It has been over six months since we first articulated our proprietary (or for-profit) education investment thesis here on Seeking Alpha. Over that time, the controversy has swelled and so has our position size.
Our investment in the proprietary education sector has proven to be one of the most volatile that we have made. In addition, while all investments involve uncertainty, in this case the uncertainty has lingered and in some ways expanded.
Through a chronological review of our investment, we attempt to give understanding to our ongoing analysis of the idea, as well as how we approach portfolio management to minimize our downside and allow for poor timing and an evolving landscape.
This case study is characteristic of our investment approach. We attempt to buy into ideas with a sufficient margin of safety and very low expectations for future company performance improvements embedded in our purchase price. In addition, for ideas where very high uncertainty abounds, we look to size our initial position in order to leave room to layer-in additional exposure should our timing prove poor or the landscape evolve to our detriment.
In the case of the proprietary education names, this conservative approach leaves our overall position currently just above break-even despite all of the negative news and the real impact this has had on enrollments.
We first purchased shares of Apollo Group (APOL) on March 5, 2010 at just over $62/share. At the time, it made up a 4% position in our portfolio. The Department of Education had proposed enhanced regulations in February, putting pressure on the entire universe of proprietary education names.
In addition, an SEC inquiry into revenue recognition practices at APOL had caused the stock to trade down more than the other names in the space. After significant research, we became confident that the market was over-discounting both the potential impact and likelihood of enactment of the regulations. We were also confident that a resolution of the SEC inquiry would have no impact on valuation.
Our purchase was followed by a series of negative news articles and TV stories, detailed presentations from short-sellers, and hostile Congressional hearings. Each of these events caused further sell-off in the sector. However, every negative analysis we reviewed was based on anecdotes and data taken out of context.
As the stocks got cheaper (including some of the highest quality names in the space), we slowly and methodically added to our position. At the close of 2010, our APOL position was down -37% but our basket of proprietary education stocks (five distinct names at the end of the year and at the time this article was written), was up just shy of 0.5%. Significant uncertainty remains and we acknowledge that our more positive outlook on the sector could prove too optimistic.
However, we believe the worst is more than priced in. Today, if APOL had 0% growth for the next 5 years and EBITDA margins went from 31% in 2010 to 22% immediately, we still think it is worth almost $60/share. A play-by-play account of our portfolio management process for this idea is available in our most recent quarterly letter.
Disclaimer: This newsletter contains general information that is not suitable for everyone and should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. For more information about Grey Owl Capital Management LLC and a complete list of holdings please contact Grey Owl at 1-888-473-9695.