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"The correctness of a decision can't be judged from the outcome. Nevertheless, that's how people assess them. A good decision is one that's optimal at the time it's made, when the future is by definition unknown. (…) The fact that something's improbable doesn't mean it won't happen. And the... More
  • Is A Stock A Piece Of A Business? - Apollo Group 0 comments
    Nov 11, 2012 4:19 PM | about stocks: APOL

    Investment is most intelligent when it's most business like.

    Stocks are not just things that wiggle up and down. Rather, they are fractional ownerships of businesses. This is doesn't seem to be the case with Apollo Group (APOL).

    Apollo is one of the largest for profit education companies in the world, its core business being the University of Phoenix, which provides distance learning university degrees. The firm boasts an average ROE of above 40%, average revenue growth rate of close to 20%, low capex, free cash flow margins of 15%. Future prospects seem reasonable enough, given the ever increasing costs of higher education, and private universities ability to offer part-time study programs, friendly to those seeking to get an education while having a day job or looking for help when studying for professional certificates suchs as CPA or CFA. Even more so, the market cap of $ 3.3 billion seems attractive relative to levered FCF of $ 436 mil (or even better, average $700 mil in the last 5 years).

    But there's a catch.

    There are 2 classes of stock: Class A and class B.

    Our Class A common stock has no voting rights. Our Executive Chairman and Vice Chairman of the Board control 100% of our voting stock and control substantially all actions requiring the vote or consent of our shareholders, which may have an adverse effect on the trading price of our Class A common stock and may discourage a takeover.

    Class A is publicly trading and it has no voting rights. That is undesirable, but it doesn't make the company worthless.

    Class B is the voting class, exclusively owned by the management of the firm, which are the only ones who have access to the board of directors. According to the 10-k the board can decide to dole out dividends to either or both classes of stock:

    (...) holders of our Apollo Class A common stock and Apollo Class B common stock are entitled to receive cash dividends, if and to the extent declared by the Board of Directors, payable to the holders of either class or both classes of common stock in equal or unequal per share amounts, at the discretion of the Board of Directors.

    I can only interpret this in the following way: The board of directors (management) can pay themselves (Class B) dividends, and not pay a single dime to Class A shareholders. So why would they pay anything to Class A shareholders? Out of generosity? Now, THIS does make the stock worthless, at least from a business investor's perspective.

    As a value investor that likes to invest in businesses, I see no investment merit in this stock, since it's clearly NOT a fractional ownership of the business. It's a fractional ownership on the (naive) hope that management will distribute earnings when they have no incentive nor legal binding to do so. They can pay as much dividends as they want to themselves through the Class B, pay nothing to Class A, and we would have nothing to do but sit and watch Apollo's management get richer. Likewise, this company (at least though the Class A stock) has zero chances of being a takeover target, given that no institution will ever bother buying something over which it will have no control whatsoever.

    I would really consider going long on Apollo if it had a different equity structure (where stockholders are actual fractional owners of the company). As I see it, this is either a bet on the company's management being stupidly generous (saying that companies' managements tend to be greedy would be an understatement) or a bet that some sucker will pay even more so than you did. Value investors will probably agree that neither option has any investment merit.

    What about shorting it? Well, I wouldn't go that way either, since the company is a cashflow machine, and it has the earnings power to back a strong dividend to support the share price. I don't think they would do it anyway, since management has an insignificant ownership of Class A. But they could very easily do it, and that doesn't seem like a pleasant prospect either.

    So I shall quote Charlie Munger: "When in doubt, don't" and keep myself busy with more interesting investment ideas.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Themes: education, no voting rights Stocks: APOL
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