Steve Mandel of Lone Pine Capital and Jim Chanos of Kynikos Associates expressed starkly different views on the investment merit of for-profit education providers at this year's Ira Sohn Investment Conference. Mandel has disclosed holdings in Apollo Group (NASDAQ:APOL) and Strayer Education (NASDAQ:STRA), while Chanos has presumably sold short shares in those companies or other for-profit education providers, such as ITT Education Services (NYSE:ESI), DeVry (NYSE:DV), Career Education (NASDAQ:CECO), Corinthian Colleges (NASDAQ:COCO), and Capella Education (NASDAQ:CPLA).
We provide a synopsis of Mandel and Chanos’s theses here, based on notes from the conference. The notes from Steve Mandel’s speech have been adopted from notes shared by Mike O’Rourke of BTIG. The summary of Jim Chanos’s speech has been written based on Chanos’s slide presentation from the conference.
For-Profit Education to Grow in Importance; Strayer (STRA) Is a Great Business
- Two components to margin of safety: price paid and strength of business franchise. The latter is more important.
- Huge underserved demand exists for working adult secondary education; traditional universities are not set up to serve these customers
Investment idea: Strayer Education has a superior franchise
- Graduation rate is above that of community colleges; student loan default rate is low
- Has partnerships with corporations to educate employees
- Operating margins are in the mid-30s; needs little capital to operate and grow its business
- In 2008, 20% of $100 million in cash flow was necessary to grow business; the remainder was returned to shareholders through buybacks and dividends
- Revenue and income may grow eight-fold over the next decade
- Company trades at 25x this year’s earnings and 20x next year’s earnings; if the stock price stays the same, the multiples will contract rather quickly due to fast earnings growth
- Market value should greatly exceed recent $2.5 billion by the time Strayer becomes fully national company
For-Profit Social Services: From the Trough to the Slaughterhouse?
- For-profit education heavily dependent on government funding (Title IV accounts for 73% of revenue at four largest companies), yet four largest companies earn 27.3% average EBIT margin, compared to 12.5% for S&P 500
- Companies spend heavily on “self-serving” marketing à advertising expense equals 53% of educational spending (this is higher than comparable spending in industries not supported by government funding)
Who comes first – students or profits?
- Instructional costs have declined as a percentage of revenueo Heavy ad spending, supported by “government money,” has produced double-digit enrollment growth, compared to 1-2% at traditional colleges
- Students typically depart with higher debt load than those who attended traditional colleges
- Student loan default rates are higher than average
Regulatory environment has changed dramatically
- “Old school” (1998-2008): for-profit schools viewed as alleviating burden placed on community colleges; industry trade groups and company executives “help write regulatory framework”
- “New school” (2009 onward): community colleges viewed more favorable by Education Department; rising scrutiny of quality, cost and recruitment practices of for-profit providers; rules on prop schools in early stages of being re-examined; future of subsidized lending unclear
- Despite regulatory risks, stocks trade at premium multiples that leave “little margin for error”
Note: The above notes represent an interpretation of Steve Mandel and Jim Chanos's theses on for-profit education. The actual theses may be different or may have changed since their speeches.
Disclosure: No positions.