCPK:LNVGY) recently announcing the creation of jobs in the US, and with the government's at least short term continued investment in these schools, it seems there may be some gains to be had, even if a meltdown eventually ensues. And if job growth does eventually excel, these stocks could prove to be huge long term winners. After sifting through all of the uncertainty we're left with only one question, the federal government is betting on the US economy via for-profit schools, will you?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.