I am convinced that the future of degree programs for working adults lies in the for-profit sector. The non-for-profits tend to offer programs for non-traditional students merely as an add-on to their self-identified principal mission of serving traditional-age students. The revenue obtained from their non-traditional programs is more often than not used to subsidize the traditional program rather than to invest back in the non-traditional programs. This produces a situation in which adult students are ill-served, and I believe they will become more and more attracted to those providers who focus all their energies and resources on serving the working adult population. Hence, it is my belief that the future for these programs lies in the for-profit sector.
Trace Urdan, writing for R.W. Baird, recently observed:
The notion of not-for profit institutions waking up to the threat posed by for-profit institutions has been a perennial threat that has failed to come true.
This is so true. It seems to be in the nature of the not-for profits to dismiss the for-profit sector as irrelevant and certainly as non-competitors. In thinking about the competitive landscape for their non-traditional programs, the not-for-profits simply do not factor in the for-profit sector. Mr. Urdan further states that "the near-term budget pressures are unlikely to alter significantly the dynamic we have witnessed over the past ten years." Again, he is right on the mark. The not-for profits are so busy trying to deal with their traditional programs that they will continue to give little thought, energy, and attention to non-traditional programs.
Finally, he writes that "we have heard of community college and small university actors who have been oblivious to the arrival of a for-profit competitor to their market." He could not be more on target here. The not-for-profits simply cannot fathom that they face a threat from institutions which are so unlike themselves.
The for-profits target primarily the working adult student. Such companies include University of Phoenix (NASDAQ:APOL), Strayer Education (NASDAQ:STRA), Career Education Corp (NASDAQ:CECO), Corinthian Colleges (NASDAQ:COCO), DeVry (NYSE:DV), Education Management Corp (NASDAQ:EDMC), ITT (NYSE:ESI), Evci Career Colleges (OTCPK:EVCI), Laureate Education (LAUR), and Nobel Learning (NASDAQ:NLCI). There are important differences among the customer base of these companies. For example, DeVry has a more trade-oriented focus, while Phoenix and Strayer offer programs for non-traditional students more like the ones offered by the not-for-profits. The big advantage which Strayer and Phoenix have over the not-for-profits is that they plow their cash back into these programs. Hence they have great growth potential. I find Strayer attractive because it is in the very early stages of growth while Phoenix is much farther along in its growth cycle.
The sense I have about Phoenix is that students are primarily attracted to their online capabilities. I see their ability to offer courses at a physical campus as something which they regard as merely supplementing their online programs. With Strayer, the situation is reversed. Strayer is primarily a brick and mortar institution supplemented by its (impressive) online offerings. I believe that adult students generally prefer the Strayer approach. They want traditional classroom instruction along with the flexibility provided by taking an occasional online course. While, of course, there are some folks who will find a primarily online program attractive, I believe this market is limited. In my view, Strayer is tapping into the much larger market of students who want to anchor their studies at a physical campus, who want to receive instruction in a classroom setting, and who appreciate the fact that Strayer also offers online courses. I believe this gives Strayer a significant competitive advantage over Phoenix.
As I mentioned earlier, the not-for-profits are too pre-occupied with their traditional students to be able to compete with the kind of focus which Strayer brings to the delivery of programs for working adults. Also, the not-for-profits are ill-equipped to offer the kind of on-line options that Strayer offers. I'm not a big fan of Phoenix because I am skeptical of the approach which places on-line experiences above classroom experiences. Thus Phoenix may have difficulty in drawing students away from the not-for-profits. Strayer, on the other hand, is perfectly poised to mine this market. They offer the classroom experience as their primary delivery system and they also have significant online offerings and academic support systems for their students. In my view, Strayer poses a significant threat to the not-for-profits, and their competitive position vis-a`-vis the not-for profits is all the stronger precisely because the non-for-profits are unable to see Strayer as a threat.
An additional advantage which Strayer has over Phoenix is its web site. Strayer's web site is about the best I have seen in the educational arena, whether for-profit or not-for profit. They provide prospective students with a great deal of information about their programs via a web site which is attractive and easy to navigate. Phoenix, on the other hand, reveals very little about themselves on their web site. The only way to get pertinent information about them is to fill out an online form so that someone from their company can contact you. I believe we have reached the point where students will make their decisions by shopping web sites. Direct marketing will yield less and less in the way of returns. Students will shop and compare web sites and make their choices according to the experiences they encounter during that process. On this front Strayer excels hands down.
Among the for-profit education providers, Strayer Education stands out as exemplary in two important respects - quality of educational program and quality of business. Strayer operates Strayer University which has 47 campuses in 11 states in the eastern US and is adding approximately 8 campuses per year via growth which is completely organic. Its goal is to penetrate all regions of the country. Strayer serves a working adult student population and offers undergraduate and graduate degree programs in business administration, accounting, information technology, education, and public administration. Worldwide access is provided via Strayer University Online.
One of Strayer's strengths is its academic integrity. Not only has it not been implicated in any of the corrupt practices which have plagued the sector, but it seems to see the maintenance of academic standards as part of its mission. It does not appear to be scraping the bottom of the barrel in its admissions practices in order to drive short-term profits. This point has been made in several recent conference calls in which CEO Robert Silberman has spoken about the fact that they often prefer it if students complete two years of junior college before attending Strayer. Silberman explains that people who have been out of high school for some time and who have had no college experience often find Strayer's program daunting and difficult to complete. With two years of college under their belt, Silberman points out that their success rate at Strayer is much higher. This is a very mature and educationally appropriate attitude. Instead of going for short-term gain by admitting students who are destined to fail, they aim for long-term student success. This is the approach that will yield long-term financial success as well. I will continue to be on the lookout for signs that Strayer understands that it is ultimately the academic quality of its programs which will determine its success as a company.
Strayer has never been implicated in any of the misdeeds and improprieties, whether educational or financial, which seem to plague this sector. In all the expose's, either in print or on TV (e.g., 60 Minutes), STRA has not appeared in the list of offending schools. span> This partly explains why STRA has traditionally traded at a higher multiple than a number of its peers. The rest of the explanation has to do with Strayer’s stellar fundamentals and excellent growth prospects.
Strayer has a sterling balance sheet with $128.4M in cash and no long-term debt. The company generated $61.8M from operating activities in 2006, and 2006 capex was $13.2M. Management has been able to produce a return on equity of 32%, and analysts are expecting earnings to grow at 18% per year over the next 5 years.
Here are some considerations which might aid in determining a suitable buy-in point.
Share price: $118.65
Market cap: $1.7B
Enterprise value: $1.57B
TTM revenue: $263.6M
PE ratio: 32.9
Analysts’ growth estimate: 18% per year for the next 5 years
Next I want to compute owner earnings (aka structural free cash flow) defined as OE = (net income) + (D&A) + or – (one-time-charges) – (maintenance capex). For Strayer, maintenance capex is about 50% of total capex according to CEO Silberman. It is interesting to note that D&A consistently comes in at a figure very close to maintenance capex. With this, we compute 2006 owner earnings of $52.8M. I have not added back the $7.4M non-cash expense for stock-based compensation in 2006.
Analysts estimate 2007 EPS at $4.21. Historically, STRA has generally traded at a multiple in the range 29-33. At 30, this would suggest a price of $126.30 a year from now, a 6.4% increase over today’s price. If the market rewards STRA with a multiple of 33 (the current PE), this would yield a price of $138.93, a 17% increase over today’s price.
Certainly, the current price is not attractive. However, STRA’s price inevitably drifts downward after a good earnings release. Generally, it has not been possible to purchase shares below a PE of 29. With EPS sitting at $3.61, a price of $108.30 (which would correspond to a PE of 30) would be an attractive entry point. I will be looking to add to my position as the price approaches $110. Whether we will see this price is hard to say. STRA has generally commanded a fairly high multiple compared to its peers due to the strength of its operations, it’s nearly flawless execution, and the lack of any legal and/or accreditation issues.
Disclosure: Author holds a long position in STRA
STRA 1-yr chart