Washington Post: Too Dependent on Higher Ed Revenues?

Aug.18.10 | About: Graham Holdings (GHC)

Warren Buffett accumulated a position in the Washington Post Company in the early 1970’s and his influence on the management style, compensation policies and accounting is apparent. The Washington Post Company (NYSE: WPO) is a conglomerate with assets in education, cable, broadcasting and publishing businesses. The Company, under the leadership of Katherine Graham went public in 1971, primarily with publishing and broadcasting assets. In the 1980’s the company diversified and entered the education and cable businesses, which have grown and become a major part of the Company under the leadership of Donald Graham, who became CEO of the Company in 1991. Today, the education assets account for a majority of WPO's profitability. These assets are at a very high risk because of the increasing default rates in that sector.

Kaplan Higher Education
Kaplan was founded by the legendary Stanley Kaplan, and bought by the Washington Post Company in 1984 for $45 million. Kaplan was primarily engaged in the test prep business but over the years it has entered and prospered in the for-profit education business. The higher education division, which is the biggest, now accounts for 38% of Washington Post’s revenues and 62% of its operating income. The company invested heavily in this business during the late 1990’s and finally turned a profit in 2002. On average, the division, organically and through acquisitions, has since grown revenues at 25%, and importantly, increased operating margins.

The Good
Kaplan’s Higher Education division within the for-profit sector exists to serve the market demand to educate individuals who the traditional schools have failed to satisfy. As the US economy transitions more and more into a service economy, and new employment opportunities require post-secondary schooling, higher education becomes essential for an individual to maintain their living standards. Kaplan and others provide individuals with the convenience of continuing with their present occupation while pursuing further education to enhance their credentials. The option to take courses online has further lit a fire under the growth engine and accelerated Kaplan’s growth. Their success is evident from the increase in market share of for-profit institutions, measured by degrees granted, which has gone from 2.3% in 1997 to nearly 6% in 2006 and rising. Furthermore, enrollments have grown exponentially in 2009 due to unemployment and, consequently, an increased interest in higher education. The growth in revenues in this division has mostly come from: (a) growing enrollments, and (b) tuition increases.

Kaplan Higher Education, through Kaplan University, Kaplan Colleges and Kaplan Career Institute operates in a fragmented industry with many competitors. Kaplan itself has few, if any, competitive advantages, but the industry as a whole is experiencing tailwinds due to pent up demand from the non-traditional student and the convenience of online education. Kaplan and others, however, have a few distinct advantages over traditional schools.

• First, their marketing prowess is unmatched. They advertise extensively. Non-traditional students are often not aware of the student aid available and consequently, are not sure if they can enroll in higher education. Kaplan admissions counselors help students with the paperwork and make the process effortless.
• Second, traditional schools do not have an extensive online offering, while Kaplan has a very advanced online education portal. Online education makes it very convenient for a student to obtain a degree as students can study and attend classes when they want and where they want. Importantly, it takes a lot of time and capital to develop and offer comprehensive, trusted, high quality online curriculum.
• Third, they are more responsive in academic program changes - their program offerings change as market conditions change. The bureaucracy and the public nature of most traditional schools cannot match the agile nature of for-profits.
• Fourth, because Kaplan is geared towards non-traditional students, they understand their customers and their special requirements. If students require extra help in the beginning or added counseling, it will be provided.
• Fifth, although the costs of an online school are comparable to an out of state public school, there can be many cost-saving advantages to attending an online school. With an online education there are no room and board expenses, travel expenses or other ancillary expenses.

Kaplan competitively differentiates itself with: (a) a trusted brand name (which is due to test prep), (b) extensive offerings, which is illustrated by its ranking as 4th among online universities in the number of degrees offered, (c) quality, where it is ranked in the top 10 among online for-profit universities by various sources, and (d) regional accreditation, which is superior to national accreditation as credits are transferable. Furthermore, Kaplan can and does raise tuition rates along with the budget constrained public schools, which have to raise rates to remain feasible. Psychologically, an expensive education is considered superior and this also helps Kaplan raise rates, but the rates will have to remain competitive with public institutions.

The Bad
The for-profit higher education industry, in which Kaplan Higher Education operates, has little to no barriers to entry. Accreditation, while difficult to obtain organically, can be bought, as evidenced by the sale of Waldorf College in May 2009. It is today a segregated industry. There are many other struggling colleges in the US which, as they capitulate, can be bought to expand or obtain accreditation by for-profits. In addition, the non-profit public and private universities are entering the online education market. Arizona State University (ASU), for example, has lenient admission standards and an extensive offering of online courses; the degree obtained by the online students is not distinguished from students who attend the brick and mortar school. Long term, as more and more traditional schools enter the fray, the only students who attend non-profits will be the ones who are unable to get into a traditional school. Then given the admissions standards, how does a degree from Kaplan university fare compared to a degree from an online traditional school? Comparatively, what is the customer’s ROI on education?

After talking to two admissions advisors from Kaplan, and after repeated attempts, I could not get any information on placement rates. Kaplan tuition rates are already at the high end of a public out-of-state college rates. Having said that, public schools, being public, will be slow to respond, will probably not be adept at dealing with non-traditional students, and will probably take a long time to widely enter the online education market. Moreover, there will always be a sect of students, those moving up in a small company for example, who will benefit from an education provided by for-profits. So, although there is a place for for-profit institutions, long term, it is not a place that harbors 25% growth and 15% margins. For-profit institutions in this environment will only prosper based on the quality of their curriculum, placement rates and marketing. They will nevertheless, retain their distinct advantages in vocational programs. However, Kaplan’s presence is mostly in the non-vocational degree programs.

In addition to the increased competition from public and for-profits alike, Kaplan had a weighted average retention rate of less than 70% and a weight average graduation rate of 42% in 2007. This means that in order to just maintain the revenue levels these students have to be replaced, while even more students need to be added to grow. The story is similar among other non-profit institutions. Although the non-traditional student demographic is large, it is still finite. One has to question the long term sustainability of this business model.

And The Ugly
Kaplan and most other for-profit universities exist on the back of government funding. In 2008, Kaplan University derived 85% of its receipts from the Title IV programs. An institution with revenues exceeding 90% for a single fiscal year is subject to enforcement, which leads to ineligibility in participating in Title IV funding. Kaplan has hired additional personnel to manage these risks, and I believe it is a risk they can manage as they can filter students with a very high proportion of Title IV funding.

Also, during 2008, funds received under the Title IV programs accounted for approximately $904 million, or approximately 71%, of total Kaplan Higher Education revenues, and 39% of Kaplan, Inc. revenues. The business overwhelmingly depends on Title IV funding. Starting in 2009, in order to remain eligible for Title IV funding Kaplan has to maintain 3 year cohort default rates (CDR) below 30% (increased from 25% and 2 year) for three consecutive and below 40% for one year. Below is a table presenting the cohort default rate for various Kaplan institutions in 2007:

Name City Retention
Rate (FT) Graduation Rate Enrollment 2 Year Default Rate Trial 3 Year Default Rate
Kaplan University Davenport 66.0 35.0 53,212 13.3 23.2%
Kaplan College Phoenix 77.0 49.0 587 18.0 25.7%
Kaplan College Stockton 97.0 67.0 1,043 14.4 27.5%
Kaplan College Hollywood 92.0 85.0 1,328 17.0 12.2%
Kaplan College San Diego 89.0 74.0 2,239 8.1 15.3%
Kaplan College Salida 86.0 66.0 1,364 14.8 27.7%
Kaplan College Sacramento 79.0 52.0 861 18.8 33.5%
Kaplan College Vista 92.0 69.0 1,686 13.2 23.1%
Kaplan College Panorama 94.0 74.0 520 17.6 28.7%
Kaplan College Merrillville 57.0 20.0 676 17.3 28.6%
Kaplan College Indianapolis 75.0 60.0 1,702 12.5 22.1%
Kaplan College Las Vegas 69.0 48.0 832 21.2 31.5%
Kaplan College Columbus 61.0 30.0 931 22.8 32.8%
Kaplan C. Institute Boston 37.0 68.0 792 15.3 31.6%
Kaplan C. Institute Brooklyn 65.0 65.0 1,105 16.8 37.7%
Kaplan C. Institute Harrisburg 73.0 58.0 916 20.4 35.3%
Kaplan C. Institute Harrisburg 73.0 59.0 916 20.4 35.3%
Kaplan C. Institute Pittsburgh 86.0 34.0 1,827 21.9 37.9%
Kaplan C. Institute Nashville 57.0 47.0 616 7.9 22.2%
Kaplan C. Institute San Antonio 68.0 67.0 1,986 16.4 29.8%
Source: Department of Education and NCES

As we can see from the above, the 3 year CDR’s for some of the institutions are already higher than 30% and many are very close to the 30% mark. Please note that these statistics are from 2007. Here is a table showing the trend in Kaplan CDR’s:

Kaplan University 2 year CDR
Fiscal Year 2005 2,006 2,007
Default rate 5.90% 9.20% 13.30%
Source: NCES

The trend, in this case, is clearly not favorable. With increasing unemployment and general economic malaise, I would expect the CDR’s for 2008 and 2009 to be much higher. Kaplan is at serious risk of losing its Title IV funding under the new rules. Kaplan will have to change its enrolment strategies in the immediate term to recruit students at a lower risk of default. This again shows that growth will (should) taper, there are no signs however, that it is. Moreover, there is only so much Kaplan can do to stem the rise of CDR’s, Kaplan cannot, for example, control the macroeconomic environment. The Department of Education will not impose sanctions based on rates calculated under this new methodology until three consecutive years of rates have been calculated, which is expected to occur in 2014. Furthermore, the company is facing three separate lawsuits related to Title IV funding.

Although the company has a prudent board and an intelligent management, the rise in the rate of CDR’s cannot be ignored. It is quite ironic that such discrepancies occurred under such conservative leadership. Make no mistake, the cable assets in Cable One and Kaplan test prep are very profitable divisions, but when the higher education business accounts for 68% of the operating profit, and is at such high risk, one has to be careful.

Disclosure: No Position