**DeVry** (DV) is a diversified, global for-profit provider of education. The biggest competitor in the space is **Apollo Group** (APOL), with more than twice the revenue of DeVry.

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DeVry's stock took a tumble in late July 2011 and is currently trading at $31.59, which is less than half of its 52-week high. Let's determine whether the current market price is undervaluing DeVry. Here are the five-year financials:

(In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
---|---|---|---|---|---|

Revenue | $933 | $1,091 | $1,461 | $1,915 | $2,182 |

Operating Cash Flow | $125 | $198 | $249 | $391 | $407 |

Capital Expenditure | $-39 | $-63 | $-75 | $-132 | $-136 |

Free Cash Flow | $86 | $135 | $175 | $260 | $272 |

Revenue grew by 13.9% in 2011, while free cash flow grew by 4.6%. Capital expenditures in 2010 and 2011 were significantly higher than years past.

**Owner Earnings**

Owner earnings is a better measure for valuation purposes than free cash flow. Warren Buffett defines owner earnings as follows:

These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.

I'll calculate owner earnings by taking the net income and adding back various non-cash items, such as depreciation, and then subtracting the average capital expenditures from 2010-2011. I'll also add interest payments adjusted for taxes since interest is tax deductible.

(In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
---|---|---|---|---|---|

Net income | $76 | $125 | $165 | $279 | $330 |

Depreciation & amortization | $44 | $39 | $50 | $62 | $64 |

Stock based compensation | $0 | $0 | $7 | $10 | $14 |

Other non-cash items | $36 | $61 | $74 | $87 | $91 |

Interest Payments | $4 | $0 | $2 | $1 | $1 |

Avg Capital Expenditure | $-134 | $-134 | $-134 | $-134 | $-134 |

Owner Earnings | $25 | $93 | $166 | $307 | $367 |

Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the owner earnings figures to determine DeVry's cash return on invested capital (CROIC). This is the cash return generated by the company on invested capital, and is simply the owner earnings divided by the total invested capital. This is a better measure than return on invested capital (NASDAQ:ROIC) because ROIC relies on earnings, which is a poor measure of profitability.

(In Million $) | 2007 | 2008 | 2009 | 2010 | 2011 |
---|---|---|---|---|---|

Owner Earnings | $25 | $93 | $166 | $307 | $367 |

Invested Capital | $844 | $1,018 | $1,434 | $1,627 | $1,850 |

CROIC | 3.07% | 9.16% | 11.6% | 18.86% | 19.87% |

DeVry's CROIC was nearly 20% in 2011, which means that given, let's say, $1 million in invested capital (retained earnings, for example) the company will generate $200,000 in cash on that investment. DeVry's CROIC is exceptionally high. Here's the current balance sheet.

Cash and Cash Equivalents | $288 |
---|---|

Investments | $13 |

Debt | $0 |

Pension Obligations | $0 |

Minority Interest | $7 |

Net Cash (Debt) | $294 |

Diluted Float | 69 |

Cash/Share | $4.23 |

DeVry has no debt and $4.23 in net cash per share; a strong balance sheet.

**Valuation**

I use a discounted cash flow analysis to estimate the fair value of a company. I will use a discount rate of both 12% and 15% and use these results to define a fair value range. You can read about my views on discount rates here. The average analyst estimate for DeVry's earnings growth for the next five years is 4.39%. I'll be conservative and assume that the owner earnings will grow at 3% in perpetuity.

Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
---|---|---|---|---|---|---|---|---|---|---|

% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% |

Year | 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20 |

% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% | 3% |

Using the above parameters, I arrive at a fair value range of $49.67-$64.81. Below is a table of buy targets for various margins of safety below this range.

Margin of Safety | Buy Target |
---|---|

10% | $44.70 |

15% | $42.22 |

20% | $39.73 |

25% | $37.25 |

40% | $29.80 |

**Conclusion**

Currently trading at $31.59, DeVry offers a nearly 40% discount to the lower end of my fair value range. For-profit education is a well-regulated industry with a heavy reliance on federal student aid, so there is some uncertainty going forward, but with such a high margin of safety and conservative growth assumptions DeVry looks like a bargain at these prices.

**Disclosure: **I have no positions in any stocks mentioned, but may initiate a long position in DV over the next 72 hours.