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The Committee on Education and the Workforce of the United States House of Representatives created a regulation known as the "90-10 rule" in 1992. The rule gave the for-profit colleges access to the federal funding in the forms of Pell Grants and federal student loans. For-profit colleges flourished as they were able to recruit the under-served students who relied on these federal aids. For example, Apollo Group, Inc. (APOL), the largest for-profit college listed on the Nasdaq, achieved an average annual growth rate of 33% from 2003 to 2010.

All that changed in 2010. The Government Accountability Office (GAO) issued a critical report of its undercover operation to exam the for-profit colleges. The GAO has found that the for-profit colleges encouraged students to falsify financial aid forms and misrepresented the future benefits of their educational programs. Furthermore, the Pew Charitable Trusts (PEW) issued a report on the student loan default rates. Forty-four percent students who attended for-profit schools defaulted on their federal student loans within two years of repayment. The reports and the negative publicity took a toll on the for-profit colleges' market value. Apollo declined 48% from the 2010's high of $65.74 and Bridgepoint Education, Inc. (NYSE:BPI), one of the least affected colleges in the sector, declined 53% from the 2010's high of $27.28.

The Obama Administration pushed the reform of the sector through the "gainful employment" regulation. The Education Department adopted a much softer version of the original proposal on 31 May 2012 after the for-profit colleges' intensive lobbying. The new rule "introduces a multiyear grace period before deficient programs are shut down". The adoption of the gainful employment rule removed a major hurdle for the for-profit colleges, because it is not harsh compared the original proposal and there is a multiyear grace period. Finally, there is relief for the for-profit colleges. Then Apollo dropped a bombshell on 16 October 2012. Apollo reported a 11% revenue decline for the 4th quarter of the fiscal year 2012 compared to the 4th quarter of the fiscal year 2011. Furthermore, "the University of Phoenix reported 13.8% fall in degreed enrollment... New enrollment (or new degreed enrollment) at University of Phoenix declined 13.7% from the prior-year quarter to 52,800."

As an individual investor, the educational stocks with their high operating margin and their above-average ROE look attractive to me. I thought the current difficulties facing the for-profit colleges are temporary. The Jaded Consumer raised the possibility of a changing regulatory environment for the for-profit colleges in his article, "Accreditation Apoplexy At Bridgepoint Education." I failed to assess the risk and what to do in such a case. Bridgepoint served as a good example of this risk. The Ashford University and the University of the Rockies are Bridgepoint's main colleges. The Western Association of Schools and Colleges (WASC) denied the Ashford University's accreditation request on 9 July 2012. The Ashford University sought this accreditation to expand its presence in the Western states. On 13 July 2012, the Higher Learning Commission of the North Central Association of Schools and Colleges (HLC) put the Ashford University on review due to the WASC's decision. HLC is the original commission that approved Ashford University's accreditation, which is effective through 2015. The Bridgepoint's stock took a dive to lose more than 50% value in a matter of days.

The economic moat of the for-profit institutions derives from the government's accreditation requirement. The accreditation serves as the barrier of entry to the competition. Once a college is accredited, it has the pricing power to earn fat returns on its capital regardless the quality of the education. The recent evaluation of the for-profit colleges showed a changed altitude of the U. S. higher education accreditation agencies. The U. S. underwent a lackluster economic growth since 2008. The rising federal debt caused more scrutiny of the higher education institutions, public and private. The widespread negative publicity and the ensuing lawsuits made things difficult for the for-profit colleges. The for-profit colleges must selectively accept prospective students like their peers at the public institutions, so the for-profit colleges cannot generate high revenue growth like the past. These colleges must also spend heavily on improving educational programs and helping students to get jobs. Their expenses will go up without the corresponding rise in revenue. In other words, for-profit colleges will much more resemble their public counterparts. In the near future, I do not see much progress in for-profit colleges to positively impact the stock prices. An individual investor may take the long term view, but as John Maynard Keynes said, "in the long run, we are all dead."

Source: Apollo Has Lost Its Golden Touch