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There are few industries more beaten-down today than for-profit educators, for good reason. Questionable corporate ethics, high student default rates, and a parade of short-sellers have blended into a potent stew of investor discontent. But investor fear paints with too broad a brush. There will be winners and losers in this space, but the industry isn't going away.
Over the last 12 years for which data are available, the number of high school graduates per year grew 27%, but the capacity of traditional universities -- often locked into their brick-and-mortar campuses -- isn't. Neither is that of community colleges, which currently lack both the bandwidth and the funding to close the gap. In that light, the rise of the 530 for-profit educational institutions (that's 20% of all educators) currently operating in the U.S. makes more sense. It also explains why they can't all go away.
There will be shakeups in the industry, though, and today I'm betting that Bridgepoint Education (NYSE: BPI ) will shake out better than Strayer Education (Nasdaq: STRA ) . These two might look similar on the surface, from their student body sizes to their revenue figures. But dig deeper, and you'll find them priced for starkly different realities: Strayer for a rosy future, and Bridgepoint for dark days ahead. I think those prospects are backward, and I'm using a pairs trade to place my bet.
To understand why, you need to consider the three key factors for any for-profit educator: regulation, competition, and valuation.
The regulation around for-profits exists in a state of flux, but the most important considerations are the cohort default rate (the percentage of students who default on their loans within two years of graduation) and the percentage of revenue derived from Title IV, or federal funding for student loans. Cohort default rates greater than 25%, or revenue from Title IV greater than 90%, violate regulations, which can have game-ending consequences for an educator. Relative to other competitors, I don't consider Bridgepoint or Strayer to be in any serious danger of regulatory infractions.
2010 Cohort Default Rate
% 2009 Revenue From Title IV
|Bridgepoint: Ashford U||
|Bridgepoint: U of the Rockies||
Source: Bridgepoint and Strayer's respective SEC filings.
After a decade of growth galore, for-profits are increasingly battling for students. The two key factors are the price the student faces and the educator's cost of attracting that student. Educators with the cheapest prices should attract incrementally more students, and those with the lowest marketing costs should do so the most profitably.
Bridgepoint and Strayer both take in about $11,000 per student. But while Bridgepoint's take has increased 2.6% annually since 2007 (roughly in line with inflation), Strayer has pushed through 5.5% annual increases.
Marketing costs tell a similar story. Strayer attracts its students cheaply, but with competition for recruits heating up, costs have grown nearly 4% per year, even while student enrollment growth has halved since 2008. Bridgepoint brought in 45% more students last year, yet did so more cheaply (per head) than it had four years ago.
In a universe of stocks priced more on emotion than rationality, looking at what an educator's stock price implies about expected business performance is as important as ever.
Strayer is priced for sunny days ahead. Today's price implies either 6% more students a year for a decade with today's recruiting costs, or 10% more students each year at industry-average marketing costs. Neither alternative is likely. When it comes to students, Strayer's already picked the low-hanging fruit. The company will have to either spend more to persuade prospects to pay its relatively high credit-hour prices, or settle for lower growth. Strayer isn't headed for the butcher's block, but I can't see the stock worth more than $125 a share, making today's $148 price quite rich.
Bridgepoint is priced as if it might close down tomorrow. This company has been growing rapidly, with its student base up 17-fold since 2006. That growth has allowed the online educator to begin realizing tremendous economies of scale; its instructional costs per student are more than 20% lower than Strayer's, which relies partially on physical campuses. The growth should slow as the company focuses on recruiting higher-quality students, but Bridgepoint would have to lose 5% of its student base annually for a decade to justify today's price. With just 4% growth -- lower than I expect for Strayer, and paltry next to the 45% Bridgepoint posted last year -- its shares are worth at least $29.
Framing this trade
Think of buying Bridgepoint and shorting Strayer as one position. Instead of betting for Bridgepoint or against Strayer, I am explicitly betting that Bridgepoint will outperform relative to Strayer, and thus removing some of the industry factor. Plan to watch the performance of the overall position, rather than evaluating either of the pieces on their own.