Capella Education Company (CPLA) was founded in 1991 in Minnesota as an education institution targeting working adults. By 1993 the company was offering doctoral and master's degrees through distance learning programs, and by 1995 CPLA had begun offering their courses through the internet. From 1998 through to today, CPLA expanded their offerings significantly to the point where they now offer 43 academic programs with 136 specializations. In 2006 the company listed on the NASDAQ.
CPLA serves around 39,000 students targeting primarily working adults. 80% of CPLA's students are enrolled in a masters or doctoral degree program, and all courses are offered online.
CPLA's performance for the 6 months to June 2011 was on track to meet its excellent 2010 performance, but is expected to drop off slightly in the 2nd half of 2011 and into 2012. Though re-enrolments are strong, the company is starting to experience a drop off in new enrollments. CPLA demonstrates some characteristics of each of a cyclical, countercyclical, and non-cyclical business. When the economy is strong, people see their peers gain career advancement, as so engage in further education to do the same. And when the economy is weak, people look to further educate themselves in the hope of improving their situation.
What we are seeing currently is a perceived lack of bright prospects for American employees in general, and people will not make the effort to further educate themselves if they do not see career advancement at the other end. This is having a material impact on CPLA's performance for 2011, and it will continue until the general economy picks up and the unemployment rate decreases. All education companies are experiencing a challenging 2011. Perhaps the well-publicized regulatory uncertainty surrounding the education industry is keeping students away also.
CPLA's financial performance to date has been excellent, which has resulted in a high quality rating for the company.
IV is set to decline over the next few years while the macro environment is weak. CPLA need to prove to investors that they can ride out the challenging macro environment for the next year or 2 and still maintain good net income and cashflows so that they are in good position to capitalize once the macro climate picks up.
Irrational exuberance is not foreign to the shareprice of CPLA. The graph shows that like many listed companies, CPLA can be way over valued or way undervalued at any point in time. Right now the shareprice represents extraordinary value should CPLA's business performance pick up in coming years.
Investment Grade Table
CPLA takes position number 41 this week on the USAStockValuation.com weekly Top 50 Investment Grade Table for the week ending 5th of Nov 2011. The investment grade table multiplies the quality rating and margin of safety together before dividing by 100 to get the Investment Grade Score. This allows only those companies with a good combination of quality rating and margin of safety to make the table.
CPLA has had a wonderful 6 year period, growing net income from $10M in 2005 to $61M in 2010 all while employing zero net debt. CPLA achieves not only high rates of return on equity, but also generates excellent cashflow which we at USAStockValuation.com like to see. This allows the company to buy back shares and/or expand their business, and in the case where they cannot achieve a high return on all their retained earnings, it gives them the option of paying a dividend also.
Future growth in the business can come from any combination of three things:
- Expansion of CPLA's offerings,
- Expansion of their geographical target,
- Increased demand from current markets,
Items 1 and 2 look to be fairly mature. As of the end of 2010, CPLA offers over 1,250 online courses and 43 academic programs with 136 specializations. It is difficult to see CPLA growing market share considerably by expanding their offerings. During the 6 year period of extraordinary growth, CPLA has now expanded to all 50 states, and another 59 countries. It would be difficult to expand much further geographically from this base. So growth will need to come from increased demand, and there is no doubt that students are moving more and more towards online learning given the convenience and time savings (not having to travel to/from the classroom). Based on a report from Eduventures, Inc, an education consulting and research firm, online graduate programs are expected to grow 140% between 2010 and 2019. CPLA is well positioned to capitalize on the growing demand for online education, and they will need to focus on this area. But growth will eventually dry up - all businesses reach capacity at some stage. In the case where growth opportunities become scarce, CPLA may consider paying a dividend.
The company spent $1M in share repurchases during the first 6 months of this year, taking advantage of the depressed shareprice. Buying back shares when the shareprice is well below Intrinsic Value adds value to shareholders and we like to see this.
If, in the future, CPLA cannot find opportunities to invest retained earnings at high rates of return, the company may begin to pay a dividend. Indeed if they cannot reinvest their cash for meaningful growth, they should adopt a dividend policy. Let's look at 2 dividend scenarios:
For these 2 scenarios, let's assume that the net income of $61M they achieved in 2010 can be expected long term. The forecasts for 2011 and 2012 are below this, but once the macro-economic climate picks up CPLA will likely return to their 2010 performance levels.
- Scenario 1: If the company employs a payout ratio of 50%: Intrinsic Value will drop to $41.55 (to understand why IV would drop as a result of introducing a dividend, see our articles: here, and here), and the yield based on the current shareprice of $34.30 would be 5.2%.
- Scenario 2: If the company employs a payout ratio of 75%, Intrinsic Value will drop to $34.87, and the dividend yield based on a shareprice of $34.30 would be 7.8%.
In the first scenario, Management would adopt a 50% payout ratio if they believed that half of their net earnings could be employed back in the business at a good rate of return. Even in the second scenario where the company pays out three quarters of its net profit, Management should expect to be able to employ the other 25% of earnings to grow the business somewhat. Once CPLA has grown to full capacity, their capital expenditures would be expected to be low given their education offerings are online and little physical assets are required to be purchased or maintained. Therefore it is not inconceivable to expect CPLA to employ a payout ratio of even higher than 75% in the future once their growth prospects have dried up.
For 2010, around 78% of the revenues of CPLA were derived from federal student financial aid programs, hence the company keeps a close eye on all regulatory developments. The remainder came from individual resources and corporate funding.
There is a wide range of criteria that a for-profit education institution such as CPLA need to adhere to in order to access federal funding, and many of the requirements have been recently reviewed and modified by the Department of Education. Just a few of the many requirements are outlined below:
Cohort Rate (default rate) - an education institution must have no more than 25% of its students default on their student loans. CPLA's cohort rate for 2009, based on data from the DoE, was 6.7%.
The 90/10 Rule - an institution cannot derive more than 90% of its revenues from federal student financial aid programs. For the year ended December 2010 CPLA derived 78% of its revenues from the federal government.
Federal officials issued new regulations for for-profit schools in June of this year, predominantly requiring proof of gainful employment of students. CPLA has commented that upon initial examination of the new rules the company is happy with the leniency of the requirements, and will be able meet the conditions. In the for-profit education marketplace, CPLA has a reputation of having its graduates land high-paying jobs and who rarely default on their loans. But the company also has a reputation of high tuition fees. The Department of Education estimates that around 5% of for-profit schools would lose their federal loan eligibility under the new requirements, and it seems unlikely that the intent of the new regulations is to bring down high quality education institutions such as CPLA.
When the shareprice of a company is well below its Intrinsic Value, one of two things will happen - either the shareprice will catch up to Intrinsic Value, or the Intrinsic Value will decline, with declining business performance, down to the shareprice. For a pure value play, Value Investors may see an opportunity with CPLA. If the performance of the company goes sideways for a few years and then slowly picks up with the general macro-economic climate, the shareprice will eventually catch up to Intrinsic Value and provide a return to investors. The danger with this approach is the risk that the performance of the business declines, and the IV drops down to meet the shareprice, rather than the shareprice catching up to IV.
For both a Value and Growth play, which we consider a better way to invest (for a number of reasons), an investor will need to be confident that CPLA can cash in on the future growth prospects derived from the increasing demand for online education. It certainly seems that CPLA are well positioned to do just that, and as such many investors will see good value in the current price levels.