For-profit, post-secondary schools are traditional, direct competitors to the nation’s community colleges. These schools have expanded their degree offerings to include bachelor and master’s degrees. In the past, these companies offered the investor a compelling story and profits. More recently, high loan default rates and allegations of misrepresentations and other abuses have stirred the ire of federal regulators.
A recent article published by Reuters, entitled “Default rate at US for-profit schools up to 15 pct.”, describes several of these problems. Share prices have plummeted over the last several years as the government investigated allegations of fraudulent loan applications and false advertising. The article points out that as the economy suffered, student loan defaults ratcheted up.
On June 18, 2010, the Department of Education proposed new regulations, referred to as the June NPRM, related to a number of Title IV program integrity issues. The June NPRM addressed each of the 14 topics discussed at the negotiated rulemaking sessions held in November 2009, December 2009 and January 2010, including, among others, the definition of a high school diploma for the purposes of establishing institutional eligibility to participate in Title IV programs and student eligibility to receive Title IV aid, standards regarding the payment of incentive compensation, establishing requirements for institutions to submit information on program completers for programs that prepare students for gainful employment in recognized occupations, revising the definition of what constitutes a “substantial misrepresentation” made by an institution, standards regarding the sufficiency of a state’s authorization of an institution for the purpose of establishing an institution’s eligibility to participate in Title IV programs, and the definition of a credit hour for purposes of determining program eligibility for Title IV student financial aid.
On July 26, 2010, the Department of Education published in the Federal Register another Notice of Proposed Rulemaking, referred to as the July NPRM, related to a definition of “gainful employment” for purposes of determining whether certain educational programs comply with the Title IV requirement of preparing students for gainful employment in a recognized occupation. On October 29 2010, the Department of Education published final regulations, referred to as the Final Rules, pertaining to the Title IV program integrity issues, addressing all 14 topics addressed in the June NPRM and the July NPRM, other than sections of the proposed definition of “gainful employment.” On June 13, 2011, the Department of Education published final regulations defining the meaning of “gainful employment”, referred to as the Gainful Employment Rule, which is effective July 1, 2012.
The Final Rules became effective July 1, 2011, except for rules pertaining to verification and updating of student aid application information, which are effective July 1, 2012. The Gainful Employment Rule is effective July 1, 2012. On May 5, 2011, the Department of Education announced its intention to establish additional negotiated rulemaking committees to consider additional regulations under the Higher Education Act. The Department of Education held three public hearings in May 2011 at which interested parties presented issues for consideration by the rulemaking committees.
The Department of Education also conducted roundtable discussions on teacher preparation, college completion, and the proposed “First in the World” competition. At this time, it is hard to say, what, if any, impact they may have on any particular company in this industry, but compliance with these and other new and changing regulations could reduce enrollments, increase the cost of doing business, and have a material adverse effect on business.
We have identified four companies in which, we think the market has discounted the worst-case scenario. These companies appear to be undervalued on both an historical basis and based on our own estimates of fair market value.
Bridgepoint Education, Inc. (NYSE:BPI) is a provider of postsecondary education services. The company’s wholly owned subsidiaries, Ashford University and the University of the Rockies, are regionally accredited academic institutions that offer associates, bachelors, masters and doctoral programs in the disciplines of business, education, psychology, social sciences and health sciences. These institutions deliver programs online, as well as at its traditional campuses located in Clinton, Iowa, and Colorado Springs, Colorado. As of December 31, 2010, it offered approximately 1,345 courses, 71 degree programs and 134 specializations. As of December 31, 2010, it had 77,892 students enrolled in its institutions, 99% of whom were attending classes online.
On September 30, 2011, Ashford University received from the Attorney General of the State of North Carolina (“Attorney General”) an Investigative Demand relating to the Attorney General's investigation of whether the university's business practices complied with North Carolina consumer protection law. Pursuant to the Investigative Demand, the Attorney General has requested from Ashford University documents and detailed information for the time period January 1, 2008, to present.
On July 30, 2010, the board of directors authorized the repurchase of up to $60.0 million outstanding shares of common stock over the following 12 months (the "2010 Repurchase Program"). On May 2, 2011, the board of directors authorized the repurchase of a maximum of $75.0 million additional outstanding shares of common stock over the following 12 months (the "2011 Repurchase Program"). The 2011 Repurchase Program is an expansion of, and does not replace, the 2010 Repurchase Program.
From the company's 8K filing dated 8/2/11:
In May 2011, we received from the Attorney General of the State of New York (“Attorney General”) a Subpoena Duces Tecum (“Subpoena”) relating to the Attorney General's investigation of whether we and our academic institutions have complied with certain New York state consumer protection, securities and finance laws. Pursuant to the Subpoena, the Attorney General has requested from us and our academic institutions documents and detailed information for the time period March 17, 2005, to present. (1)
The company’s revenue for the three months ended June 30, 2011, was $239.9 million, representing an increase of $66.1 million, or 38.0%, as compared to revenue of $173.8 million for the three months ended June 30, 2010. This increase was primarily due to enrollment growth of 24.8%, from 67,744 students at June 30, 2010, to 84,545 students at June 30, 2011. In addition to the increase in student enrollment, the revenue increase was also positively impacted by the 5% tuition increase for online courses at our institutions which became effective on April 1, 2011. The tuition increase accounted for approximately 11.3% of the $66.1 million revenue increase between periods. Earnings per share increased to $0.90 for the three months ending June 30, 2011 as compared to $0.56 for the three months ending June 30, 2010. Earnings for the twelve month period ending June 30, 2011 increased to $2.88 as compared to $1.77 in the year-ago period. (2)
Analyst estimates for the year ending December 2011 range from a low of $2.64 to a high of $2.87. The consensus estimate for FY 2011 is $2.74. For next year, analyst estimates range from $2.10 to $3.00 and the consensus estimate is $2.58. Analysts provide a 3-5 year growth rate of 17.5 percent. BPI grew sales at the rate of 44.3 percent over the last twelve months as compared to the industry median growth rate of 13.95 percent.
Gross margins expanded to 73.9 percent in the last twelve months, above the company’s five year average of 68.0 percent and above the industry median of 61.1 percent. Operating margins jumped to 32.3 percent as compared to the company’s five year average of 10.3 percent. The industry median operating margin is 16.35 percent. Over the past seven fiscal years, operating margins ranged from (416.7) percent to the current high of 32.3 percent.
The company reports a current Return on Equity of 65.0 percent, up from 7.2 percent in 2007 and above the industry median of 24.05 percent. The company has a Return on Invested Capital of 53.0 percent for last fiscal year. Last fiscal year, the industry median ROIC was 24.8 percent. The company carries no long-term debt.
By way of valuation, BPI is trading at 6.6X TTH earnings and 7.0X consensus FY 2011 earnings. Price to Book is 3.28 and Price to Sales is 1.18X. The Enterprise Value to EBITDA ratio is 2.88X. We put fair market value of BPI at $44-$48.
Capella Education Company (NASDAQ:CPLA) is an online postsecondary education services company. Through its wholly owned subsidiary, Capella University, the Company offers a range of doctoral, masters and bachelors programs. As December 31, 2010, it offered over 1,250 online courses and 43 academic programs with 136 specializations to over 39,000 learners. It also offers certificate programs, which consist of a series of courses focused on a particular area of study.
In addition, Capella Education Company also offers academic services, such as new learner orientation, technical support, academic advising, research services (particularly for doctoral degree candidates), writing services and online tutoring. It also provides appropriate educational accommodations to learners with documented disabilities through its disability support services team. During the year ended December 31, 2010, it formed the joint-venture Sophia Learning, LLC, as majority owner.
On July 15, 2011, the company acquired 100% of the share capital of Resource Development International Ltd. (RDI) for £9.3 million (approximately $14.9 million) in cash. RDI is an independent provider of United Kingdom (UK) university distance learning qualifications and markets, develops and delivers these programs worldwide via its offices and partners across Asia, North America, Africa and Europe. RDI's online distance learning offerings span from degree entry programs to doctoral level programs and are offered in a variety of disciplines, including business, management, psychology, law, and computing. The acquisition of RDI enhances the Company's market leadership through access to the fast-growing international higher education market, with a presence in the UK and Commonwealth countries.
In the quarter ending June 30, 2011, Capella reported EPS of $0.99 on sales of $106.4 million. In the year-ago quarter, the company reported EPS of $0.86 on sales of $105.2 million. For the twelve months ending June 30, 2011, Capella reported EPS of $3.78 on sales of $437.5 million. In the year-ago period, the company had sales of $384.5 million and reported EPS of $3.20. For FY 2011, analysts estimate EPS in the range of $3.35 to $3.62. The consensus estimate is $3.49. For FY 2012, estimates range from $1.95 to $3.56. The consensus is $3.02.
Sales growth has slowed to 13.8 percent in the trailing twelve month period as compared to the seven year average growth rate of 26.6 percent. During the same periods, the industry median growth rates were 13.95 percent and 16.25 percent respectively. The growth rate for gross income declined to 13.9 percent from the company’s seven year average of 31.8 percent. These growth rates compare favorably with the industry medians of 12.35 percent and 19.7 percent respectively.
Gross margins, at 61.1 percent for the most recent twelve month period are above the company’s seven year average of 57.2 percent. The median industry gross margin for the most recent twelve months is 61.1 percent. The operating margin is 21.9 percent, also above the company’s seven year average of 15.9 percent. Operating margins for both periods exceed their respective industry median. We also see strength in Return on Invested Capital. The company’s ROIC expanded to 38.3 percent in the most recent twelve month period as compared to its five year average ROIC of 17.7 percent. The company has no long term debt.
The company trades at 7.6X trailing earnings and 8.2X FY2011 consensus earnings. The current Price to Book is 2.37 and Price to Sales is 1.03X. The Enterprise Value to EBITDA ratio is 4.46. Capella is currently trading at $28-$29 range. We estimate fair value at $41 to $51 per share.
Career Education Corporation (NASDAQ:CECO), through colleges, schools and universities that are part of the CEC family, offers education to a diverse student population of over 116,000 students in a variety of career-oriented disciplines. The Company has more than 90 campuses that serve these students are located throughout the United States and in France, Italy and the United Kingdom and Monaco. Its institutions includes American InterContinental University (AIU), Brooks Institute; Colorado Technical University (CTU), Harrington College of Design, INSEEC Group (INSEEC) Schools, International University of Monaco (IUM), International Academy of Design & Technology (IADT), Istituto Marangoni, Le Cordon Bleu North America (LCB), and Sanford-Brown Institutes and Colleges. CEC organized its businesses across four segments: University, Health Education, Culinary Arts and International. On April 15, 2010, the Company acquired IUM, an international business university.
For the quarter ending June 2011, EPS declined year-over-year to $0.74 from $0.82. Sales also declined Y-O-Y to $497.2 million from $527.7 million. For the trailing twelve months, EPS declined to 2.22 from $3.24 in the year ago period. Sales declined to $2,107.6 million from $2,890.9 million. Analyst estimates for the current fiscal year range from $2.26 to $2.49. The consensus is $2.38. Next year, analysts expect a further decline. The range is $1.00 to $2.04 and the consensus is $1.78.
The gross margin has held at 69.0 percent, above the five year average of 67.0 percent. Operating margins are also above the average, at 12.2 percent. In the past, operating margins have ranged from 7.0 percent to 20.6 percent. The current operating margin is below the industry median.
Return on Equity is a respectable 17.7 percent but significantly below the industry median of 24.05 percent. Return on Invested Capital is 17.7 percent; above the company’s five year average but below the industry median. The company has $0.5 million in long term debt or a LT Debt to Equity ratio of 0.1 percent. Cash and short term investments total $388.7 million.
With a market valuation of $1,114.9 million, the company sells at 6.7X trailing earnings and 6.3X estimated FY 2011 earnings. The multiple rises to 8.4X FY 2012 estimated earnings. The company’s seven year average PE is 20.5X. Price to Book is 1.17X; Price to Sales is 0.53X; EV/EBITDA is 2.62X. Our estimate of fair market value is $26 to $28.
Lincoln Educational Services Corporation (NASDAQ:LINC) is a provider of career-oriented post-secondary education. As of December 31, 2010, it operated 45 campuses in 17 states. It offers degree and diploma programs in five areas of study, such as health sciences, automotive technology, skilled trades, business and information technology, and hospitality services. During the year ended December 31, 2010, its health science program, automotive technology program, skilled trades program, business and information technology program and hospitality services program accounted for approximately 40%, 30%, 11%, 10%, and 9%, respectively, of its average enrollment.
As of December 31, 2010, it had 29,221 students enrolled and its average enrollment was 31,535 students. The Company’s schools operate under brand names, such as the Lincoln Technical Institute, Lincoln College of Technology, Lincoln College of New England, Nashville Auto-Diesel College and Euphoria Institute of Beauty Arts and Sciences.
Revenue decreased by $24.6 million, or 16.1%, to $128.2 million for the quarter ended June 30, 2011 from $152.8 million for the quarter ended June 30, 2010. This decrease was primarily attributable to a 20.2% decrease in average student population to 24,711 for the quarter ended June 30, 2011, from 30,965 for the quarter ended June 30, 2010. In the same time periods, EPS declined to $0.22 from $0.50. Revenue decreased to $607.8 million for the twelve month period ending June 2011 from $611.2 million for the twelve month period ending June 2010. EPS increased to $2.48 in the TTM period as compared to $2.37 in the prior year period.
Analysts estimate that earning will be in the $0.95 to $1.18 range for FY 2011. The consensus estimate is $1.07. Looking ahead to FY 2012, analysts estimate EPS in the range of $-0.50 to $1.26. The consensus is $0.71. LINC experienced negative sales growth in the past twelve months, a trend that may grow.
The company managed to maintain gross margins in line with the industry median and, at 61.1 percent, above the company’s five year average gross margin. Operating margins are also holding. The operating margin at 16.8 percent is above the average margin of 12.5 percent. Return on Invested Capital is 26.5 percent, also above the company’s five year average. LINC has long term debt of $36.3 million, down from FY 2010 total of $56.5 million. The company has $30.3 million in cash and short term investments. Long term debt to equity is 15.2 percent.
Investors are even more pessimistic about LINC than the companies described above. The trailing PE is 3.4X; Price to Book is 0.77; Price to Sales is 0.30X and EV/EBITDA is 1.96X. We place fair value in the $25-$28 range.
All four companies face serious headwinds. We can expect revenue declines for as long as the economy remains weak with fewer students enrolling in these schools. We can also expect with lower enrollment numbers, better quality enrollments. Student retention is critical to company profitability.
Educational institutions are being more selective in accepting students. They are looking for students who have a greater likelihood of successfully completing a program and gaining meaningful employment. They are enrolling students that demonstrate a strong ability to achieve successful student outcomes, including higher graduation rates, repayment rates and lower student debt levels.
|08/02/11||10-Q||Quarterly report which provides a continuing view of a company's financial position|
Disclosure: I am long BPI.