In the past few months, I have written a few articles, An Education on Bridgepoint Education and Bridgepoint is Now an Even Stronger Buy, which both made an enthusiastic case for why Bridgepoint Education (NYSE:BPI) was undervalued and an attractive investment at the time. Since the writing of those articles I have continued to follow the company and delve deeper into the company's reports and I am now experiencing a change of heart.
I am now less optimistic about Bridgepoint's prospects and I want to express my new view and how I arrived at it.
I now believe that Bridgepoint is not a shareholder-friendly company or a company with a sustainable presence, hence it is not a good long term investment. I am still drawn to all the cash on the company's balance sheet ($393 million) which could be a source of price appreciation short term, but when I ask myself, "Is this a company I'd want to own for 5 years?" the answer is inevitably "No."
My new view is not so much the result of new developments as it is due to a change in my own personal investment standards. I am coming to understand that companies are usually cheap for a reason. I believe that this is the case with Bridgepoint. It certainly is cheap with all that cash on the balance sheet, no debt, and a PE of 4.25, but there are also many reasons for the market valuation.
I do not intend to focus on the positives that Bridgepoint has going for it in this article. I already wrote extensively about what I liked about the company in my other articles. This article will focus on the risks surrounding the company and a prospective investor would be best off reading this article in conjunction with my other articles to get the full picture.
Excessive Executive Compensation and Stock Dilution
Bridgepoint pays CEO Andrew Clark and the rest of its corporate officers very handsomely; much too handsomely in my opinion. To put Andrew Clark's compensation package in perspective, I compared his pay to that of Apple (NASDAQ:AAPL) CEO Tim Cook, the highest paid CEO of a public company today. Tim Cook's compensation package was structured such that he received around $377 million in restricted cash, stock, and options upon taking his position and about $4.2 million annually. To b conservative, I used $377 million as the value of his annual package. What I found was that Clark received a significantly larger percentage of BPI's market cap than Cook did of AAPL's market cap. I know executive compensation isn't directly a function of market cap, but I still have a problem with this discrepancy.
The company makes extensive use of stock options and restricted stock grants, something I've always been disgusted by. Stock-based compensation dilutes earnings and can have devastating long-term effects. The idea is that by paying management in stock, it creates financial incentive for management to perform. At some companies this does work but at BPI, literally every corporate officer sells their shares upon the lifting of restriction on the stock. The yearly corporate sell off drives stock price down and nothing good comes of it. The most recent sell off occurred on November 15, 2012. The image below shows all the corporate officers who exercised their stock options and immediately sold the shares along with their restricted stock:
Provided by sec.gov
The chart below shows the impact on stock price the sell off had on November 15:
Provided by YCharts.com
Now take a look at how stock-based compensation impacted earnings. Shares outstanding increased 3% in the past year as shown in the chart below:
Provided by YCharts.com
As a result of the increased shares, earnings for FY12 were 5.37% less than what they could have been. 5.37% is extremely significant when we consider that stock price is usually correlated with earnings growth. BPI robbed shareholders of a 5.37% return.
Lack of Insider Buying
Another thing that really worries me about Bridgepoint is the lack of insider direct stock purchases. Ask just about any know-something investor and they'll say that insider buying is a strong signal that a stock is a good investment at or below the price the insider bought in at. Insiders tend to have more information (hence the term 'insider information') and more understanding of the inner workings of the company they work for than the average investor.
Insider trading is becoming more and more important to me in my analyses of companies. In the comments of my first article on Bridgepoint, a fellow contributor questioned my bullish position saying something to the effect of "If BPI is such a great buy, why hasn't a single insider directly bought stock ever?" I searched the company's SEC page to confirm the commenter's claim. He was right; not a single insider has bought stock in BPI with their own money. Sure, there have been plenty of times when officers have held restricted stock that they were awarded, but this means very little considering they are not allowed to sell during the restriction period.
The word 'lawsuit' is the business owner's bane. 'Lawsuit' almost always means financial loss and/or reduced profitability to come. In my experience, I have found that, for a company the size of BPI, even a single serious lawsuit can drive investors away and depress the stock. Bridgepoint doesn't just have one lawsuit to deal with right now though. In the FY12 report, there are 9 items within the 'Legal Proceedings' section of the report:
- Iowa Attorney General Civil Investigation of Ashford University
- New York Attorney General Investigation of Bridgepoint Education, Inc.
- North Carolina Attorney General Investigation of Ashford University
- California Attorney General Investigation of For-Profit Educational
- Securities Class Action
- Shareholder Derivative Action
- Guzman v. Bridgepoint Education, Inc.
- Qui Tam Complaints
- Employee Class Actions
These lawsuits are serious. Bridgepoint is being sued for almost everything by just about everyone- shareholders, past employees, and the federal government. I'll summarize the company's descriptions of the lawsuits below.
The state attorney general investigations involve consumer protection and whether Bridgepoint is marketing in an honest manner. The Securities Class Action lawsuit is over whether Bridgepoint withheld accreditation information about the University of Ashford from shareholders for months. The Shareholder Derivative Action relates to what I discussed before- unreasonably high executive compensation. The Guzman case is centered on unfair recruiting practices involving commission-based pay for recruiters and the use of quotas. The Qui Tam Complaints are based on claims that Bridgepoint violated the Federal False Claims Act by misrepresenting itself and its use of commission-based compensation to the Department of Education in order to maintain access to Title IV federal funds. The Employee Class Action suits relate to mass layoffs Bridgepoint made in January and July of 2012. The employees claim they didn't receive proper notice or severance pay and seek the benefits now.
All of the cases have some grounds, especially those relating to commission-based pay because it is well known that the company made use of this payment structure. The quantity and diversity of claims against the company makes it seem likely that at least a few cases will be ruled against the company. I don't want to own the stock when that happens.
This is probably the point of discussion that you are most familiar with. A Senate Committee led by Sen. Tom Harkin conducted a 2 year investigation of the for-profit education industry and released a report in late 2012. The report discussed what was found as well as possible regulations to come in the future. Included in the report are profiles of 30 of the largest for-profits including many of those of interest to me- Bridgepoint, Apollo Group (NASDAQ:APOL), ITT Educational Services (NYSE:ESI), and Strayer Education (NASDAQ:STRA). I mentioned in my other articles how the US government was cracking down on the for-profit education industry. As of now no one really knows what will happen or how the industry will look in the future. I have compiled a list of just a few of the many possible regulations to come in the future directly from the Congressional report:
- Require that the Department of Education collect comprehensive student outcome information and enable data retrieval by corporate ownership
- Increase the regulation of private lending.
- Tie access to Federal financial aid to meeting minimum student outcome thresholds.
- Prohibit institutions from funding marketing, advertising and recruiting activities with Federal financial aid dollars
- Require that for-profit colleges receive at least 15 percent of revenues from sources other than Federal funds
- Enforce minimum standards for student services that include tutoring, remediation, financial aid, and career counseling and job placement.
- Extend the ban on incentive compensation to include all employees of institutions of higher education, and clarify that this ban extends to numeric threshold or quota-based termination policies.
As of now the regulations have not yet gone into effect but I would count on them as an inevitability given how much effort and money Congress has already sunk into the issue and that President Obama was reelected. What all of this could mean is that for-profits will receive less revenues from the Federal Government and have to spend more and admit less students to improve student outcomes. All of this will severely impact profitability.
Bridgepoint's colleges, like most other for-profits, are at risk of losing accreditation. I thoroughly discussed this in my last article but basically the University of Ashford has until February of next year to meet the accreditation criteria of its current accreditor or get accepted by a new accreditor or it loses accreditation completely. The company has already felt the impact of the situation though. Students are wondering what's going on and transferring when they don't get an answer. Just the thought of a college losing accreditation can do terrible things to its reputation. Enrollments are declining for the first time since the company went public. I believe it is pretty likely that BPI's colleges will maintain accreditation just because of the amount of time and money that management has to transform the company. The risk of accreditation is still very real though and if the University of Ashford did in fact lose accreditation, BPI would lose nearly all its students and all access to Federal funds.
I suppose I am becoming pickier in my criteria for potential investments. That or maybe I am just realizing now how real the risks are at Bridgepoint. Either way, I now believe Bridgepoint Education is a non-buy. I do not advise shorting the stock. BPI may have a lot going against it but the price is already depressed. The time to short was when it was selling at $25. Also, a lot of what I mention as risk factors in my article could work themselves out. My thesis is not that BPI is doomed, only that the risks at the company are so overwhelming and real as to make the stock an unattractive investment at current levels. In my past articles on for-profit education companies, I have received plenty of really informative comments from contributors with inside knowledge (through their careers) about the industry. I have found this all very helpful and would appreciate more of the same in the comments section of this article. For-profit education is a tricky industry to figure out right now with all the risks and uncertainties and I believe that the more we all know, the better off we'll be.