The Next Big Short? For-profit colleges are stealing your tax dollars. How long will they get away with it?
Several months ago I read Michael Lewis' latest book The Big Short (it's an excellent read for anyone who's interested in investing). The book contains several story lines that follow a number of the smart investors who figured out early on that the U.S. housing market was going to collapse and profited handsomely from it.
One profiled investors who impressed me the most was Steve Eisman. He works for a hedge fund called FrontPoint Partners, which is essentially a group of funds that is overseen by Morgan Stanley. Eisman is quite a character. He was Meredith Whitney's mentor. Enough background. Needless to say I found the man impressive and I have been keeping my eye out for anything that he has to say.
Yesterday he made the first presentation that I have seen him give since The Big Short Was published. He spoke at the Ira Sohn Investment Conference. This is the same event that was mentioned in the fantastic book about David Einhorn's battle with Allied Capital, Fooling Some of the People All of the Time. Other famous presentations made there include Bill Ackman's long case for the bankrupt General Growth Properties and Einhorn's short thesis for Lehman.
The following is a link to outstanding presentation that Eisman made yesterday courtesy of Market Folly:
Subprime Goes to College
It is definitely worth checking out. The gist of the presentation is that for-profit colleges such as Apollo Group (APOL), ITT Educational Services (ESI), Corinthian Colleges (COCO), and Education Mgmt (EDMC) are screwing the government out of millions and millions of dollars by providing Title IV student loans, which are government guaranteed, to "students" who have almost no hope of ever repaying them.
These loans have accounted for more than 100% of the revenue growth at these fast-growing institutions. Eisman used Apollo Group as an example. In 2009 APOL's revenue increased by $833 million. More than $1.1 billion of that, over 100%, came from federally-funded loans. Guess how much of that money APOL spent on faculty and instruction...wait for it...$99 million. As Eisman put it, only nine cents of every dollar in student loans provided by the government went to the actual education of students.
On its own, this situation does not appear sustainable, making these companies good short candidates. However, there is an actual catalyst that could cause them to lose a huge chunk of their revenue already in the works. It's called the "Gainful Employment" rule. The Department of Education is rumored to be scheduled to introduce this proposal some time in the next several weeks. This rule seeks to limit students' debt-service-to-income ratio to 8%. It makes sense if one thinks about it...the government should only guarantee loans that students have a realistic chance of actually paying back. What a novel concept.
If this new rule actually passed it has the potential to slice the revenue of public colleges by as much as half by the year 2011. Ouch.
This great presentation has convinced me to add CAPS shorts to all of the four companies that I mentioned above. Check it out, it's definitely worth a read.