Lincoln Educational Services: Playing The Game Right

| About: Lincoln Educational (LINC)

Considering recent struggles in the maligned for-profit education industry, any company collectively favored by three of Wall Street's most respected investment firms is arguably doing something right.

Per an August 9, 13G filing with the Securities and Exchange Commission, Blackrock, Inc. increased its stake to over 10% in Lincoln Educational Services Corporation (NASDAQ:LINC). Blackrock, the world's largest asset manager, joins noted value investors, Heartland Advisors and Royce Associates, as the leading shareowners in Lincoln Educational. Each holds stakes north of 10% according to most recent SEC filings.

In fact, all three players combined now own close to 40% of the company's outstanding shares, with Heartland leading at about 17%. This level of bullish interest is a rare compliment in the investor shorted, government scrutinized, and media slaughtered, U.S. for-profit education sector.

Following its Q2 2013 earnings release and call on August 7, [see SA transcript], here is my current take on Lincoln Educational:

What the Numbers are Saying

Population and Revenue

Student population for Title IV financial aid eligible programs was 14,460 as of June 30, 2013, down 17.5% from 17,535 for same period in 2012. For the three months ending June 30, 2013, new student starts from Title IV eligible programs were down 20.4% to 3,768 from 4,731 for same period in 2012.

Automotive and skilled trades active enrollment was a combined 52.4% of Lincoln's total student population, followed by healthcare (including nursing) at 33.0%, hospitality (including culinary and cosmetology) at 8.6%, and business and information technology programs at 6.0%. These figures represent average student counts during Q2 2013. Percentages for most program verticals are slightly down from same period 2012, the exception being automotive/skilled trades, which increased from 46.8% of average total population.

Lincoln's student population drove revenues of $85.2 million in the second quarter of 2013, a decrease of 12.2% from $97.0 million in Q2 2012. For the six months ending June 30, 2013, revenue declined 11.5% to $175.3 million from $198.2 million for first six months of 2012.

Expenses and Income

During the first six months of 2013, the company spent 51.9% of revenue on educational services and facilities and 58.6% on general sales and administration. After allowing adjustments for sale of assets, goodwill, and campus closings, representing 4.0% of revenue for same six-month period, the company yielded an operating margin loss of (14.5%).

In its earnings release, Lincoln management attributed higher percentage spending on educational services to a "fixed cost component not as leverageable as some of our other expenses."

Arguably, an education company that spends better than 50% of revenue on the student experience is putting itself in a position of setting standards of excellence in academic quality and student services. Lincoln has the opportunity to leverage this differentiation by maintaining its investment in educational services and facilities.

General sales and administrative expenditures filed with the SEC are what originally put the industry on the federal government's radar after its notorious run-up in student enrollment and profitability during the Great Recession of 2008-09. Irrespective of student default rates and other regulatory issues, members of Congress started looking at the SEC filings from the publicly traded education companies. Alarmed by the percentage of revenues spent by the industry on sales, marketing and corporate overhead, lawmakers summoned the United States Department of Education (USDOE) and mainstream media. It became a downhill slalom from there.

Obviously, the opportunity for Lincoln Educational to become profitable again is increasing revenue with student enrollment growth and continued improvement in student persistence, while simultaneously decreasing expenditures on general, sales and administration. Certainly the challenge is finding ways to grow student population with fewer dollars invested in marketing, admissions and corporate overhead.

Bad debt expense as a percentage of revenue for the quarter was 4.7% down from 5.9% in Q2 2012. When an education company keeps its bad debt below 5%, it typically reflects a combination of effective collection procedures, capable Title IV financial aid processing, and satisfied students.

Lincoln Educational reported a loss of $14.4 million for Q2 2013 vs. $16.7 million in Q2 2012 or a decrease of 13.8%. Loss per share was ($0.42) for the quarter as compared to ($0.62) for Q2 2012. But only ($.20) of the loss was attributable to continuing operations. The company recently reported the closing of five underperforming campuses in Ohio and Kentucky, which contributed ($0.12) of the EPS loss with the remaining ($0.10) attributable to impairment charges.

Granted, the Q2 2013 loss per share was an improvement from prior-year same period.

Balance Sheet and Cash Flow

Lincoln reported $4.3 million of cash and equivalents as of June 30, 2013, compared with $61.7 million on December 31, 2012, an alarming decrease. However, total debt decreased to $35.8 million on June 30, 2013, from $73.5 million at December 31, 2012.

Free cash flow history for Lincoln Educational Services:

LINC Free Cash Flow Chart

LINC Free Cash Flow data by YCharts

90/10 Rule and Cohort Default Rates

According to the company's most recently filed 10Q with the SEC, it reported 90/10 percentages ranging from 72.3% to 93.0% for its institutions in 2012 fiscal year. The Higher Education Opportunity Act (HEOA), enacted by Congress in 2008, holds a proprietary institution ineligible to participate in Title IV programs if in any two consecutive reporting years it derives more than 90% of cash basis revenue from federal financial aid programs.

At 93%, its Dayton, OH main campus is apparently the only institution currently exceeding the 90% cap. Furthermore, Dayton is one of the five schools scheduled to close on or before December 31, 2013.

The company's acquisition of Florida Medical Training Institute, which offers short-term, cash-only programs such as paramedic and firefighter, combined with any future acquisitions of similar non-Title IV operations, should contribute to further improving Lincoln's 90/10 ratios.

In March 2013, the USDOE published its draft three-year cohort default rates for FY2010 for all Title IV eligible institutions. Lincoln's group of schools have rates ranging from 19.5% to 38.9%, with six of its institutions having three-year draft cohort default rates of at least 30%.

All Title IV eligible institutions must stay below 30% in its three-year rates to avoid sanctions from the USDOE as authorized by the HEOA of 2008. Actions will not begin until 2015, thus giving institutions some breathing room to improve disparaging rates. Draft rates are subject to appeal, possibly resulting in further upward or downward revisions before the USDOE publishes final rates this September. Lincoln says it appealed all its 2010 three-year draft rates.

Below are most recent official cohort default rates for Lincoln:

CVCR F+V+MoS Charts* for Lincoln Educational Services

The following charts illustrate leading indicators (among literally hundreds) when looking at a company's stock performance in a simplified screen. It focuses on an investing discipline of fundamentals, valuation and margin of safety (F+V+MoS):

Sources: Charles Schwab & Co. /Thomson Reuters/S&P Capital IQ/Market Edge as of August 12, 2013

*Disclaimer: CVCR Charts are produced by Country View Capital Research, LLC. The specific indicators used in the above chart(s) are based on David Waldron's own account personal portfolio and investment philosophy that has returned a cumulative 116.31% since inception on 7/1/2004 vs. 49.32% for the S&P 500 during same period (as of July 31, 2013). His personal equity portfolio consists of a basket of global companies supporting an investment objective of buying and holding large, dividend paying, well managed, financially sound companies that produce easy to understand products/services, have enduring competitive advantages, enjoy strong free cash flow, and are trading at a discount to their intrinsic value. The CVCR F+V+MoS Chart, Technical Trading Indicators, and personal investment objective are for illustrative purposes only and not meant as investment advice nor as a recommendation to buy/hold/sell or short LINC or any other security. Readers should always engage in further research and/or consider consulting a certified financial planner, licensed broker/dealer, or registered investment advisor before making any investment decisions.

It is clear from the CVCR Charts that LINC is presently flawed in fundamentals, receiving just one $ sign (for liquidity.) However, its valuation is compelling with all five indicators suggesting the company is trading at bargain basement multiples. And earning three $ for margin of safety is rare for education companies in today's environment. This is testament to Lincoln's willingness to pay a dividend to shareholders as well as a reputation for a transparent and ethical operational history. Consequently, it is demonstrating more favorable market risk than many competitors.

The above technical trading indicator for LINC is included for readers who follow stocks or options based on charts, short interest, put/call ratios, or ownership activity. As always, further research and/or consultations with financial industry professionals are strongly recommended before making any investment decisions.

What Management is Saying


Lincoln Educational updated previously issued 2013 guidance because of the campus closures and continuing softness in student starts. For 2013, they now expect revenue of approximately $355 million and a diluted loss per share of ($1.00). The full-year diluted loss per share includes approximately ($0.60) to ($0.65) related to the closures. The company projects student starts from continuing operations to be essentially flat for this year compared to 2012.

Expected revenue for third quarter of 2013 is now $86 to $88 million, a decrease of approximately 15% over Q3 2012, and a loss per share of ($0.20) to ($0.25). Loss per share includes ($0.12) to ($0.14) related to the campus closures.

Also announced in its Q2 '13 release: the company's board of directors set a cash dividend of $0.07 per share, payable on September 30, 2013, to shareholders of record as of September 13, 2013.

Conference Call

Shaun McAlmont, chief executive officer, paid a rare corporate America homage to the communities, staff, and students affected by the closures in Ohio, and Kentucky. As shared by McAlmont, these campuses were built primarily off the ability to benefit, or ATB provision of the Higher Education Reauthorization Act, allowing enrollment and financial aid awarding to students lacking a high school diploma or its equivalent. When ATB was removed per the HEOA on June 30, 2012, it had an immediate negative impact on participating institutions in the industry including the five Lincoln campuses.

As an industry veteran, I was skeptical of ATB enrollments in career training programs as the general rule of thumb is most employers require a high school diploma or equivalent to work for their organization in the first place. But many employers do not background check high school credentials to the extent they do college degrees, thus contributing to the loophole. Having never understood why the federal government originally condoned ATB, I wasn't surprised when the feds rescinded it.

This venture into ATB enrollments was a rare misstep for a company like Lincoln Educational that enjoys excellent standing for ethics and compliance, contradictory to an industry reputation otherwise. Granted, there was nothing illegal or unethical about Lincoln's participation in the ATB program, but it went against a company that historically goes about its business the right way. Ultimately, choosing to embrace ATB led to an avoidable black eye for Lincoln as demonstrated by the campus closures.

CEO McAlmont also reported marked improvement in student retention, graduate employment, 90/10 calculations and cohort default rates companywide, stressing: "We continue to be maniacal about compliance and {student} outcomes."

His statement regarding the company's genuine commitment to sound regulatory and legal compliance stands in the face of many education companies where 10-Ks submitted to the SEC are laden with regulatory issues and legal actions:

Lincoln has continued to maintain a strong regulatory record with no student or staff class action, extremely clean Department of Education program reviews and accrediting visits, and limited contacts from other regulatory agencies. Lincoln was at the forefront in managing our student outcomes by reducing the number of challenged students in our schools over the past three years.

In his remarks, Cesar Ribeiro, chief financial officer, attributed the company's recent margin erosion to lower student enrollment and the resulting capacity utilization which decreased in Q2 2013 to 36% from 41% in Q2 2012. For any on-ground education operation, capacity utilization, or the percentage of campus facilities efficiently populated with students, is a key measurement rarely discussed in earnings releases. This transparency gives investors a clearer view of how student enrollment relates to a company's fixed capital investment in educational facilities.

CFO Ribeiro also addressed the company's negative free cash flow, a 4% increase in revenue per student, the improved bad debt results, and higher cost per new student start, which he attributed to elimination of the online program.

Ribeiro expects capital expenditures to be 4% of revenue for 2013, a figure considered reasonable for on-ground education operations.

What the Analysts are Saying

Lincoln Educational missed Q2 '13 analysts' estimates for both EPS and revenues.

During the end of call Q&A session, Scott Schneeberger of Oppenheimer & Co. asked a pertinent question regarding how Lincoln Educational can justify continuing to pay a dividend despite its current profitability and cash position. Ribeiro reminded analysts the board of trustees considers dividend payouts on a quarter-to-quarter basis and can eliminate them any time in the future. Seemingly, the decision to continue the payouts implies the company is optimistic about its forward profitability and cash flow.

Schneeberger also queried management about Lincoln Educational's upcoming foray into manufacturing programs, unique to the sector, as well as a registered nurse [RN] offering, which is a natural ascension from its established practical nursing programs [LPN].

As of this article's submission, there were no known public disclosures of renewed brokerage analyst opinions. In March of this year, Barrington Research had raised it price target on LINC from $6.00 to $7.50. Around the same time, BMO Capital Markets had downgraded Lincoln Educational to "underperform" from "market perform," maintaining its $4.00 price target. BMO cited a "belief the stock was being supported by its dividend yield as well as speculation for a going-private transaction."

What Isn't Being Said

Despite industry shared challenges in enrollment growth, sustained profitability, and student loan default rates, Lincoln Educational Services' value proposition, cleverly titled Careers that Build America, has shifted the company strategy to shorter term, on-ground, vocational-based training. These programs can be completed within the associates degree, diploma, or certificate level, thereby affording significantly lower tuition costs than higher degreed training.

This might be a brilliant paradigm shift within the U.S. higher education industry where both for-profit and non-profit operators are beginning to crowd the online and advanced degree markets. It can be argued hands-on career training programs such as Lincoln Educational's focus of skilled trades, culinary, cosmetology, and healthcare, may be challenging for a student to master in a 100% online environment. And bachelor's degrees or higher are simply not necessary for employment success from Lincoln's program mix.

As the below pie chart demonstrates, close to 50% of Americans, age 25 or older, who had achieved more than a high school diploma, but less than a bachelor's degree by 2012, were potential students for companies like Lincoln Educational. This group represented approximately 54 million Americans.

The chart does not include an additional 62 million high school graduates, age 25 or older in 2012, who had not attained an education level beyond high school. Combined, this equated to over 100 million prospective students for shorter-term vocational training, an area of higher education often touted by President Obama as an opportunity to improve America's competitiveness.

Source: U.S. Census Bureau (American education achievement beyond a high school diploma)

Conceivably, decreasing exposure through elimination of its on-line division and underperforming ground campuses has positioned Lincoln Educational to return to growth and profitability without compromising its long steady reputation as one of the most compliant and transparent industry players. That being said, the company's present struggles remain noteworthy.

But the collective smart money of Blackrock, Heartland, and Royce, has apparently uncovered an out of favor company, trading at back-up the truck valuations, and exhibiting a relative wide margin of safety in a high risk industry. This rare level of institutional investor confidence in an education company may suggest Lincoln's intrinsic value can also be measured by its willingness to play the game right.

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. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I was previously employed by Lincoln Educational Services Corporation from 2005 to 2012, but am not bound by any third party agreement with the company.

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