ITT Educational Services Can Be Bought At Fire Sale Prices Due To Incredibly Overstated Fears

Aug. 5.14 | About: ITT Educational (ESI)

Summary

ITT Educational Services stock finishes down over 46% on Monday.

The drop is caused by an August 1 filing that indicated that a $119M property leaseback deal has been cancelled.

ITT rejected an extension of the due diligence period in order to entertain other potential buyers.

The market treated the news by subtracting $155M off of ITT's valuation, essentially saying that the property it owns is now worth less than zero from $119M on Friday.

On May 21 with ITT Educational Services (NYSE:ESI) stock trading at $25, Nick Mulcahy wrote a bullish article. As the stock closed today at only $7.71 clearly he was quite early on his call. However, his points are still valid, both the negative and positive. Yet the stock is down 70% from when he made the call to buy. Not much has really changed. We have already seen the bearish arguments and know that enrollment is down and we know that the company faces increased regulatory scrutiny. This is why the stock was trading at just over $14 on Friday from Mulcahy's $25 entry in May.

However something happened on Monday that shocked just about everybody. In response to an 8-K filed on Friday, the stock sold off over 46%. In fact it opened up at $13.98, only down a few points seemingly shrugging off the filing but then high volume selloff throughout the day ensued. It was relentless and unlike anything that I've seen in quite some time. And all of this was caused by the cancellation of a seemingly innocuous property leaseback transaction. What happened was that the undisclosed buyer wanted to extend the due diligence period but ITT rejected the request because it did not want to tie up the property for another 45 days. Rejecting the amendment to the due diligence period allows ITT to "enter in to negotiations with other potential buyers."

It is important to remember that this deal involves a sale of property that ITT owns. The value of the deal was projected at about $119M. On the news of the deal being cancelled, ITT's market valuation dropped $155M. So the market is saying that suddenly all of this property that ITT owns is now not only completely worthless, but it has a negative value of over $35M. Clearly this does not make sense and the drop was likely fueled by a series of panic selling and perhaps margin calls in a frightened private education market. This hysteria was accentuated by media like Bloomberg who throughout the day kept hammering away about various regulatory issues that we already knew about but coupled with this catalyst of the leaseback deal being cancelled mass fear ensued.

Despite all of this negativity, a cool headed Bank of America analyst reiterated her neutral rating on the stock and lowered the price target from $19 to $16, which represents over 100% upside from Monday's closing price. Furthermore, the company released a statement in after hours trading that the CEO has resigned and as expected the fear mongering continued on Twitter. Even Herb Greenberg can't resist firing off a few random shots. I'd expect that the company will have a more formal response to this shortly and also that the analysts, who are sitting on a $22 median target, will likely further defend the stock from this absurd and unwarranted drop. There is no telling how the 5 hedge funds that own 50% of ITT's common shares will react. I don't imagine that these funds were scared money selling in to the panic. Certainly a potential positive upside catalyst can come from imminent activism at these depressed levels.

It is important to mention that when the deal was originally announced for the $119M leaseback the stock did not move on this news. The fact that it sold off more than 46% based on a cancellation of this deal indicates to me that it is purely fear based irrational selling. Accordingly, ITT's stock should rebound sharply off of these lows once logic ultimately takes over. After all, this is a company that is expected to make over $60M net profit this year and over $50M next year. A company with 19 properties that it is shopping around that is worth around $119M and cash in hand of at least $170M with only $60M in easily manageable debt. Not to mention that ITT has an additional 11 properties likely worth over $50M as well that can be sold. I can't believe that I was able to buy this company today for only a $180M value. Do not expect this fire sale to last very long.

Disclosure: The author is long ESI. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.