'For-Profit' Educational Stocks: The Coming Months Will Be Quite Telling

by: Soos Global Capital

Much has been said of late regarding the US educational system. Test results have been hitting the headlines showing that on many levels, US institutions that are meant to educate everyone from children to young adults and beyond, have not been producing enough graduates qualified with the types of higher-level skills required by more and more jobs in many fields of business and government. Furthermore, the US has been falling behind other countries around the globe when measured by various tests and other metrics. For example, last month, the AFP news service reported on Yahoo.com that the “US Falls to Average in Education Ranking”. Among other things, the article noted:

The United States has fallen from top of the class to average in world education rankings, said a report Tuesday that warned of US economic losses from the trend.

The three-yearly OECD Programme for International Student Assessment (PISA) report, which compares the knowledge and skills of 15-year-olds in 70 countries around the world, ranked the United States 14th out of 34 OECD countries for reading skills, 17th for science and a below-average 25th for mathematics.

In addition, the Associated Press ran an article last month in which the title spoke volumes about the underwhelming output of the US education system, namely: “Study: Nearly 1 in 4 Students Fail Military Entrance Exam”. Implication, you might ask? Implications, indeed. More specifically, how the US educates its children and young adults will impact US competitiveness in STEM fields (science, technology, engineering and mathematics) both for jobs and business creativeness, military preparedness, medical advancements, foreign policy related interactions and much more.

Once broached, this topic can travel in various directions, from a deeper dive into any of the aforementioned areas of impact, to a broader assessment of the relative importance of education among the long list of socio-economic and geopolitical issues facing the US at a time of increasing calls for fiscal austerity. Stepping aside from these deeper and arguably more meaningful levels of analysis, one more callous avenue of thought to pursue relates to the following question: Is there an investment opportunity somewhere in the midst of this education decline, or as some see it, education crisis? Perhaps. But not without some serious degrees of risk.

One sector that has benefited handsomely in recent years has been the “for-profit” education businesses in which various types of degrees and technical skills are offered by private institutions that are run as profit-making entities and who service students (ie: clients) either through on-campus classes, or more likely, online or on-site courses. A look at just some of the names in this investment class shows how well many of these companies have done, from the numbers of ‘clients’ who’ve benefited from access to the education offerings, to the revenues and profits that have been a by-product of strong demand and effective operating efficiencies.

Some of the names in this space include Education Management Corp (NASDAQ:EDMC), Strayer (NASDAQ:STRA), Capella (NASDAQ:CPLA), Lincoln (NASDAQ:LINC), Grand Canyon Education (NASDAQ:LOPE), Apollo Group Inc (NASDAQ:APOL) (owner of University of Phoenix), DeVry Inc. (NYSE:DV), ITT Education (NYSE:ESI) (owner of ITT Technical Institute and Daniel Webster College), Corinthian Colleges Inc (NASDAQ:COCO) (operates under Everest, WyoTech and Heald) and Kaplan Higher Education which is owned by Washington Post (WPO).

Many of these stocks fared well since the overall market lows of early ’09, but most hit a brick wall early in 2010. Any many of the issues that were among the building blocks of that brick wall still exist, plus some. While it’s not the place of this article to offer any form of investment advice, it is a suitable forum for offering up some thought-provoking input that investors can choose to use in their own investment decision process that they are obligated to make on their own based on their financial profile, risk tolerance and portfolio goals.

On the surface, there are, arguably, some good reasons to consider buying these stocks. For one, President Obama has clearly made education an important priority among his policy objectives, and the President’s Education Secretary, Arne Duncan, has been quite visible in various forms of media pounding the table for politicians to set partisanship aside and to come together to fund various initiatives that he is advocating in order to achieve the President’s stated goal of having the US regain the mantel of “to once again have the highest proportion of college graduates in the world”. That quote comes from President Obama’s speech to the joint session of Congress back in February 2009, and was cited by Arne Duncan in his article that appeared in last month’s Foreign Affairs, entitled, “Back to School”. In that same article, Duncan writes:

In the coming decade, the United States has a unique opportunity to reverse its declining economic competitiveness. The American Recovery and Reinvestment Act of 2009, the stimulus package enacted by Congress in February 2009, included nearly $100 billion for education, the largest investment of its kind by the U.S. federal government in history. It also granted the secretary of education more than $5 billion in competitive discretionary funding -- more than the total of all such funding provided to the Department of Education since it was established 30 years ago. Discretionary monies fund programs such as Race to the Top, Investing in Innovation, and School Improvement Grants, which help boost K-12 student achievement and readiness for college and careers and help turn around the nation's lowest-performing schools. The Obama administration has also sought unprecedented funding for STEM education. The 2011 budget proposed investing $3.7 billion in federal STEM education programs, including $1 billion for improving math and science achievement among K-12 students -- a funding increase of over 40 percent.

Furthermore, Secretary Duncan wrote an op-ed in Monday’s Washington Post in which he appealed again to lawmakers in the new 112th Congress to come together to further these challenging educational rebuilding goals, stating:

The urgency for reform has never been greater. Today, American students trail many other nations in reading, math and science, and a quarter of them do not graduate high school on time. Many college students do not finish, despite the clear national need for more college-educated workers who can successfully compete in the global economy.

President Obama in 2009 set a national goal that America will once again lead the world in college completion by 2020. With our economic and national security at risk, this is a goal Republicans, Democrats and all Americans can unite behind.

So with a declining US educational system, a President who has prioritized its rebuild as a matter of national security among other things, and an Education Secretary who has been ferocious in pursing the goal, one would have to consider the for-profit educational institutions as being in a prime place to benefit. And many of them already have as enrollments have gone up and operating efficiencies have allowed for impressive operating profits.

So how strong of a brick wall can it be to have stopped this seemingly strong sector and to even augur for further fierce headwinds in coming months?

For one, the strongest brick in the bunch starts with the fact that much of the funding for students attending these institutions comes from US taxpayer money in the form of various Federal grants, most notably, Title IV grants. Critics argue, that wouldn’t be so bad if those who have borrowed the money actually benefited from the education that the money bought in the form of jobs that would allow them to repay those loans. Therein lies the issue. As CNBC reported on December 17, 2010:

A combination of low graduation rates and high loan default rates, along with questionable job placement numbers has raised concerns that the schools are abusing the system, merely collecting government funds, and delivering little in the way of a usable education.
A recent report from Education Trust, an influential Washington think tank, equated for-profit colleges to subprime lenders and accused the industry of "peddling access to the American dream but delivering little more than crippling debt."

Furthermore, last August, the GAO (General Accounting Office) issued a report on fifteen for-profit institutions in which they cited many of the schools for using misleading and fraudulent information in the admissions process. Clamoring for a close scrutiny into the industry has been getting louder and louder from various perches, including from the SEC, some State Attorneys General, and members of Congress. Many have gone so far as to say that the outstanding student loan problem is another US mortgage/housing crisis waiting to explode.

These are more than just your average, run-of-the-mill ‘headwinds’. These are serious risks to investing in this sector, despite the seemingly glowing opportunity that for-profit educational institutions face with the burgeoning demand for their services. The scale that weighs the balance of pros and cons of buying these stocks might very well be tipped in either direction by where this issue lies on the new Congress’ overall agenda. It seems likely that at a minimum, this industry will be taking a visit to the “principal’s office” in the form of answering to various authorities that are raising questions about performance. The coming months will be quite telling on that front. Until then, like a student whose behavior has been not quite up to snuff, these stocks may just be spending some time in the ‘detention room’.

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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. While I have no current positions in any stocks mentioned, and at this time I have NO plans to initiate any positions within 72 hours, if there is a meaningful change in valuation, positions may change at anytime without notice.