Should We Follow Steven Cohen Into ITT Education Services?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Recently, Steven Cohen has filed a 13G filing to disclose his passive stake in ITT Educational Services (NYSE: ESI). He accumulated more than 1.23 million shares in the company, equivalent to around a 5.3% stake in the company. Since the beginning of the year, ITT has gained nearly 55% on the market, much higher than the S&P 500’s return of only 15.23%. Should we follow Steven Cohen into ITT at its current trading price? Let’s find out.

Business snapshot

ITT, incorporated in 1946, is one of the leading providers of post-secondary degree programs in the U.S., having around 61,000 students with 147 campuses and two learning sites in 39 states. Around 40% of the students were at least 31 years old, while the students from 25-30 years old accounted for 29% of the total student number. In the past five years, ITT has experienced fluctuating performance in both revenue and net income. In 2012, the company generated nearly $1.29 billion in revenue and $140.5 million in net income, or $5.88 per share.

What I like about ITT is its ability to generate free cash flow. Since 2003, ITT has generated consistent positive, but fluctuating, free cash flow, fluctuating in the range of $74 million to $996 million. In 2012, with the operating cash flow of $244 million, ITT’s free cash flow came in at $160 million. However, what I worry about with ITT is its not so strong balance sheet. As of March 2013, it had $663 million in equity, $483 million in cash and no debt. However, it booked $330 million in pensions and other benefits and as much as $758 million in goodwill and intangible assets. Consequently, ITT had a negative tangible book at $(95) million.

How about Apollo Group and DeVry?

ITT is trading at around $26.80 per share, with a total market cap of $626.5 million. The market values ITT at around 10.8 times its forward earnings. Compared to its peers Apollo Group (NASDAQ: APOL) and DeVry (NYSE: DV), ITT is the smallest company among the three. Apollo Group is the owner of several educational subsidiaries, including The University of Phoenix, the Institute for Professional Development and the College for Financial Planning Institutes Corporation. The acquisition of Carnegie Learning in 2011 has help Apollo to incorporate adaptive learning into its academic platform and improve the retention and graduation rates.

For the full year 2013, Apollo expected to generate annual revenue of $3.65 to $3.75 billion, with operating income in the range of $500 to $550 million, excluding special items and other charges. In March 2013, the company’s board authorized a share repurchase program of up to $250 million, with no expiration date. Apollo is trading around $21.30 per share, with the total market cap of $2.4 billion. The market values Apollo cheaper than ITT, at 9.6 times its forward earnings.

DeVry, the global leading career-oriented educational services, focuses its course offering on the business field. For the full year 2013, DeVry expected to reduce its operating costs by 1%-2%, because of huge cost management at DeVry University and Carrington Colleges. The company estimated around $100 million in addition cost savings in those two institutions, higher than the previous estimate of $80 million. DeVry seems to have the highest valuation. At $30.10 per share, DeVry is worth $1.9 billion. The market values DeVry at 12.1 times its forward earnings.

Income investors might like DeVry the most, as among the three companies, it is the only company that pays dividends. At its current trading price, its dividend yield is 1.1%. Interestingly, the dividend payment policy of DeVry is quite conservative, with only 14% payout ratio.

My Foolish take

Jim Chanos, the famous short seller, has said that the for-profit education model was broken because it depends so much on government funding. Thus, it is not a good industry for investors to be in. Investors need to dig deeper into each companies to find out the suitable stock for themselves. Personally, I like DeVry the most with its dividend payment and low payout ratio.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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