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Daily Trouble
October 8, 1999

Strayer Education Inc.

Ticker: (Nasdaq: STRA)
Phone: 703-339-2511
Website: www.strayeredu.com
Price (10/7/99): $14 1/4

By Paul Larson (TMF Parlay)

How Did it Find Trouble?

In today's class we will examine the trouble that hit the shares of Strayer Education. After peaking above $40 per share last December, the stock headed slowly yet steadily down the entire year, recently hitting a new low in the mid-teens.

The only salient chunk of news to really cause the downfall came on July 28 when the company released its second quarter earnings. Wall Street expected the firm to report $0.35 in EPS, and that's exactly what the company reported. However, nearly $1 million worth of income, or about $0.04 per share, came courtesy of non-operating activities that analysts weren't anticipating.

In other words, operating profits weren't up to expectations, raising "quality of earnings" issues. Two of the nine analysts following the stock immediately downgraded their ratings on Strayer, and nearly all the others voiced some disappointment with the earnings.

With little good news beyond an increased share repurchase program and a hiked dividend, the stock has continued to slide. One might even say that Wall Street gave the shares a detention.

Business Description

Strayer Education is the parent company of one of the nation's larger private, for-profit universities. Strayer University has more than 10,000 students in 13 campuses clustered in the greater Washington, DC, region.

The vast majority of Strayer's students are working adults looking to advance their careers or further their skills. To serve this demographic, the university has flexible class schedules, including a large number of weekend and evening classes. The school offers both bachelor's and master's degrees, and the vast majority of students are in information technology or business-related programs.

Though founded in 1892, the university has a decidedly modern curriculum, since Strayer recently started offering "distance learning" courses via the Internet. Strayer's parent company came public in 1996.

Financial Facts

Income Statement
12-month sales: $66.2 million
12-month income: $19.3 million
12-month EPS: $1.21
Profit Margin: 29.2%
Market Cap: $228.8 million (16.059M s/o)

Balance Sheet
Cash and Equivalents: $15.0 million
Current Assets: $32.9 million
Total Assets: $92.4 million
Current Liabilities: $12.9 million
Long-term Debt: None
Total Liabilities: $13.1 million

Ratios
Price-to-earnings: 11.8
Price-to-sales: 3.5

How Could You Have Seen it Coming?

One way to have perhaps seen Strayer's trouble coming was to simply look at the company's expansion plans. Over the past year, the company has added four different campuses to its portfolio. Considering that before the expansion there were only nine locations, it was fairly obvious that Strayer was making a relatively bold attempt to grow its business. Not only does it take time to ramp up enrollment at new campuses, but the company must spend more on marketing to attract new students. It was fairly obvious that near-term earnings were likely to take a hit.

Furthermore, Strayer's same-campus enrollment growth has been below that of its peers. In the spring of 1999, Strayer increased its same-campus enrollment by 1.8%, while DeVry (NYSE: DV) and Apollo Group (NYSE: APOL) increased their enrollment by 12.2% and 12.6% respectively. Whether from fundamental weakness or from the new campuses cannibalizing students from the older locations, this lower growth rate was surely a warning sign.

Finally, Strayer has been swimming upstream against some larger macroeconomic factors. When the economy is booming like it is today, folks are more likely to stick with their current well-paying jobs than to return to school. More importantly, the labor market has been exceptionally tight, and Strayer's profits, like those of nearly all service-oriented companies, is sensitive to increases in the cost of its workforce.

Where to From Here?

It appears that Strayer's future looks much brighter than its recent past. When one looks at Strayer Education it is imperative to look at the attractiveness of the industry as a whole. Luckily for Strayer, the private secondary education industry is seeing some fairly robust growth. Institutions that can provide a convenient, cost-effective education are set to thrive as expenses at traditional four-year universities spiral out of reach. Total enrollment at Strayer and its peer schools is expected by analysts to increase roughly 10-15% per year for at least the next few years.

Of course, companies can and do fail even in thriving industries. As Strayer expands it will be forced to compete with other similar universities, such as DeVry, for students. The increased competition could cause margins to dip. Plus, much of Strayer's future success depends on how well its new campuses perform, including its virtual campus on the Internet. Current Strayer investors would do themselves a favor to keep an eye on both the total and same-campus enrollment figures when the company releases earnings on October 27.

One positive sign coming from Strayer is the fact that the company's board recently increased the stock's dividend and also cranked up its stock repurchase plan. While not good news from an operational standpoint, it represents a great deal of confidence by the board in the company's future performance.

From a financial standpoint, Strayer looks like it could be an interesting value. The company has lofty margins and a clean, debt-free balance sheet. More importantly, Strayer has an impressive history of steadily growing profits that is not expected to stop. For a company expected to grow its earnings at a 20% annual clip that is trading near 10x forward earnings estimates, it's probably worthwhile for investors to look at Strayer's prospects and its upcoming earnings to grade the stock for themselves.

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