For-Profit Colleges: Don't Stop Shorting Them

 |  Includes: APOL, CPLA, DV, ESI, STRA
by: Adam Ballantyne

Since Summer 2010, for-profit college stocks have been selling quick, reducing prices by as much 30-60% from their highs in Spring 2010. A rebound in early 2011 was not enough to change the trend and for-profit stock prices have since been beaten down near their 2 year lows. If you missed both the first and second boat of selloffs, don't worry, there will be a longer and much harder third selloff yet to come over the next 1-2 years.

Before we look at why (and when), here's a look at five of the largest for-profit institutions and how their valuations have changed recently:

For-Profit Schools

School Name P/E (ttm) Price Change Since 2010 Highs
Devry University (NYSE:DV) 8.97 -41%
Capella University (NASDAQ:CPLA) 8.00 -68%
University of Phoenix, Apollo Group (NASDAQ:APOL) 14.76 -51%
ITT Technical Institute (NYSE:ESI) 5.57 -49%
Strayer University (NASDAQ:STRA) 9.04 -65%
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Clearly, much of the anticipated declines of for-profit college earnings have been priced in, despite the fact that all of these institutions have had very healthy EPS and revenue growth over the past five years. Still, I think another wave of price declines is inevitable once revenue and enrollment declines are confirmed over the course of the next two years. Additionally, government aid contraction, current enrollment declines, and increasing student debt defaults will quicken the pace of revenue decreases within the next 6-12 months--meaning another round of selling and a possible shattering of the already weak stock prices.

Reduction of Government Aid

Along with the increased debt ceiling this past August, the government stated that it would reduce a vast amount of its federal aid grants to students over the course of the next decade; specifically, graduate students seeking Stafford loans won't get them with government subsidies and they will have to start paying interest as soon as they start school as opposed to after they graduate. Additionally, Congress has already levied a potential cut to Pell Grant funding by $5.7 billion (a cut of about 18% of total funding), which will take place for the 2011-2012 school year if approved by congress. In general, aid recipients attending for-profit institutions make up about a third of total recipients

Given that the Federal government has to have a plan to reduce spending by $1.5 trillion by December 2011, we can be fairly certain that there will be a larger portion of these loans that will be cut, affecting both undergraduate and graduate students as well as their institutions.

Student Debt Defaults

Students at for-profit universities have had higher default rates than those from public or private, nonprofit universities, as can be seen in the graphs below. According to the Department of Education, 40% of students default on their loans 15 years into repayment, which is a drastic increase from the originally calculated rate of default from for-profits. Even to begin with, a fifth of students from for-profits are defaulting into their first year (averaged between two and four-year programs). In 2007, for-profit defaults accounted for 44% of all defaults entering the first year of repayment.

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To see these statistics at the firm level, let's look at ITT Tech (ESI):

ITT's Cohort Default Rate (CDR) has increased from 9.4% in 2006 to 22.4% in 2009; what's more troubling is that if the CDR is above 25% for three consecutive federal fiscal years (FFYs), then the institution loses the ability to participate in the Pell Grant and Federal Direct Loan (NYSEARCA:FDL) programs. Thus, the ability to maintain default rates below 25% is critical to the survival of the institution. In order to maintain these rates, the schools will have to raise eligibility requirements, hurting revenues in both the near and long term if we assume the spending cuts could go on for some time.

Similarly, the 2010 CDR for the University of Phoenix is 19% while Strayer and DeVry have stopped posting their CDRs after 2008--which are very likely to be much higher than the 2008 CDRs of 6.8% and 7%, respectively.

Enrollment Declines

As already stated, a reduction of government aid and a scramble to maintain CDRs among students will drastically lower the growth of attendance, and I wouldn't even be surprised to see a contraction of attendance. However, declines in student enrollment have already begun taking place, more likely because student candidates are realizing it doesn't pay off to go massively into debt for a job market that probably won't hire you.

If we look again at ITT and DeVry, we find that ITT's new student enrollment has fallen 20% for the 2010-2011 school year, while DeVry has taken a new student enrollment hit of 25% from the Summer of 2010 to the Summer of 2011.

Investment Conclusion:

Plan on shorting these companies even more in the next 6 months or so, or as soon as Congress convenes to pass another debt bill this December. ESI, DV, APOL and STRA are my favorites because they have a solid mix of scandals, enrollment declines, high graduate figures (most likely to not receive federal aid), and overall reliance on Federal packages--even their currently fragile prices won't be able to be maintained as a number of variables are running against them, and each year we see continually declining revenues confirming the gradual stock price declines. The faster the US government, et al continue to expose a lot of the scams these businesses represent and continue to reduce budgets appropriated to funding the students in these institutions, the faster these companies--and this industry--will go extinct.

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