Why Apollo Group Will Benefit From a Republican House

Jan.12.11 | About: Apollo Education (APOL)

The battle for increased oversight over the for-profit education industry began with the Department of Education, led by Arne Duncan, piloting the requirement that for-profit vocational programs yield "gainful employment," as measured by the ratio of salary to loan debt among graduates.

This rule cuts federal aid to for-profit schools if graduates spend more than 8 per cent of their starting salaries on loan payments. The Department of Education has already backed off this rule in light of heavy industry lobbying. In late September, the Department of Education delayed setting the gainful employment rule in place until 2011.

Democrat lawmakers are now split, with a large, vocal contingent coming out in support of the for-profit education industry. Rep. Edolphus Towns (D-N.Y.), chairman of the House Oversight Committee, established that,

These programs are vital to educational achievement of students who would otherwise consider postsecondary education out of reach.

47 other Democrats lodged similar statements with the Department of Education when it opened its regulatory framework for comments. Democrat heavyweights in support of the sector include Sen. Bill Nelson (FL) and Reps. John Spratt (SC) and Debbie Wasserman Schultz (FL).

The lower-income and minority lobbies are particularly stressed about new regulations which would hamper enrollment at for-profit institutions, whose students typically come from lower income households and include working adults. Oftentimes, for-profit institutions cater to technical trades and vocations that serve an unmet need not filled by non-profit colleges.

Senate Republicans have gained momentum in an attempt to curb the breadth of the Department of Education's regulations. In October, senator Jim Risch (R-ID) introduced legislation designed to prevent the Department of Education from denying federal financial aid to students whom attend for-profit institutions and vocational programs. Senator Risch said of his effort:

"The ‘gainful employment’ rules could deny hundreds of thousands of students access to the training and skills development they need to secure a job in today’s troubled economy. Highly-skilled workers are in high demand in certain sectors and propriety schools are uniquely qualified to meet that need. It is simply irresponsible for the government to throw roadblocks in front of students and institutions at a time when job creation in America should be the administration’s number one priority."

Apollo Group (NASDAQ:APOL), the largest for-profit education institution known for its flagship University of Phoenix, has already taken measures to adjust for any impact stemming from new regulations. The share price nose-dived after its latest conference call on October 13, in which the company's leadership showed that the University of Phoenix began offering free orientation to incoming students.

The new program demonstrated an 80% retention rate once orientation was completed, however it was suggested that most of those students would have dropped out anyway. The orientation, coupled with a restructuring of how enrollment counselors are compensated should do much to help Apollo reduce federal loan defaults and help it manage around the 90% loan cap.

Currently, Apollo students obtain around 88% of their funding from federal loans, a number which has risen steadily over the last decade. Management also indicated that it had price increases at its disposal as well as emphasizing a larger proportion of graduate level and four-year students, in order to govern down student loan default rates.

And again, on Monday, shares took a hit after word that industry peer Strayer Education (NASDAQ:STRA) tumbled nearly 20% on news that new student enrollments fell approximately 20% across the Strayer University campuses and online system.

The sell-off in shares over the past months is overdone in our opinion, and the Republican election win will act to buffer the tempest against the for-profit sector initiated by the Department of Education. Shares are worth $75 apiece based off our discounted cash flow estimate.

We anticipate that operating margins will fall to 22% in 2011 as the orientation program and restructuring measures kick into full gear, and we expect revenue growth to average 1% over the next 5 years. Both enrollment and earnings growth are likely to resume by 2014, putting positive pressure on margins.

Shares in Apollo and are ripe for investors looking to capitalize on the Republican takeover of the House.

Disclosure: I am long APOL.