Background: American Public Education is an exclusively online provider of higher education with a focus on the military and public service communities. The latter group includes police, firefighters, emergency medical technicians, and so on. The company operates two universities: American Military University (AMU) and American Public University (APU). American Military University began offering courses in 1993, while APU was established in 2002 to focus on non-military students. The two universities share a common faculty, curriculum, and technology infrastructure, so the distinction is pretty much just branding.
In 2011, 58% of APEI's students were active duty military personnel. However, civilian enrollments are growing much faster than military enrollments, shifting this business mix. APEI's target students are particularly well-suited to the company's internet-based teaching methodology, considering their irregular schedules, frequent travel and relocations, on-call work responsibilities, and limited financial resources. The universities offer a wide variety of degree programs, but with a focus on national security, military studies, intelligence, homeland security, criminal justice, and similar fields. The company has increased its appeal with the civilian population by receiving regional accreditation in 2006 (which is necessary to be eligible for federal financial aid under "Title IV") and by expanding its degree programs to education, business administration, nursing, technology, liberal arts, etc.
APEI went public in 2007 at $20 per share, although it started trading in the mid-30s. The stock has had a bumpy ride since but mostly gone sideways, trading as low as $25 and as high as $50. Growth has been fantastic during this time. Between 2007 and 2011:
- Revenue compounded at a 39% annual rate, rising from $69 million to $260 million.
- Operating income compounded at a 44% annual rate, rising from $15 million to $63 million.
- Earnings per share compounded at a 37% annual rate, rising from $0.64 to $2.23.
- Cash and equivalents on the balance sheet increased from $27 million to $119 million.
- Total enrollment increased from 30,000 students to 110,000.
The stock hasn't kept pace with this terrific underlying performance because of P/E multiple contraction from around 55x in 2007 to less than 15x currently.
Market Opportunity: The postsecondary education market is both huge and extremely fragmented. According to the U.S. Department of Education, as of 2009 there were around 4,500 Title-IV-eligible, degree-granting institutions in the U.S., which were attended by around 20.4 million students. According to UNESCO, the number of postsecondary students globally is around 160 million. According to APEI, there are around 2.2 million active and reserve military professionals in the U.S. Armed Forces, with around 300,000 new service members enlisted or commissioned each year. With the increasingly complex global economy, it seems likely that the demand for an affordable college education will only continue to grow in the coming decades.
The higher education market in the U.S. is dominated by non-profits. Traditional universities often have priorities other than just providing a cost-effective, practical education, making them relatively inefficient. They often focus on building their own prestige-with extravagant facilities, professors that are focused on research and publication more so than teaching, and so on-as much as providing a return on investment for students. For-profit education companies have taken advantage of this situation, charging tuition toward the low-end of traditional universities, eliminating unnecessary expenditures, and still earning rich operating margins. Historically, the availability of financial aid from the federal government has tended to make students relatively price insensitive.
Unfortunately, the educational value offered by many for-profit universities is questionable. The worst offenders spend more on marketing than education, basically deceiving under-qualified students into maxing out financial aid in the hopes of improved career prospects and a better life. These students may end up with a worthless diploma (if they even graduate), few marketable skills, and a massive amount of debt that they have little chance of repaying. For-profit universities have faced increased scrutiny and regulation in recent years, which has led to tightening admission standards and declining enrollments. I think APEI may be an exception within a generally shady industry, creating real value by offering a worthwhile education at a price far below most competitors. This is central to the bull thesis on the company. Consensus estimates for fiscal 2012 revenue growth of some of the major publicly-traded universities can be seen in the following table (source: Yahoo Finance). APEI stands out for its robust growth despite the industry headwinds.
|Fiscal 2012 Proj. Revenue Change|
|American Public Education (APEI)|
|Apollo Group (APOL)||-9.4%|
|BridgePoint Education (BPI)||9.9%|
|Capella Education (CPLA)||-1.4%|
|Career Education (CECO)||-18.5%|
|Corinthian Colleges (COCO)||-11.4%|
|Education Management (EDMC)||-4.4%|
|Grand Canyon Education (LOPE)||13.2%|
|ITT Educational Services (ESI)||-10.6%|
|Strayer Education (STRA)||-7.6%|
APEI's first-quarter revenue growth was strong at 29%, with net course registrations up 24%. However, management guided for second-quarter revenue growth to slow to between 14% and 22%. This was due in part to a fraud prevention measure that may have inhibited some legitimate new students from enrolling. The company revealed that new student enrollments fell 25% in the month of June after growing by a mid-teens percentage in the previous months, which spooked investors. I found management's explanation reasonable, and believe the situation will be corrected in future periods.
Competitive Position: There are so many accredited schools already in the U.S. that barriers to entry are hardly relevant. APEI faces competition from two primary sources: traditional non-profit universities that are expanding their online presence, and for-profit universities that are expanding into the military niche. The possibility of market share losses or margin contraction are key risks for APEI. The company's operating margin was 24% in 2011. Less than 37% of revenue is spent on instructional costs and services, which is typical of a for-profit university. This might be interpreted as for-profit universities offering relatively low-quality education, or it could merely be a sign of just how inefficient most non-profit universities are.
I suspect that many people are biased to think of even mediocre traditional universities as superior to for-profit schools. In the short run, for-profit schools have an incentive to boost enrollment as high as possible, which can be accomplished through aggressive marketing and easy coursework. However, over the long run this kind of mindset could prove devastating to any university. If a university ends up with a reputation as a "diploma mill," employers will hesitate to hire its graduates, which will inevitably hurt future enrollments. Recent developments support the view that many for-profit universities have been prioritizing growth over educational quality, including regulatory rumblings, declining enrollments, and events such as Bridgepoint Education's recent accreditation rejection, the fallout from which has sent its stock down more than 50% in the last week or so.
I see American Public Education as the baby thrown out with the bath water. In my view, APEI has two main advantages over its for-profit education peers: cost and reputation. In terms of cost, APEI is much cheaper than the majority of alternatives. I am particularly impressed by how straightforward and simple its pricing is. Undergraduate tuition is $250 per credit hour, or $750 for a typical three-credit course. Graduate tuition is $325 per credit hour. The company charges no fees for things like admissions, registration, and dropping courses. Even books are included in undergraduate tuition, which the company estimates saves students around $4,500 for a four-year degree.
APEI only recently announced a $50 per course technology fee. Other than this, the core undergraduate tuition has not changed since 2000, which is a remarkable feat considering average tuition at other universities increased more than 60% during the same time. A full four-year undergraduate degree can be earned at AMU or APU for a little over $30,000, which is around half the cost of a typical public university or a quarter the cost of a private university. APEI's universities are 20% cheaper than even in-state tuition at the average public university. APEI's tuition also compares very favorably with for-profit education competitors. Pricing at Apollo's University of Phoenix isn't nearly as straightforward, but appears to be at least 50% higher than APEI at more than $10,000 per year. The Department of Education's website lists the American Public University System as the cheapest for-profit, four-year university in the country.
Being one of the cheapest options for a postsecondary education grants APEI with a number of advantages. The company should be insulated from pricing pressure, especially from traditional universities that may not want to dilute their brand and cannibalize their physical enrollments with an inexpensive online option. APEI should also have relatively little exposure to recent regulatory changes, as its students graduate with manageable debt levels. Indeed, recent negative regulatory and press attention may actually help APEI in the long run, as students increasingly focus on the value received for their education dollars. For-profit peers may be faced with simultaneously declining pricing and enrollments, while APEI may be able to both gain market share and increase pricing over time since it is starting out as the low-cost provider.
Reputation is much harder to assess, but it is critical to sustained long-run growth. If APEI is perceived as offering a quality education, employers will hire its graduates, alumni will refer colleagues and friends to the university, and the company will gain market share while saving on marketing expense. I spent several hours scanning through online reviews of American Public University and American Military University, and was generally impressed with the proportion of students that seem to feel APEI offers a rigorous learning experience. I suspect that APEI is helped in this regard by its relatively long operating history and focus within the military and public service niche, where it can offer a differentiated curriculum and likely attract students with above-average dedication and seriousness.
Valuation: Valuations of for-profit education companies have come down in a big way in the past couple of years due to the heightening regulatory uncertainty and declining enrollments. Valuing shrinking companies is tricky business, particularly when a floor on earnings isn't known. As of this writing, Apollo is trading for 8.9x consensus 2012 earnings and 10.2x consensus 2013 earnings. Bridgepoint, with its accreditation issues, is trading for 3.9x consensus estimates for 2012 and 3.5x estimates for 2013. Devry is trading for 8.2x estimates for 2012 and 9.5x estimates for 2013. Some of these companies could turn out to be cheap, or they could turn out to be value traps, depending on how far enrollments and margins fall.
As the publicly-traded for-profit education provider with the best growth outlook, APEI gets the richest multiple in the group. APEI's $31 stock price is 14x the consensus estimate for 2012 earnings, or 12x consensus for 2013. While this seems high compared to peers, APEI is growing revenue at a double-digit rate while some of its competitors are shrinking nearly as fast. Furthermore, APEI has a rock-solid balance sheet, with $126 million in cash and no debt at the end of the first quarter. If we take out the cash balance of about $6.90 per share, the company is trading at 11x 2012 earnings estimates, or 9.4x 2013 estimates. These multiples would be acceptable for a company barely growing at all.
Growth will inevitably slow from historical rates given the larger base of students and industry headwinds. However, considering how large the market opportunity is and APEI's advantage as a low-cost provider, I think a low-to-mid-teens revenue growth rate should still be attainable for the foreseeable future. Margins may be under pressure in the near term, but the company has more room to increase tuition to offset higher costs than pretty much any competitor. Capital requirements are minimal, which leaves most cash flow free for share repurchases (the board recently authorized $20 million of repurchases). If APEI can grow earnings per share 15% per year for the next five years-about in line with average analyst expectations-earnings will have approximately doubled by 2016. If the company then trades for a 15x P/E on 2016 earnings of around $4.50, it will be worth $67, more than a double from current levels.
Risks: The for-profit education business is undergoing major structural changes, and investors should not underestimate the risks in this idea. If APEI's accreditation were to come into question, as occurred to Bridgepoint suddenly and without warning, the result could be devastating. Other regulatory changes, such as reductions to military tuition assistance benefits or cuts to federal financial aid, could also reduce the demand for online degrees. APEI's reputation could be tarnished by its own actions-with execution becoming increasingly difficult amid rapid growth-or by a general deterioration in perceptions of for-profit schools due to the actions of peers. Without barriers to entry, the company could also face increasing competition over time, especially from traditional non-profit universities with brands that may be perceived as inherently superior to the American Public University System.