The Valuentum analyst team discusses the challenges many for-profit institutions face, the growing student loan problem, and hopes for a less-stringent regulatory environment during the Trump administration. The team’s favorite idea in the space is also revealed. ~8 mins.
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Brian Nelson, CFA:
According to a recent article by the Wall Street Journal, “more than 40% of Americans who borrowed from the government’s main student-loan program aren’t making payments or are behind on more than $200 billion owed.” How much is $200 billion? To put that number in perspective, it equates to wiping the entire equity value of a global bank like JP Morgan (JPM) completely off the map, or about two Citigroup’s (C), or AIG (AIG), General Motors (GM), and Boeing (BA) combined. One in six borrowers is in default on their student loan, meaning they haven’t made a payment in over a year.
The implications on society may be far-reaching, perhaps playing into the attendance growth of more-affordable community colleges as opposed to the proliferation of attendance at expensive four-year universities that may never deliver on student expectations after graduation. The for-profit education industry has been pummeled by regulations for the past few years, with companies including Apollo (APOL) and Strayer (STRA) taking considerable lumps, but the problem goes far beyond institutions that are looking to make a profit for shareholders. America truly has a student loan problem, and there may not be an easy answer.
This is Brian Nelson for Valuentum Securities, and today I have Mr. Kris Rosemann and Mr. Chris Araos joining me to talk about the for-profit education stocks. I’ll start with you Mr. Araos.
Chris Araos:
There are several complications investing in for-profits. Wrinkles exists in the decision-making for prospective students. Graduates of some private, for-profit and universities make near or below poverty wages. Graduates of almost 1,000 programs at public taxpayer-supported community colleges and some four-year colleges earn less than $14,500 per year in the year 2016. US college enrollment is also dropping. Enrollment peaked in 2010 with just over 21 million students. However, in 2012, there were 20.6 million and 20.2 million in 2014. Enrollment is dropping in for-profit and community colleges also.
Brian:
So we have an interesting dynamic going on, and what’s really startling to me is that for for-profit institutions, that is investor-funded universities, enrollment dropped 14% in 2015, and we’re starting to see the for first time ever enrollments in universities declining — and there’s a number of challenges. Wouldn’t you say Mr. Rosemann?
Kris Rosemann:
Definitely — and we’ve seen a lot of Title IV funding issues in the past few years with the Obama administration kind of clamping down on these for-profit institutions that might be misleading prospective students as to their job placement rates afterwards. We have a few examples of that.
Corinthian Colleges was one in April 2015 that was forced to eventually close all the doors of its 28 ground campuses due to the misrepresentation of job placement rates, and they were denied all their pending applications and were denied the continuing participation in those Title IV programs which was a very large chunk of their revenue.
ITT Educational Services is another more recent instance, and they were forced to delist — their shares were delisted from the New York Stock Exchange recently as financial oversight increased due to significant concerns about their administrative capacity, organizational integrity, financial viability, and ability to serve students.
More recently, Devry (DV) has been a for-profit educational center that has been put on high watch by the Education Department, and we might see a little more higher push of this kind of crack down on for-profit institutions as the Obama administration tries to finish up its time here in the White House.
Just to give a little more background on the dependence of these for-profit institutions on the federal government. Only 12% of for-profit colleges depend on Uncle Sam for less than half of their revenue, which is pretty incredible. The Title IV program comes with kind of a 90/10 rule, which means that they are only allowed to depend on the federal government for 90% — now only 90% of their revenue is allowed to come from the federal government — which the word only is not the correct word to be used there.
Brian:
That sounds like a pretty risky proposition — and when you think about the dependence on government revenue, which is fickle and exposed to the political cycle, there’s also concerns about the regulatory environment, in general, and the for-profit education stocks are probably among the most highly-regulated entities out there. Not only are they dependent on the government, but the government seems to have its hands in all sorts of different things related to their businesses.
If they happen to disappoint expectations, the concern is that there’s FTC and attorney general investigations, and this has been widespread across the industry, Apollo probably being one of the more prominent examples there (Apollo owns the University of Phoenix). The political pressure and the regulatory environment is just not really conducive to these being fantastic investment opportunities, despite what could be a blossoming global growth market for enrollment trends for students, despite the more recent period being challenging.
It looks like some of the political pressure may be alleviating a bit in light of the (Donald) Trump victory. One of the things that we’ve been looking at is the issues surrounding Trump University and how the new President may potentially be a little bit less stringent on some of the for-profit institutions given perhaps his own personal experience with civil litigation, but there are a few companies that we do think are worth looking at if one has to have exposure to this particular space.
We’re just not big fans of the for-profit education space, but there is one company that is probably one of the highest-rated Economic Castles in our coverage universe, and that company is Capella (CPLA). Kris, do you have a couple things you want to share about Capella?
Kris:
Yes, definitely. Like you said, they have a great, very-high Economic Castle rating, and we think they are one of the better business models in the for-profit education space. Its online based platform keeps its investment in check — it’s a very capital-light business model — and we’re seeing some nice trends in their enrollment growth, which is actually expected to outpace their revenue growth in 2016, which sounds kind of funny, but that’s just due to a mix shift in their degrees, with more of a shift to master degrees from doctoral degrees, but the enrollment growth there is the encouraging thing that we’re seeing relative to some of the broader industry trends that Mr. Araos alluded to earlier.
We also are big fans of their FlexPath program, which is a very innovative program at this time, and the interesting thing about that program is that it offers bachelor’s and master’s degrees based on the competencies a learner can demonstrate rather than on the traditional credit-hour model, and it was the first institution approved by the Department of Education to offer such a program.
Not only do we really like its programs, its asset-light business model, but those things both lend itself to a very healthy dividend, and the company currently registers a 3.8 Dividend Cushion ratio, which is just tremendous, and that is due in large part to its free cash flow positive nature and holding about $140 million cash on the balance sheet versus no debt on the books, so it’s just another great thing — and it has almost a 2% yield to boot, so that’s just a little icing on the cake for one of our favorite ideas in the education services industry, despite the fact that it’s highly regulated and is still exposed to those myriad risks that come with Uncle Sam having his hands in their pie.
Brian:
I think the way to approach this idea is that, if you have to have exposure to a very challenging business environment, this is a company that one might think should be in a different industry, given its financials, given its free cash flow generating capacity, given its asset-light business model — it’s just really a gem among a heap of very troubled businesses. Thank you so much for sharing that insight, and we continue to monitor developments on the for-profit education front, as Trump plays out his initiatives over the next few years. This is Brian Nelson for Valuation Securities. Thank you for joining us.
Education (For-Profit): APOL, BPI, CECO, CPLA, DV, EDU, LOPE, LRN, STRA, UTI