Boom Times in For-Profit Education

Lately it’s been all the rage to complain about companies that are too big to fail. However, there’s another prominent American institution that’s also become too big to fail. It’s bloated, overstaffed and to fails to meet the most basic need of its customers.

Welcome to American higher education.

More Americans are wising up to the fact that college is a big fat waste of money. Sure, if you’re lucky enough, and smart enough, and get into a big-name school, college is just fine. But for millions of other students, a four-year degree often puts them under a mountain of debt and doesn’t give them the skills they need in the job market.

First, let’s consider how long it takes many students to finish college. Even after six years, only 54% of college students even get a degree. For high-school students in the bottom 40% of their class and who go to a four-year college, an amazing two-thirds hadn’t earned a diploma after eight-and-a-half years. Sheesh, that’s worse than Bluto! I can’t think of another industry that has such a dismal record.

As David Leonhardt recently wrote in the New York Times: “At its top levels, the American system of higher education may be the best in the world. Yet in terms of its core mission—turning teenagers into educated college graduates—much of the system is simply failing.” He’s exactly right.

Still, tuition costs continue to skyrocket. Between 1982 and 2007, tuition and fees rose 439% compared with just 147% for median family income. The trend shows no sign of stopping. One year at Yale now goes for $47,500. The University of Florida system wants to raise tuition by 15%, the maximum allowed.

Much like the housing bubble, the Higher Ed bubble is being driven by cheap, government supported credit. The problem is compounded by the fact that hugely important financial decisions are placed on the backs of 19-year-olds, many of whom simply don’t have the life experience to weigh the implications of a gigantic, 20-year debt load. Heck, at least the irresponsible mortgage borrowers during the crazy days were adults (even though many acted like infants).

One report shows that students from lower-income families need to pay 40% of their family income to enroll in a public four-year college. That’s a lot of coin to have some Marxist feminist theorist tell you the about atavistic nature of late-stage capitalism. Please, you can watch the Oscars to learn that. Don’t think community colleges are a bargain, either. The average tuition is up to 49% of the poorest families’ median income from 40% in 1999-2000.

The pro-college crowd likes to repeat the claim that college grads earn $1 million more, on average, over their working lifetime. Sure, this is true, but college grads start out in a big hole. On average, they don’t even catch up to high school grads until age 33.

The debt load piled on students is scandalous. One in five students who graduated in the 1992–93 school with over $15,000 in debt defaulted on his or her loan within 10 years of graduation. We’re setting young people up for failure and ruin credit records. Thanks to the recession defaults are up 43% over the last two years. Many students go to grad school and pile on even more debt. The average law grad owes $100,000. Plus, many schools often use grad students as greatly underpaid professors in order to cut costs. Think of Lehman Brothers. Now imagine if they had a football team.

The loans fall especially hard on minorities since colleges love to boast their “diversity.” For African-American students, the overall default rate is more than one-third. That’s five times higher than white students and over nine times higher than Asian students.

What makes things even worse for many colleges is that the recent bear market put the squeeze on their endowments. Harvard’s endowment dropped by $11 billion and they announced they’re laying off 25% of their investment staff. Cornell’s endowment plunged 27% in the final six months of 2008. Yale lost $5.9 billion, or one-fourth its value. Lower endowments means… you guessed it, higher tuition.

School financing has exploded in recent years, doubling in just ten years. Total student debt now stands at over half a trillion dollars. The average borrow took out a loan worth $19,200. That’s a 58% jump since 1993.

Naturally, the government is set to make a bad situation worse. Last week, the House of Representatives voted to elbow Sallie Mae (SLM) out of the student loan biz and shift all student loans to a government-run, taxpayer financed system. So instead of government subsidized loans run through banks to students, we’ll now have a government monopoly. Hmmm…what could possibly go wrong?

I got a better idea. It’s a real simple government program. I call it, “Dude, you really shouldn’t be going to college.” Best of all, the program is very cheap. The costs are solely a postcard and my consulting fee. If you don’t want to listen to me, fine, then listen to the folks at the ACT who say that only 23% of students have the skills to do well in college.

The good news is that Americans are catching on to the college scam. Admissions applications are dropping at elite schools. Applications are off by 20% at Williams College. Middlebury saw a 12% decline and Swarthmore had a 10% drop. I believe this is just the beginning.

The reason I’m so confident is that these are boom times for the for-profit education sector. Long derided as diploma mills, these companies are raking it. Already this decade, shares of Strayer Education (STRA) are up over 1,000% and shares of ITT Educational Services (ESI) are up over 1,300%.

Business is so strong that the schools are having difficulty even making earnings estimates. In January, ESI issued 2009 EPS guidance of $6.25 to $6.45 which well above the Street’s view of $5.73. Since then, the company raised guidance three times. The current EPS range is now $7.55 to $7.85. In other worlds, no bailouts needed here.

These schools are ideal for older students who are attending school on their own initiative instead of doing what their parents expect. Many of the schools have comprehensive programs but students often go there to take a few courses to round out their job qualifications. Businesses also like to use the schools for employee training. The graduation rates tend to be high and the default rates are low (though still not ideal as some members of Congress have noted).

I also like the fact that the school has an efficient business mode. Operating margins tend to be high and they businesses don’t drain capital.

Look at the success of a company like Lincoln Educational Services (LINC). A few weeks ago, Lincoln reported blowout Q2 earnings. Check out these digits. Revenue rose 51% and earnings-per-share jumped an astounding 440%. The company netted 27 cents a share which schooled the Street’s consensus of 19 cents a share. On top of that, Lincoln boosted its full-year EPS guidance to a range between $1.40 and $1.45 from their prior range of $1.25 to $1.30. Who’s laughing at the diploma mill now?

Lincoln is hardly alone. Last month, Corinthian Colleges (COCO) issued 2010 EPS guidance of $1.30 to $1.36 which was well above the Street’s view of $1.14. If COCO hits their range, then we’re talking about a growth rate of over 50%.

The big kid on the block is Apollo Group (APOL) owner of the University of Phoenix which has more than 200 campuses and over 400,000 students. Apollo has a market cap of $10 billion and it’s the only for-profit stock in the S&P 500. The shares have vaulted nearly 100-fold since the IPO 15 years ago. Apollo is doing more than any bureaucrat to reshape the landscape of American higher education. Make no mistake how serious they are. Three years ago, the company shelled out $150 million to turn the home of the Arizona Cardinals into the University of Phoenix stadium.

The for-profit sector still contains many risks. Loan defaults rates are a problem which doesn’t look so good considering the schools have healthy operating margins. The industry was dreading a recent GAO report which turned out to be milder than expected.

Of all the for-profit schools, I think Lincoln Educational Services offers the best value right now. The company just gave a big earnings boost and the shares are now going for about 12 times 2010’s forecast. Strayer, on the other hand, is the one to avoid. The stock is up to 23 times next year’s consensus. For a school stock, that’s not very smart.

Comments

[TinyTim:]

"Make no mistake how serious they are. Three years ago, the company shelled out $150 million to turn the home of the Arizona Cardinals into the University of Phoenix stadium."
Yeah, they must be pretty damn serious on education to name a football field. LOL

I used to think these places were diploma mills. Then I started paying attention to what was happening with my son at a big state school.

I think UOP got their critical mass years ago with public school teachers who have a pay scale based on years experience and degree credits. They were all over and teachers could get to the classes easily for quick raises. BTW UOP ain't cheap for this reason.

This has been common knowledge for years, but I still feel sorry for the kids graduating with unmarketable degrees. It's even worse now with the Great Recession. I meet them all the time.

RE your "postcard and my consulting fee" idea. This article is a real tear jerker:
www.theatlantic.com/do...
Good perspective on why for-profit Ed is doing so well.
The business plan fits right in with the Millenial Y generation.

Sep 23 08:44 PM

[Jonathan Hi...:]

Funny...I just wrote about this a few days ago. College is indeed a bubble: blog.theascendancegrou.../.

Sep 24 11:10 AM

[pasca:]

It matters for what degree they are going to school. Certain areas of study are quite profitable. However I do agree that the future of education is online. The college experience is just not affordable for all anymore. It is about the skill set not the grass or trees. We are way behind other countries in the use of technology in the classroom. Maybe one day the teachers will start to learn. BTW I've been an academic for 22 years.

Oct 02 06:14 PM

[NCMFL:]

Your statistics are interesting, though I wonder where many came from.

You cite the percentage of income it costs to attend public schools but have you crunched the same numbers for for-profit schools?

For-profit school prices are through the roof-we're talking $80k for a three year degree in graphic design. Give me a break. Make no mistake, most for-profit school graduates will default on their student loans. It will take time since they will be granted forbearances and deferments but when it comes time to make full payments, very few will be able to afford the $500-$1,000 per month payments that will be coming due on both their federal loans and high-cost private loans.

Tragically, minority students are disproportionately represented at for-profit schools (and are heavily marketed to by these companies) and will suffer immensely under the weight of this debt.

Some for-profit schools are even lending their own student loans at extremely high interest rates. Often ignoring state lending laws. For-profit school stocks may be up for but in my view they will soon be in the toilet with the student loan lenders who preyed on young people trying to better themselves.

Oct 06 01:48 PM

[been ther d...:]

I worked in a for profit school that was primarily an automotive school. We accepted students that could barely pass the ATB (which is like the GED). We even started a few that couldnt and ended up forced to drop. I have no problem with your population being not of the intelligence seen at Yale. I actually was proud because for many of our students this was the only option for them at creating a career and supporting a family. In many instances they were the first person in their family to "go to college". However, many of our policies cared only for the bottom line, not the person we were teaching. So sad. Our housing and meal plans added in excess of $10k to the $30k+ cost of attendance. In fact the school I worked in utilized their meal plan offerings as a means of scamming the students. We offered multiple meal plans, even as low as 4 meals per week (only super models could eat based on that plan). We allowed the students aprox $8 worth of food each time they scanned their card. But that 4 meal per week plan ended up costing the studnt almost twice that! The worst part is that our in house loan limit was so low that many of our students couldnt receive funding enough to get the larger meal plan that would give them adequate meals as well as dropping the cost to around $10 per meal. The previous owner of the school I worked at also forced kids to leave their tools behind when they dropped and then resold them to other students. The students that purchased these used tool boxes were forced to do so when they required a private loan financed through a company with extremely high rates and hidden fees. That practice was extinguished. We also charged the states maximum drop calculation when the student left school which ranges from 25%-100% of the total program cost depeding on the length of time the student did complete. Dont get injured because when you have to drop due to your injury (they also dont offer a LOA policy) they will charge your account this fee and IMMEDIATLEY send your account to receivables. As if treating their customers terrible isnt bad enough they treat their employees as expendable pieces of machinery in the shop (which is full of machines older than many of the adult students). That job was the worst experience of my life. I attend college at a traditional college so I am very aware of the elevated costs of education. Never ever ever in a million years would I recommend a Lincoln school.

Nov 20 01:48 PM