The For-Profit Education Bubble?
The For-Profit Education Bubble?
If you’re a fan of the film Apocalypse Now, you recognize that phrase as Marlon Brando’s closing line. As the Dow has fallen from the 14,000 level all the way down to the 8,000 mark, many of us have suddenly found ourselves identifying with the famous Brando line. Yet, despite the all-out slaughter of capital that left very few stones unturned, one industry has managed to thrive. In fact, it has seemingly managed to reach bubble-like proportions in one of the worst market downturns of most of our lives. The industry: for-profit education.
Surely you’ve seen the ads. There are a host of companies in the sector including DeVry (DV), Strayer (STRA), and Apollo (APOL), which operates the University of Phoenix. All three companies plus others have seen their stock go upwards significantly during a time when the rest of the market has been enduring all-out carnage. Yet, with more traditional universities offering online options and state universities offering much lower costs to students, plus a degree that is viewed as much more valuable, is all the optimism about the for-profit education sector a bit excessive?
Taking a look at some of the players in this sector: (1) DeVry (DV)
Arguably, DeVry is the most famous of the for-profit education bunch. We’ve all seen the ads for many years now. They also appear to be the least aggressively valued of the group from my perspective.
For a lot of companies, I will run what I call a “quickie DCF” on them to get a ballpark idea about valuation. At first, I will normally set my spreadsheet up in an effort to disprove my initial hypothesis. For all of the stocks mentioned in this article, my null hypothesis is that they are overvalued, so I initially use very aggressive figures for my discounted cash flow analysis.
For DV, I go with a low cost of capital at 8%, assume free cash flows of $2 per share for Year 1 (Y1) and $2.10 for Year 2 (Y2) before assuming a constant growth rate of 5%. Using these aggressive valuation metrics, I come up with a value around $58 – 60 for DeVry; which also happens to be where it’s trading right now. Based on this, you could say that DeVry appears to be “priced for perfection.”
If we use somewhat less aggressive numbers, the valuation drops considerably. If we go with a 10% cost of capital, assume free cash flows of $1.75 per share for Y1 with a constant 4% growth rate, our valuation suddenly falls all the way down to about $40.
If we assume their recent performance is somewhat of an aberration and use $1.50 for Y1 free cash flows, we come up with a valuation closer to $35. Even this latter valuation could arguably be perceived as “somewhat aggressive” given that it assumes that DeVry will continue to thrive for many years to come and that their most successful fiscal years are not outliers.
One might also want to take a look at recent insider transactions as it appears there is a great deal of selling going on. There's a $1.8 million sale at $50, an $8.3 cash-out at $55, and lots of $1 million+ sales earlier in 2008 at prices above $55. There was also a more recent $1 million sale at $60.
Based on all of this, it would appear to me that DeVry is overvalued and should be trading closer to the $30-40 range. (2) Strayer (STRA)
While I think there’s a case to be made for DeVry, I have a difficult time seeing the case for Strayer (STRA). Free cash flows for FY '07 were around $4.60 per share and earnings were about the same. Even if you take their most profitable recent quarter (ending Mar '08) and extrapolate yearly earnings based solely on that, you'd only come up with $7 per share - and that looks like an aberration.
In spite of this, I use extremely aggressive figures for my first valuation attempt. I go with an 8% cost of capital, and assume they bring in FCFs of $8 per share for the next three years before achieving a constant 5% growth rate. Even based on these extremely aggressive figures, I come up with a valuation closer to $200. Given STRA’s recent trading range of $210-220, it seems that the market is extremely bullish about its prospects.
Using a saner 10% cost of capital and assuming $6 in FCFs for Y1 before achieving a constant 5% growth rate, I come up with a valuation around $125-130 for STRA. That’s quite a drop-off and it’s still quite easily arguable that this is an extremely aggressive valuation. If I drop Y1 FCFs down to $5, the valuation drops to the $105-110 range. If I lower my constant growth rate down to 4% on top of that, I come up with a valuation in the $95-100 range.
By the way, just in case you were wondering, insiders seem to be selling this one, as well. Mr. Robert Silberman sold $30 mil worth of his stock at $228, while director Todd Milaon dumped off about $1.7 mil at $220.
Based on all of this, it would appear to me that Strayer is significantly overvalued and probably should be trading closer to the $100 price point. (3) Apollo (APOL)
I saved the best for last. If DeVry and Strayer are “overvalued”, Apollo may have even bigger concerns. Citron Research recently released a damning two-part report on APOL (Part 1, Part 2) that may very well emphasize some larger problems are afoot. The report highlights a recent lawsuit brought by former students that is critical of the University of Phoenix for returning federal loan money to the lenders. The problem, as Citron puts it:"So here’s the question: why would the [University of Phoenix] surrender cash in hand that is rightfully theirs, in exchange for a hard-to-collect receivable, plus collection costs and risks? Why would UOP intervene in a lender/borrower relationship that they actually helped facilitate?"
It’s a good question and it raises questions about Apollo’s financial reporting. What makes it all the more suspicious is the high amount of insider selling. Insider selling at DeVry and Strayer look minor compared to the massive swath of insider sells at Apollo; many of the recent ones are valued in the tens of millions of dollars.
Taking a look at a quick DCF analysis for Apollo, things don’t look too bad on my initial aggressive valuation. I use an 8% cost of capital and I assume FCFs for Y1 are $5 per share before achieving a 5% constant growth rate. Ignoring the Citron Report and closer analysis of APOL’s financial statements, this is not that off-base as APOL achieved $5 in FCFs for their most recent fiscal year. While it does look like somewhat of an aberration, one could argue that it is not. Using this “aggressive valuation”, I come up with a price in the $130 range. Not bad considering APOL has recently been selling between $80-90.
Using a more conservative 10% cost of capital and Year 1 FCFs of $4 (with our 5% constant growth rate), we end up with a valuation in the $80-85 range; much closer to the current price. If we start that DCF analysis with Y1 FCFs of $2.50 and use a 4% constant growth rate, we come up with a valuation closer to $45. I’d argue that would be the most realistic of the bunch if it were not for the other problems at APOL.
With concerns over financial reporting, I’d argue that APOL is worth closer to $20 right now than $80 and despite not seeming to be as aggressively valued as Strayer, it would appear to be the scarier of the two right now. Other Stocks
While I did not take quite as in-depth of a look at these companies, Capella Education Company (CPLA) and Grand Canyon Education (LOPE) are two more companies in the for-profit education sector that might be significantly overvalued. The latter company recently held an IPO and concerns have been raised over the fact that 75% of the proceeds from that IPO going to insiders. American Public Education (APEI), which is mentioned in the article about LOPE's IPO, might also be worth a look. Concluding Thoughts
Is there a for-profit education bubble? Everyone has to decide for themselves, but it’s amazing to think that a bubble could have formed in one of the worst market downturns in history. All the same, the valuations for the companies in the for-profit sector appear to be extremely aggressive from this author’s perspective.