Grand Canyon Education: A Good Apple In A Rotten Barrel

| About: Grand Canyon (LOPE)

For-profit education companies are having a rough time lately--and deservedly so. Last year, a Senate report exposed most for-profit colleges as little more than scams for siphoning up federal student loan money. Threats of stricter regulation have only increased for-profit ed's troubles. But one company has been thriving in the midst of this downturn, and it will continue to do so for a long time to come: Arizona's Grand Canyon Education (NASDAQ:LOPE).

Of the dozen publicly traded universities, only Grand Canyon is projected to have significant revenue growth in 2013. Its second quarter revenues grew 19 percent, while earnings per share rose 20 percent versus last year. Adjusted EBITDA was $40 million, up from $32 million a year ago. GCU's management projects full year 2013 revenues and EPS of $583M to $588M and $1.78 to $1.80, respectively. And while LOPE's PE of 19x and 8.5x enterprise value to EBITDA is high compared to its peers, the company's recent positive enrollment and revenue growth is unique in this beleaguered industry.

Not surprisingly with these numbers, LOPE is up more than 70 percent in the last year--and it's going to go a lot higher. This is going to be a huge stock, and not just because the school's baseball and basketball teams recently joined Division I athletics. That unprecedented move for a for-profit institution has gained a lot of attention, and it will certainly help raise the school's profile, but it is little more than a smart branding opportunity. There are two main reasons LOPE is--and will remain--the class of for-profit education.

Number One: The Ground Game

While Grand Canyon's online student enrollment is still growing, the company's management has recognized that its future depends on building brick-and-mortar campuses that can offer quality undergraduate and graduate degrees. For the 2012-2013 calendar year, GCU's main campus in Phoenix had 6500 students. The school expects that number to grow to 8500 this coming fall and to 15000--12000 undergrads and 3000 graduate students--within three years. The company will soon break ground on its second campus in Mesa, Arizona, where it plans on enrolling 10000 new students by as early as 2015. These steps are only the beginning of what could be a wide network of GCU institutions across Arizona and the Southwest region.

This emphasis on offering traditional on-campus learning shows that GCU is not just trying to compete with low-quality diploma mills and glorified trade schools like Devry and ITT. It wants to lure competitive, well-qualified students away from traditional nonprofit universities like Arizona State. This is reflected in the cost of a degree at GCU. Unlike most of its overpriced peers in the for-profit sector, its tuition is comparable to public universities like ASU and the University of Arizona. At the same time, GCU has been tightening its admissions standards, only allowing in students with high GPAs and qualifications.

Last year, I met with the company's CFO at its flagship Phoenix Campus. He was excited about the school's expansion plans, and he predicted that GCU would soon begin to draw students from the huge population center of Southern California. At the time, he told me eighty percent of the on-campus students were from Arizona. By the following school year, he predicted that would drop to 70 percent. This is an extremely threatening prospect for nonprofit universities in Arizona--and, in my opinion, it's the real reason the president of Arizona State raised such a fuss about GCU's sports teams joining the Western Athletic Conference. ASU and the other nonprofit schools in Arizona all rely heavily on out-of-state students, especially those from California. GCU's management recognizes this, and it's doing all that it can to offer those coveted recruits a comparable, even superior education but with one important difference, which brings me to the second major reason LOPE is going to be a huge stock in the years to come:

Reason Number Two: You Gotta Have Faith

For most of its 64-year history, Grand Canyon was a small, nonprofit Baptist university. But when it went for-profit in the early 2000s, it made another change, as well: it became a nondenominational Christian school. That might seem like a minor switch, but I believe it is going to be a critical factor in GCU's continued growth.

While you may not hear about it much in the national media, evangelical Christians make up one of the largest and fastest-growing demographics in the country. More importantly for GCU, evangelicals tend to have more kids than other groups--and they don't necessarily want to send those kids to public universities like Arizona State or any of the 23 branches of the Cal State system. If GCU can offer Christian parents a comparable education for their children to its nonprofit competitors, at comparable tuition rates, while also offering them the peace of mind that their kids will be surrounded by a wholesome environment and like-minded peers, the school will have no problem filling up as many campuses as it can build.

By drawing students from religious households, I believe GCU will also continue to see success in key metrics like bad debt and loan defaults. The school's three-year cohort default rate and 90/10 compliance are already better than almost all of its for-profit competitors, and those numbers will only improve as GCU implements its strategy of growing ground enrollment. Perhaps most promising, more than half of its students are seeking degrees in nursing or education, fields with solid employment prospects. Those students are going to find good paying jobs when they graduate, and they're going to repay their loans on time.

Trading Bonus: Unwarranted Short Exposure

From a short term trading perspective, almost ten percent of LOPE's outstanding shares are sold short at the moment. As someone with decades of experience shorting stocks, that figure astounds me. I can only attribute it to the troubles of the for-profit education industry as a whole. I'm sure that many shorts are expecting stricter federal regulations to drag down every publicly traded education stock. But, as I've shown, Grand Canyon is already well positioned to succeed in a more heavily regulated environment. Other shorts are probably underestimating the attractiveness of GCU's ground campus growth and its Christian orientation. But every single one of LOPE's financials are clearly headed in one direction: up and to the right.

As Grand Canyon continues to grow and beat expectations quarter after quarter, all those shorts are going to get more and more nervous. The squeeze is on, and it will get tighter in the months and years ahead. The best part for longs like me is that all those misguided shorts will eventually have to buy LOPE to cover their positions, and that's only going to push the stock higher.

Finding great investments requires a non-consensus worldview. When an entire industry gets tainted by the actions of its best-known firms, it's still possible to find great opportunities--even in the most-maligned sectors. LOPE is a classic example of this phenomenon. As it expands its ground campuses and recruits better-qualified students, it will take market share from both for- and nonprofit universities, neither of which can offer Grand Canyon's religious culture, low cost, and academic quality. This could be a five or ten bagger over the next decade.

Disclosure: I am long LOPE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.