Consider Buy: $22
Current Price : $28.69 (6/7/12)
Consider Sell: $40
Recommendation: Hold with negative outlook
DeVry Inc. (DV) is a speculative company as the extent of financial impact by regulatory changes are uncertain. DV is facing a barrage of scrutiny for unethical recruiting practices, high student loan default rate and high executive compensation. The DOE has introduced rules that would curb unscrupulous loan distribution, and would threaten eligibility for Title IV funds if DV did not comply. Losing funding would cripple DV. While I believe that it is unlikely for DV to lose eligibility, other legislation such as banning the use of federal funds for advertisement and commissioned recruiting is likely to happen. This will weed out the students who are likely to default and schools that perpetuate this problem the most. The market is valuing DV at a 3% perpetual growth rate, which is appropriate as enrollment and revenue growth are non-existent or declining for 2012 and 2013. However, no significant margin of safety exists relative to the market price to warrant a buy on this battered stock. While it is likely that DV will weather through these regulations after the bad apples have gone, the lasting effect is uncertain while the medium for education is also evolving.
Overview- DeVry Inc. provides educational services as the parent of Advanced Academics, American University of the Caribbean, Becker Professional Education, Carrington College and Carrington College California, Chamberlain College of Nursing, DeVry Brasil, DeVry University, and Ross University. DeVry operates in 26 states, Canada and Brazil. DV is the third largest for-profit school by enrollment.
DeVry Needs More Doctors to Save Itself- DV offered 56% of their degrees as bachelor's degrees, with 45.8% of them business degrees. While business degrees are the most common undergraduate degrees, according to NCES, constituting 21.7% of degrees in 2008-2009, the fastest growing jobs are biomedical engineers (72% growth until 2018), network systems (53%), home health aides (50%) and many other medical care professions due to an aging demographic and technological advancement, according to the Bureau of Labor Statistics. DV provides programs from their medical subsidiaries that cater to these needs and continues to allocate capital there to drive further growth.
The Golden Rule of Business- While the medical profession is expected to have the highest long-term growth rates, operating income fell 3.7% for the academic year of 2011. The business segment also contributed 72% of their operating income which is expected to decline significantly. Diversification is a weakness with DV.
No More Irresponsible Lending- Enrollment trends are the backbone of DV's revenue stream. It is startling that new enrollment for summer of 2012 decreased 25.6% and 5.8% for total students. Possible reasons include unemployment steadily falling from 10.5% to 8% between March 2011 to March 2012 for high school graduates above 25, bad public relations for the entire industry, and new regulation on Title IV funding to be enforced by July 2012. Lower enrollment is likely due to more cautious allocation of student loans, otherwise risk losing funding with new regulations.
A Student's Perspective- DV to the education industry is what Mary Kay is to the cosmetic industry, both stigmatized by salespeople that push the bottom-line with commissioned recruiters. Some students suggest that a degree from DV can be "embarrassing", as a degree from a for-profit institution is often marginalized for its low selectivity standards. DV discloses that 89% of graduates obtain a job in their field of study within six months, earning $43,000 on average, at fortune 1000 companies. This does, however, include graduates that were already employed. Some students also claim that the jobs received are nevertheless, menial, which isn't surprising in this difficult economy.
Gluttony of Problems- According to a recent study by Harvard in the Journal of Economic Perspectives, for-profit schools accept more minorities, the disadvantaged, older demographic, and have success with retaining students to complete shorter degrees, compared to non-profit schools. On the other hand, for-profit colleges' leaves higher debt burdens, higher unemployment and "idleness" rates, lower earnings after six years of entering their programs, higher defaults on student loans and higher dissatisfaction with courses than their public schools. Higher debt is also a result of higher tuition at for-profit schools. These problems are unsustainable, and will curb with regulation. To avoid downside risk, the investor should consider these changes with the glass half-empty.
Risks [Low, Mid to High Risk]
Failing to meet new rules is subject to a loss of Title IV funding, which accounts for a large portion (~80%) of revenue. New regulations include:
[High] Federal Student Assistance Must not be used for Advertising: Marketing expense makes up 12% of revenue ($252 million) for 2011. However, DV derives as much as 89% of revenue from federal funds, which overlaps its advertising expenses.
[Mid] Provide Courses that Meet "Gainful Employment" Status: Gainful employment status is earned when at least one of the metrics are achieved: at least 35% of former students are repaying their loans, estimated annual loan payment of graduate does not exceed 30% of his or her discretionary income, and/or estimated annual loans payment of graduate does not exceed 12% of his or her total earnings. DV discloses that they meet the gainful employment rule. However, DV does not meet the first requirement. According to the federal student aid website, repayment rates are below 35%. DV graduates have 89% placement success, which is estimated that 75% were already employed based on their 2001 financial statement disclosure. With an average earning of $43,000, a 3.4% interest rate on a loan of part-time program costing $35,000, or full-time $65,000 will meet the gainful employment rule (counting only interest).
[High] Government Aid can't Exceed 90% for Two Consecutive Years (90/10 rule): Government aid approaches extremely close to 90%, especially Ross University. Legislation is also being proposed to bring the funding number to 85%, which would devastate DV.
[Mid] Losing Funding for Military Assistance Loans: The DOE is increasingly scrutinizing loans that are given for military tuition. They are accusing for-profits schools for providing an insufficient educational standard, while giving them expensive loans. President Obama introduced the "G.I. Bill" to put further restraints on recruiting veterans. Such action would hurt DV, as ~26% of funding comes from military (also includes student accounts, cash payments and private scholarships).
[High] Incentive Compensation: For-profit schools are now disallowed to pay recruiters based on performance, which DV has been accused of. DV is currently facing lawsuits by pension funds for not disclosing these practices. This rule would also make recruiting much more difficult, but would be beneficial for the much needed goodwill of the industry.
[Low] Cohort Default Rate of 25% for Two Consecutive Years or 40% in One Year: DV discloses that they have maintained a CDR below 25% at all institutions. The federal student aid website confirms the results, 14.2%, 10.2%, 9% for FY 2009, 2008 and 2007, respectively.
[Mid] Misrepresentation: This rule that would broaden the scope of liabilities to DV. This rule is vague and may invite many more lawsuits even if harm or liability is trivial and dubious.
$33.28-$36.70 using Discounted Cash Flow (DCF) Model:
DCF- The DCF model uses conservative estimates, reducing as much downside risk as possible. Long-term growth rate assumes a very conservative 3% perpetual growth even though enrollment grows at a 2-3% a year for the entire education industry and prices typically rise with inflation too. Ironically, for-profit education costs far exceed public school while providing a lower quality of education, and I wonder how much longer this discrepancy would last before tuition prices contract. DV admits that the 2012 fiscal year and 2013 revenue will remain flat or slightly lower than 2011. The weighted average cost of capital (WACC) is calculated to be 13% using the CAPM. Sensitivity analysis suggests that the intrinsic value is between $33.28-$36.70.
Margin-of-Safety- With conservative estimates, the intrinsic value should be priced at least $33, compared to a market price of $31.06 or market cap of $2.07 billion. For a company that has a potentially broken business model, a higher margin-of-safety should be necessary for the cautious investor.
Look Somewhere Else- DeVry has been a profitable company, with recognizable schools, no debt, and positioned in an industry that would grow steadily in the coming decade. However, there are many uncertainties about the new regulations. If DV fails to comply with these rules, one should sell their stock as the loss of federal funds would cripple DV. This scenario is unlikely, but the era of fast growth and high profits is surely over with other regulations being enforced as discussed. With barely a margin-of-safety, this stock is more speculative than investment grade even in the long-run. Warren Buffett often said, "It is better to buy a good company at a fair price than a fair company at a good price". In this situation, DV is a fair company at a fair price. At a really good price, all else being equal, it may be worthwhile to consider investing in DV if the fundamentals improve. If one is looking for a short-term gain driven by an event, I wouldn't hold my breath. For the risk-averse investor, I would look somewhere else.