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Dropout Investor: Reasons to Avoid the For-Profit Education Sector

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

Editor's Note: The initial version provided an incorrect P/E ratio for ITT Education Services and referenced Grand Canyon's opening of a campus in Massachusetts. This version has been corrected.

During March 2009, I had the opportunity to meet professional investor Mark B. Fisher at a conference in New York City. Mr. Fisher is Founder/CEO of a major futures clearing firm and a graduate of University of Pennsylvania’s Wharton School.

In the presence of a small crowd, Mr. Fisher described the for-profit education sector as the “ultimate short,” stating the entire industry would embark on a steep downturn once the recession ran its course and university enrollees went from unemployed to underemployed. Furthermore, once the economy improved, why would students pay to attend Apollo Group’s (NASDAQ: APOL) University of Phoenix when financial aid would partially offset the benefits of a private research institution, such as my alma mater, Case Western Reserve University.

At the time of the conference, shares of Apollo Group were trading in the $70 range as the for-profit education sector benefited from record enrollment driven by the 2008-09 recession. Degreed enrollment reached an all-time high of 455,600 during 2009, and has subsequently fallen to a multi-year low of 324,100. While I haven’t spoken to Mr. Fisher since the conference, I’m willing to bet he participated in nearly every dollar of downside in shares of Apollo Group over the past three years.

The publication of this article is timely as Apollo Group reported first quarter 2013 results on Tuesday, January 8. Shares initially rallied nearly 5 percent in the after hours session, only to reverse direction and reach a new 52-week low on the disclosure that The Higher Learning Commission may decide to put the accreditation for Apollo Group’s University of Phoenix “on notice.” In summer 2011, HLC notified Apollo that “significant questions and areas” remained for the university to improve the quality of its educational offerings.

Despite these qualitative concerns, Apollo Group beat expectations for the quarter on a quantitative basis with $1.22 EPS vs. $0.90 consensus and revenue of $1.06 billion vs. $1.03 consensus. Analysts on Wall Street are clearly looking past the surprise Q1 2013 earnings beat, as Deutsche Bank, First Analysis Securities, and Morgan Stanley all downgraded the stock on Wednesday, January 16. In addition to the citation received from The Higher Learning Commission, Apollo Group experienced a continued decline in student enrollment.

As readers might anticipate, the issues affecting Apollo Group are not entirely company-specific. Rather, the industry continues to be dismantled by numerous economic and political trends. Market participants didn’t hesitate in reacting to the Obama reelection on November 7, as the President has introduced reforms which limit the price of tuition charged by for-profit operators.

According to my calculations, several billion dollars in collective market value was lost on November 7 among Apollo Group and competitors DeVry (NYSE: DV), Strayer Education (NASDAQ: STRA), and Grand Canyon Education (NASDAQ: LOPE). ITT Educational Services (NYSE: ESI) lead the group to the downside with more than a 10% single day loss. Clearly, the President’s moral-based initiatives represent a victory for students across the US and a near death sentence for the for-profit industry model.

As of this writing on January 11, shares of DeVry, Strayer Education, and ITT Educational Services remain at or near their respective 52-week lows. DeVry initially rose a massive 23% on October 26 when the company met Q1 2013 expectations for cost containment; however the lingering concerns about enrollment growth have caused the stock to return most of the recent gains. DeVry also increased its quarterly dividend by 13 percent on November 8, in a possible attempt to put a floor underneath its falling share price.

In contrast to DeVry, Strayer Education fell 11% following Q3 2012 results and announced it would completely suspend its dividend going forward. Similarly, ITT Educational Services is struggling to manage its debt obligations, with the likelihood of further write-downs becoming a strong possibility.

Grand Canyon Education appears to be the defiant exception among the group, as shares are trading at the higher end of their 52-week range. Analysts believe the Phoenix, Arizona based company's NCAA status change to Division I from Division II will boost enrollment beginning in the 2013-14 academic year. Still, I would be wary of Grand Canyon as the company is equally exposed to the structural challenges affecting the industry.

<table> <tbody> <tr> <td> </td> <td><strong>Apollo Group</strong></td> <td><strong>DeVry</strong></td> <td><strong>Grand Canyon Education</strong></td> <td><strong>Strayer Education</strong></td> <td><strong>ITT Educational Services</strong></td> </tr> <tr> <td><strong>Market Cap</strong><span> ($)</span></td> <td>2.2 B</td> <td>1.5 B</td> <td>1.0 B</td> <td>678.8 M</td> <td>338.0 M</td> </tr> <tr> <td><strong>P/E Ratio</strong></td> <td>6.24X</td> <td>13.8x</td> <td>16.17x</td> <td>8.75x</td> <td>1.59x</td> </tr> <tr> <td><strong>Ann. Dividend/Yield</strong></td> <td>--</td> <td>$0.34/1.41%</td> <td>--</td> <td>Eliminated as of Nov. 9 2012</td> <td>--</td> </tr> <tr> <td><strong>Beta</strong></td> <td>0.4</td> <td>0.6</td> <td>0.5</td> <td>0.7</td> <td>0.6</td> </tr> <tr> <td><strong>Short Interest</strong></td> <td>13.88</td> <td>13.92</td> <td>11.23</td> <td>17.84</td> <td>31.83</td> </tr> </tbody> </table>

 

On a macro level, Moody’s Global Credit Research recently issued a press release indicating that one-third of US colleges are facing “falling or stagnant tuition revenues.” The report states that 17 percent of public and private universities are currently experiencing declines in revenue, while an additional 16 percent of universities expect their tuition revenue to grow at less than the rate of inflation. Congress is also pursuing legislation that would require educational institutions to disclose the amount of debt that students would incur from attending school.

Foolish Bottom Line

Overall, the economic picture for the for-profit education industry is far from bright. While every company has value at a certain price, in my opinion the business model for this group is permanently damaged. At the very least, each of the above for-profit universities has an endless list of hurdles to manage in the months ahead. I would strongly advise readers to withhold investment in the sector, and look to other areas of the market where stronger fundamentals should lead to future revenue and earnings growth.


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