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Career Education Corp. (NASDAQ:CECO) did awful Wednesday night as the company issued a slew of announcements, none of which are good news for the company. The announcements were the following:

  • The resignation of CEO Gary McCullough.
  • An update on its internal investigation into placement rates.
  • Its third-quarter results (a week earlier than expected).

CECO has made Board chairman Steven Lesnick temporary CEO while the board conducts a search for a permanent replacement.

CECO revealed that 36 of its 49 ACICS-accredited Health Ed and Art & Design schools failed to meet minimum accreditation standards for its placement rates in 2010-2011.

All this bad news has lead to a backlash of downgrades from analysts. I too am downgrading the stock, as there are just to many troubles surrounding the company.

Projections are lowering CECO to Underperform. This, to start with, is not good for business nor the stock’s future. Why is it expected to underperform?

  • The likelihood that estimates will come down a lot for 2012 and 2013.
  • The chance of a material fine/settlement could occur.
  • Visibility on a recovery in starts for every franchise but the international business, it is difficult to value (in other words, where would the stock be a buy?) the enterprise with traditional metrics.

On a rough sum-of-the-parts basis (no value for Health or A&D, $50 million to $150 million in legal liabilities or fines, and $300 million in teach out cash flow losses over 2 years at Health and A&D), I believe the stock is worth probably $10 to $12, but a lot of that value depends on what 2012 profits in the University segment are. Hopefully they will get a better feel for that on Wednesday’s call.

In addition to the downgrades above, other analysts cut CECO to Underweight. I believe this is worthy as the independent counsel has not yet completed its investigation into the company's other segments, suggesting additional issues may still be uncovered. This is another giant warning flag and another reason to stay away.

I expect Career Education's stock will continue to trade down through week's end. However, given the difficult-to-quantify and potentially substantial nature of the issues noted above, I find it awfully difficult to recommend even investors with a deep value focus take the risk and invest in CECO.

I believe other names in the sector may trade down as well, as investors ask whether others could have similar issues.

I think we can expect shares of CECO to decline sharply as investors come to terms with the CEO’s sudden departure, findings by outside counsel of improper placement practices, and pre-reported weak Q3 results. CECO has a history of accreditation issues, and in the current environment, in which accrediting bodies have been under pressure to better police the industry, I do not expect this to be handled with leniency. I think that this issue appears to be CECO-specific, and while the whole group is likely to trade off, I would view this as a buying opportunity for companies with better records of regulatory compliance.

You think it might be bad now? Well, it could get a lot worse. Take into account that the 49 colleges investigated represent around 40% of CECO revenues. So there could be more to come.

CECO has $6 cash per share on the balance sheet, which should limit the downside to $9-$10 level.

Overall, I think CECO is a stock you should avoid. I believe this could hurt the entire sector, as it's unlikely CECO is alone in this with its placement issues.

Source: Career Education: Avoid This Troubled Stock