Why Value Investors Should Take A Look At For-Profit Education Companies

Includes: BPI, CECO, ESI
by: Bottom Up Investments

As the dog days of summer come to a close and school starts back up across the country, we here at Bottom Up Investments think For-Profit education stocks may be worth a look for value-oriented investors.' While it is certainly a controversial sector and there is quite a bit of regulatory risk, we think the risk-to-reward is in our favor due to depressed valuations, strong balance sheets, and the potential for a short squeeze. We recommend value-oriented investors consider adding ITT Educational Services (NYSE:ESI), Bridgepoint Education, Inc. (NYSE:BPI), and Career Education Corporation (NASDAQ:CECO) to their portfolios.







Net Cash/

Mkt Cap

% Off

52 Wk High


Int. %

ITT Educational Services (ESI)







Bridgepoint Education, Inc. (BPI)







Career Education Corp. (CECO)







Source: Bloomberg

What’s Not to Like

In our view, the hardest part about investing in these stocks is separating our personal views about the industry from our professional obligation to find attractive investment ideas with suitable risk characteristics. Personally, we question for-profit education industry’s value proposition to its students given the high cost of their education and marginal job prospects following graduation. Further, we think that for-profit colleges have grown in part through aggressive sales tactics and an accommodative government that has been distracted by the industry’s army of lobbyists. These have lead to high student debt levels and default rates, negatively impacting both the individual and all of us as tax payers. Personally, there isn’t a lot to like about the industry.

Why We Believe the Industry is Compelling

Professionally, however, is a different story. Trading at an enterprise value of less than four times twelve-month free cash flow, we think the three stocks’ valuations more than reflect the risks of increased regulation, stricter government loan standards, and restrictive recruiting practices. While enrollment growth is likely to suffer from difficult comparisons in the next few quarters due to stricter recruitment practices (Q2 numbers were awful at most companies in the industry), we think investors will begin to warm to these companies in 2012 for three reasons:

  • Enrollment growth numbers should stabilize when the education companies lap new, more restrictive recruiting standards put in place during 2011.
  • We think investor focus will shift to their attractive valuations when it becomes clear that government regulation is not going to cripple their business anymore than they already have. Our thesis is that the industry’s army of lobbyists will be too much to handle for the divided legislature. Further inroads by Republicans in the 2012 election could actually prove to be a major tailwind for the industry.
  • If the economy sinks back into recession, enrollment growth could surprise to the upside, leading to multiple expansion (the education stocks are thought of a counter-cyclical).

If any or all of the above factors come to fruition, we think shareholders will benefit from a short-covering rally that could drive prices significantly higher than their current level.

Risks – We recommend potential investors view Steve Eisman’s presentation on for-profit education stocks given at the 2010 Ira Sohn Investment Conference for a full breakdown of the bear case.

(1) The biggest risk is increased regulation. However, we have little faith in government at this point, so we are not putting much stock in this risk.

(2) A grass roots-like movement against higher education. Students throughout the country are increasing being saddled with more debt as the cost of education skyrockets and the economic returns of a college education are increasingly being called into question. As the most egregious offenders, there is a chance that the for-profit space becomes the symbol of all that is wrong with the education system, resulting in declining enrollment figures through 2012.

(3) Another risk is from a recovery in jobs growth. Higher employment numbers would reduce the number of available students.

Author’s Note

We understand that for-profit education companies have very passionate supporters and critics and welcome those interested to participate in the discussion below. Also, be sure to sign-up to follow Bottom Up Investments as we will certainly publish updates on our thoughts as new information comes to light.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ESI, CECO, BPI over the next 72 hours.