Perdoceo Education Corporation: A Solid Opportunity For Shareholders

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Modern Graham
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Summary

  • Confluence of events will lead to sharply higher earnings and share price.
  • Management has consistently downplayed future estimates and is now revising expectations upward every quarter.
  • The stock traded down for no reason at all, and is now rebounding, creating an excellent buy opportunity.

This week, Career Education Corporation changed their name to Perdoceo Education Corporation (NASDAQ: NASDAQ:PRDO). This is the culmination of a 5 year long transformation of the business, first announced in May 2015.

The business first went public around 2000, and the share price rapidly went from about $2 per share to about $70 through a series of bolt-on, brick-and-mortar style, physical campus acquisitions.

This page from the company's 2005 annual report shows the extent of their, then successful, growth strategy.

The company had approximately 70 campuses spread across the globe.

A few things of note. While successful at that time, the business model carried heavy fixed costs in the form of physical campus infrastructure, and an inefficient human capital requirement necessary to run a dispersed network. Also notable, the company did have a small but growing "Online Education" division (see end of list).

Through a series of events (including prior management missteps), but more importantly, unprecedented regulatory pressure, a great depression, and a high fixed cost business as shown above, the stock collapsed.

In May 2015, correctly seeing the future of education as online, the company adopted an almost exclusively online future, and began an expensive and time consuming wind down or "teachout" of the the vast majority of their brick-and-mortar schools.

Put succinctly, the company continued running these schools, while accepting no new enrollments. This was very costly to shareholders, and greatly distorted the company's future prospects as compared to their GAAP reported results for the years 2015 to 2019.

While certain efforts were made by the company to break out "ongoing" results from the "transitional" or "teachout" results, this author believes management did a fairly poor job of communicating this to the Street. This, in addition to what has historically been very conservative forward guidance and little to no analyst coverage, created a tremendous buying opportunity of the stock that is still in play today.

Management has Consistently Downplayed Future Results

Management had their first analyst day in many, many years in April of 2019.

Slide Deck

At that time, management presented the following guidance.

Investor Presentation: Page 82

Specifically, they called for 2019 revenue growth of 3-4% and new enrollment growth of 3-5%. Both are important numbers. So how have they done now that 2019 is over?

While Q4 results are still a month out, total enrollment is up almost 8% so far for the year, and new enrollments are up 16%. Their guidance, even in April 2019, significantly underrepresented their actual results even 6 months into the future.

Put another way, management has in every quarter so far of 2019, raised guidance in every important metric, and not by a little bit. It appears that the business is outperforming all management expectations.

Legacy Teachouts are Over. Highly Accretive Business Remains.

From 2015 until now, the business spent, by my calculations, approximately a quarter of a billion dollars in expenses on

  1. teaching out students at now closed institutions
  2. lease expenses related to closed institutions
  3. employee severance related to closed institutions
  4. legal expenses related to closed institutions

This represented a very material drag on reported earnings. To investors using screeners or investors otherwise not able or willing to understand the company's transition, the company's actual prospects and ongoing fundamental strength was greatly obfuscated.

What remains now is a highly accretive, scalable business that appears to be doing even better than management expected.

The business is almost exclusively online today, deriving over 90% of their revenues from online students. This author believes that online is the future for the majority of students going forward. Further, the business model is far better scalable than it was before, and inherently less risky, given the massive reduction in fixed costs.

While the company doesn't break out the marginal value of each new online student enrolled, it is my opinion that it is extremely high.

Valuation

Through nine months of 2019, the business has reported free cash flows of 82 millions vs 14 million in the prior year period. While Q4 is still a month out, it should be their best quarter of the year, and this author expects continued improvement going forward.

This is an outrageous improvement year-over-year, and speaks to the obfuscation of prior results noted above.

The board in only the last quarter implemented their first buy-back in many years. This, in addition to a fundamentally more scalable and adaptable business, a highly accretive business model, macro shifts in consumer preference toward online delivery, and potential M&A that management believes should be both accretive and conservative, create a powerful future for Perdoceo Education.

Backing out cash and accounting for future credits that will offset taxable income (the business has no debt), the enterprise value of the business trades at a very low multiple to current and future earnings.

Given the later-part of the cycle that the market is in, and that education generally tilts counter-cyclical, PRDO is very well positioned to continue growing revenues and earnings.

2020 should be a banner year for both the business and stockholders.

This article was written by

Modern Graham profile picture
163 Followers
Deep value investing. Misunderstood securities.
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Disclosure: I am/we are long PRDO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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