It's not entirely surprising that the blow came. What's surprising is where it came from. For-profit education companies have been under fire for some time, from politicians, the media, and investors; the Bloomberg U.S. For-Profit Education Companies Index [USEDU] has fallen sharply in 2012 amid an avalanche of negative publicity and new federal regulations, among them the "gainful employment" rule.
But it seems almost certain that neither the industry's harshest critics, nor its shareholders, nor the executives running the colleges themselves would have imagined that one of the biggest blows to the industry's reputation -- and its share prices -- would have come from the Accrediting Commission for Senior Colleges and Universities of the Western Association of Schools and Colleges. Indeed, few outside the industry likely knew of its existence, at least before last Monday. On that day, the WASC denied Ashford University's application for initial accreditation. The Clinton, Iowa-based college is owned by Bridgepoint Education (BPI), who uses the Ashford name to enroll thousands of students in online courses. Without Ashford's accreditation, Bridgepoint could lose access to federal funding; without that funding, which created about 90% of BPI revenue, Bridgepoint's entire business model would collapse.
Bridgepoint stock fell by one-third on Monday; fell another 8% on Tuesday, and kept falling. On Friday, the Higher Learning Commission of the North Central Association of Schools and Colleges -- Ashford's current accreditor -- placed the college on "special monitoring" status. This meant that Ashford's accreditation, which had thought to have been safe through the 2014-15 school year, could be revoked by the end of the upcoming school year. BPI fell another 24 percent. All told, BPI stock lost nearly 60 percent of its value in a week.
Bridgepoint's drama is just the most recent in a series of events that have damaged the reputation, and the value, of for-profit education companies. Congressional hearings led by Senator Tom Harkin (D-IA); a joint investigation by multiple state attorneys general; an executive order from President Obama limiting recruitment of veterans; and new federal regulations passed last year comprised a multi-pronged political attack. Criticism in the media has been stinging, with the colleges called "predatory" and "unethical," with PBS' Frontline documentary creating an expose on the schools' treatment of veterans.
These headwinds have taken their toll on earnings -- and stock prices. Devry (DV) fell nearly 25% Tuesday after pre-announcing disappointing fourth quarter earnings; the miss echoed throughout the sector, as the USEDU index fell 7.8% on the day. That index is now off 25% from its intraday high on July 2 and 44% in the last six months. Perhaps most amazingly, the index is down nearly 50% from its level at the broad market lows in March 2009, while the broad market has doubled.
The carnage in for-profit education stocks has resulted in extraordinarily low valuations across the industry:
|American Public Education (APEI)||$27.20||11.8||10.7||44.7%|
|Apollo Group (APOL)||$27.81||6.7||8.0||52.3%|
|Capella Education (CPLA)||$28.47||8.6||9.3||40.6%|
|Career Education (CECO)||$4.80||N/A||13.0||81.0%|
|Corinthian Colleges (COCO)||$2.25||22.5||5.9||56.8%|
|Education Management (EDMC)||$4.30||2.5||5.7||85.6%|
|Grand Canyon Education (LOPE)||$17.78||14.3||11.9||18.7%|
|ITT Education Services (ESI)||$53.39||5.0||6.8||41.8%|
|Lincoln Educational Services (LINC)||$5.00||27.8||10.4||73.0%|
|Strayer Education (STRA)||$91.51||11.3||12.5||35.2%|
P/E = price/earnings ratio; Fwd P/E = forward price/earnings ratio; %F52WH = % below 52-week high; price as of market close July 24. data courtesy finviz.com
* -- using FY12 earnings (June) at midpoint of Q4 guidance
Looking at the chart, the numbers jump out. Three different stocks -- BPI, EDMC, and ESI -- trade at 5x trailing earnings or less. Seven of the stocks trade below 10x forward earnings. And ten of the stocks are more than forty percent below their fifty-two week highs, with four down 70% or more.
Of course, bears would point out the low forward multiples are likely based on outdated earnings; on CNBC today [video], Herb Greenberg noted that PAA Research's Brad Safflow, who correctly predicted the sector's steep slide, sees analyst estimates coming down significantly. According to Greenberg, Safflow also claimed that DeVry's surprise drop in enrollment was, based on channel checks, likely to be echoed at other schools. There is still "meaningful downside" in the sector, Greenberg quoted Safflow as saying.
Indeed, bears have plenty of ammunition. Not only do revenues look likely to decrease, as enrollment dips, but spending is increasing. Higher student acquisition costs and a stronger focus on quality classes and extracurricular offerings mean that the traditionally strong margins in the sector look set to decrease strongly. Add in the regulatory and political headwinds and the bear case for for-profit education stocks is very easy to make.
But is there a bull case? On a valuation basis, perhaps. Bridgepoint Education, in particular, seems to have a very interesting risk/reward profile. Its market capitalization at Tuesday's close of $8.66 is $454 million; as of March 31st, BPI's cash and investments totaled $442 million. Its enterprise value is just $12 million, compared to 2011 free cash flow of $186 million; a staggering ratio. Unless Bridgepoint is literally forced to close its (virtual) doors in the next twelve months, it seems likely that the company, even assuming lower future revenue and higher future costs, is massively undervalued. With the company's conference call coming on August 7th, and a massive amount of pessimism priced in, BPI looks to be a near-term buy. If BPI management can convince analysts that the company's long-term future is sound -- even if it is damaged -- BPI could rise sharply.
For the rest of the sector, investors simply have to look past the numbers. Earnings multiples mean little if a company's business model is undergoing a massive change. For example, Capella looks cheap at 8.6x trailing earnings; but if earnings are halved, investors will, in a year, own a stock with a P/E of 17 that seems likely to face significant and continuing political and legal headwinds.
And, discounting the numbers, it seems clear that it can get much, much worse for the for-profit education industry. Political pressure will continue, as Democrats such as Harkin and Kay Hagan (D-NC) push a ban on using federal revenue for advertising. With Republicans generally looking to reduce federal discretionary spending, the for-profit education industry likely has few supporters left on Capitol Hill. There may also be competition from more traditional, non-profit colleges; both MIT and Stanford, among many others, now offer free online classes, perhaps the first step in a massive change in the US system of higher education.
Furthermore, within the sector, stock-picking looks difficult. The sector's two worst performers of late are EDMC and CECO, both of whom have a strong focus on vocational training. (Educational Management runs The Art Institutes, while Career Education operates Le Cordon Bleu cooking schools.) These programs are most likely to be affected by gainful employment rules; indeed, both companies struggled mightily in the initial round of tests based on that rule. It is true that the specific rule was struck down by a federal judge on July 1st, as Judge Rudolph Contreras said the aspect of the rule requiring debt repayment by 35 percent of graduates was an arbitrary benchmark.
Still, the Department of Education plans to re-write the rule to satisfy Contreras' requirements; and the larger point remains: the for-profit education industry is under attack. Even if it survives, it will altered radically; and it seems unlikely, if not impossible, that the schools will able to replicate the earnings and cash flow of the last few years. Based on those figures, the stocks look cheap; but 12-18 months from now, the earnings multiples will be far different. Buying these stocks today means owning them at double-digit earnings multiples in the near future. The headwinds facing for-profit education stocks will surely not be gone by then.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BPI over the next 72 hours.