Career Education Corp. - Value Hidden In The Details

| About: Career Education (CECO)

Career Education Corporation (NASDAQ:CECO) is a for-profit education provider with over 90 colleges in USA and Europe. The CECO family includes, among others, the "master chef" schools named "Le Cordon Bleu", the "International Academy of Design and Technology" and the health education brand "Sanford-Brown". CECO has a current market cap of 700 million divided in 75,916,618 shares according to the latest 10-Q.

Studying the balance sheet we see that CECO has 1,532 million assets, equal to $20 per share. The net asset value (NAV) is 947 million, equal to $12.5 per share. The company has $1.05 of current assets for every $1 of liabilities and $1.08 cash for every $1 of short-term liabilities. This reveals a company with great liquidity. Finally, in a worst case scenario, if we exclude all intangible assets the liquidation value of the company is about $6 per share.

But how is CECO doing with earnings? For the last three years CECO has a pretty stable operating margin of 14.8% and a 9.8% net profit margin. The average 10-year return on assets is 15% before tax and 9,75% after tax (a more than decent return) showing a well run company. Profits are estimated for 2011 between $2.08 and $2.30, which means we are talking about at least a 20% earnings yield at $10 a share.

Reading so far you'll probably wonder: "Why is Career Education so cheap?", "What are the dangers lying ahead?" Career Education is cheap because a major part of its campuses - 49 of them to be exact - failed to report the true placement rates of their graduates (the percentage of graduates who were able to find a job within a year of their graduation) and are facing the possibility of losing accreditation. Accreditation is needed if a college/university wants to participate in federal goverment programs that help students get a loan and pay tuition.

The company, in response, fired its CEO and launched an investigation to find the true placement rates and the employees involved. According to the latest 10-Q (page 21) 13 of the 49 troubled colleges pass the minimum placement requirements (65%) and according to the new CEO at the latest conference call all involved employees are gone and the company has began a massive restructuring on its procedures and deal with the problem on the source.

All the results of the internal investigation have been sent to ACICS, which is the institution overseeing the relevant colleges, and ACICS responded with a show-cause directive (paragraph 2-3-403) in which CECO is called to "come forward and prove that a negative or conditioning action should not be taken". Now here is the critical part. The ACICS council is likely either to place CECO under probation (if it's not convinced) or not penalize it at all since the company has not only demonstrated extraordinary cooperation and willingness to fix the problem and also has good chances of solving it before the next school year. Probation means that the schools continue to operate but no new ones can be opened or new programs started without pre-approval.

In addition here is an excerpt from the Q3 conference call that clearly shows management's attitude towards the problem:

Steven H. Lesnik (Chairman & CEO):

We expect to have a dialogue with ACICS as quickly as we possibly can and I think we have already scheduled a meeting with them. This is Steve speaking. And with respect to your question, I would say that we have gone to extraordinary lengths to try to investigate this matter and identify the causes of why it cropped up in a number of places in our company. I believe that a report the we have received from independent counsel to the Board of Directors was just extraordinary. The independent counsel literally went student-by-student, so I'm not sure anybody has ever investigated its placement activities as closely as Career Education has done. And we have uncovered the fact that we’re going to be reported as placements in a number of cases and a number of places were not genuine placements according to our standards as a company. We have reported therefore accurate numbers to ACIS (sic) [ACICS] at the appropriate time, the time to report to them was 1 week or 2 ago. And we did that on time and with the results of this investigation. We have identified as you stated a myriad of possible causes of this. And as Mike has tried to detail, we have addressed all of the causes that we have been able to identify and we will continue to work on this problem until we are certain that we have it completely rooted out.

As a closing remark I would like to point out that even if CECO closes down the 36 colleges and universities that have the problem, the losses will only bring the company to around break even for the current year, since the units in question, though many in number, contribute only 35% of revenue (around $500 million). Of this, though, $300M to $400M will be offset by variable cost reduction (less personnel, less rents) and the pre-tax earnings of the rest of the group.

I believe CECO is a good opportunity below $10 per share and a great one below $8. My estimation is that the fair value of the company is around $12.50 if it loses accreditation and $20 to $23 if not.

All the numbers used in this article come from the latest 10-Q, 10-K, and Q3 earnings call of the company, and can be found here and here.

Disclosure: I am long CECO.

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