Rising Star Buy: Going to School With Bridgepoint

This article is part of our Rising Star Portfolios series.

There are a lot of investors here at The Motley Fool who are smarter than me, and who are investing in for-profit education company Bridgepoint Education (NYSE: BPI  ) . Fellow Rising Star portfolio manager Alex Pape first purchased shares last month, and earlier this week he told us he's going back for seconds. Three of our real-money services also own shares. Now it's my turn.

Thanks to a growing dislike of for-profit education, and what could be classified as a Congressional witch hunt specifically aimed at Bridgepoint, the expectations about this company's success currently built into current prices are about as low as you can go. I believe that those expectations are messed up, and I'm going to take advantage of that by purchasing some shares for my Messed-Up Expectations portfolio.

"Greedy vultures"
That's just one of the epithets being used to describe this industry. Companies ranging from American Public Education (Nasdaq: APEI  ) to Apollo Group (Nasdaq: APOL  ) to Corinthian Colleges (Nasdaq: COCO  ) are under fire for saddling students with debt without delivering on the education. When emotion-laden comments get bandied about in the news -- even NPR has gotten in on the act! -- there's an opportunity to invest while the prices are low.

Are there problems with the industry? Yes. When recruiters' incentives are tied to bringing in more students, that's what they'll do, even to the point of breaking the law, as noted in a report from the Government Accounting Office last summer. Please note, however, that the GAO looked at only for-profit colleges, and didn't compare them to traditional not-for-profit colleges.

Did Bridgepoint use incentive compensation in recruiting? That depends on whom you talk to, but if it did, it was taking advantage of the changes to the rules implemented in 2002. Is the solution to kill for-profit education? No. Instead, we should once again make it against the rules to use incentive compensation for college recruiting -- at all colleges, not just for-profit ones. Note that Bridgepoint is already in the middle of changing its admission counselor compensation system, and it's made its stand against unethical recruitment clear.

Congressional hatred
Of course, Congressional hearings can often exacerbate negative feelings. Sen. Tom Harkin (D-Iowa) has said, "The whole business model of the for-profit school industry depends on taxpayer money." (Well, so does the entire defense industry, but let's not go there.) Harkin's held hearings investigating the situation, with one last March aimed specifically at Bridgepoint.

However, Harkin's data was questionable, often mixing apples and oranges. For instance, Harkin had a chart showing that Ashford University -- one of two colleges run by Bridgepoint -- spent less and less on instruction per student between 2004 and 2009. According to Bridgepoint, those numbers did not reflect reality.

For instance, Harkin's data for 2006 through 2009 shows a pitiful, declining amount of money spent on instruction per student. However, the calculation confused the years from which the numerator (money spent) and denominator (number of students) came from. There is a one-year lag in reporting money spent, for which Harkin didn't correct. Bridgepoint's quickly growing enrollment makes Harkin's results artificially low. When corrected, Bridgepoint shows that, yes, there is a decline between 2006 and 2008, but the amounts spent per student were a lot more than what Harkin had shown.

With Bridgepoint's business model, a decline in money spent per student is exactly what we should expect. Online instruction is scalable, allowing the university to teach more students without a commensurate increase in cost.

An opportunity
When an industry finds itself in the crosshairs of public and Congressional opinion, that negative sentiment can drive prices down, creating good investment opportunities. I've successfully taken advantage of that with Transocean, for instance.

Today, even after yesterday's upgrade by Piper Jaffray, the market is not expecting very much from Bridgepoint. At last night's close of $22.89 per share, expectations priced in for free cash flow growth are a pitiful -0.9% annually for five years, -0.4% for the next five years, and then no growth forever after that, discounting at my hurdle rate of 15%.

For a company that is growing revenue, has no debt and a growing cash balance, and is proactively adapting to expected new regulations from the Department of Education, that seems to be much lower than what Bridgepoint can reasonably do. With free cash flow growth expectations of as little as 5% annually for the next five years and 2.5% for the following five, shares would be priced at far more than $30 each.

Tomorrow, I'll open a 2% position in Bridgepoint Education, with the potential to add more.

After you add Bridgepoint to MyWatchlist, come discuss the investment decision on my Messed Up Expectations discussion board or follow me on Twitter.

This article is part of our Rising Star Portfolios series, where we give some of our most promising stock analysts cold, hard cash to manage on the Fool's behalf. We'd like you to track our performance and benefit from these real-money, real-time free stock picks. See all of our Rising Star analysts (and their portfolios).

Fool analyst Jim Mueller owns shares of Transocean, but has no position in any other company mentioned. He's an analyst for the Motley Fool Stock Advisor newsletter service. The Motley Fool owns shares of Bridgepoint Education, American Public Education, and Transocean. Motley Fool newsletter services have recommended creating a call spread position in Bridgepoint Education.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool's disclosure policy is never messed up.


Read/Post Comments (13) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 26, 2011, at 12:52 PM, jimmy4040 wrote:

    Witch hunt? I guess you don't care that this company is defrauding the government of your tax dollars?

    Virtually everything you are writing is a lie or a distortion. Use the company's OWN numbers. Revenue up 47%, spending flat. Between 85-90% of it's revenue comes from student loans. This a company dedictated to getting unqualified people to take out loans which are paid whether the student ever passes a single course.

    The business model is EXACTLY the same as the sub-prime industry. Get people to take out loans using virtually any incentive and the company gets paid no matter what else happens..

    Why didn't you ask them about their graduation rate or their default rate on loans, not that they would tell you the truth?

    Why didn't you mention they have just been subpoenaed by the State of NY?

    For non-financial reproters, these guys did a pretty good job:

    http://www.voiceofsandiego.org/public_safety/pavement/articl...

  • Report this Comment On May 26, 2011, at 12:57 PM, jimmy4040 wrote:

    Another piece of information you forgot to mention:

    "Take a look at the slides posted by Harkin today. The last slide shows that Ashford alums are having a tougher time paying their student loans than you’d know from the stylized “cohort default rate” that affects a school’s eligibility for federal student aid. Nearly 85% of Ashford alums delinquent on their student loans have been granted deferments or forbearance – practices that keep them from showing up in Bridgepoint’s official default numbers. Harkin argues that Bridgepoint arranges for these deferments and forbearances in order to game the government default measures."

  • Report this Comment On May 26, 2011, at 1:00 PM, jimmy4040 wrote:
  • Report this Comment On May 26, 2011, at 1:35 PM, jimmy4040 wrote:

    From the NYT:

    "Using data from federal filings and documents provided by Bridgepoint, Senator Tom Harkin, the Iowa Democrat who is chairman of the committee, described an institution that gets 86 percent of its revenues directly from the federal government, but sees the vast majority of its students drop out, burdened with student-loan debt. Of the students who enrolled in 2008-9, for example, 84 percent in the associate degree programs were gone by September 2010 (63 percent had left the bachelor’s programs).

    Bridgepoint employs 1,703 recruiters, the senator said, but only one employee is charged with job placement. "

  • Report this Comment On May 26, 2011, at 1:44 PM, XMFAloha wrote:

    Nice pick Jim!

    But, don't go giving Alex all the credit. Remember, I did recommend the stock in my own Rising Star Portfolio back when I could hardly find anyone who'd listen to the idea:

    http://www.fool.com/investing/general/2010/12/07/rising-star...

    Just look at the comments on that rec! It really wasn't a popular pick at the time. It took several months of pounding the table on this one to get any real attention.

    I usually get worried when too many people start to like an idea I'm excited about, but I respect yours and Alex's work, so I feel quite complemented to see both you guys add it to your RSPs.

    To online education!

    Andy Louis-Charles (TMFAloha)

    http://www.fool.com/specials/risingstars/rising-stars-andy-l...

  • Report this Comment On May 26, 2011, at 4:41 PM, jimmy4040 wrote:

    Andy:

    From your last:

    "At the same time, think about these numbers:

    •Unemployment among bachelor's-degree holders: 5.1%

    •Unemployment among high-school graduates: 10%

    •Unemployment among those without high school diplomas: 15.7%

    Roughly 67% of the U.S. population above the age of 25 -- 88 million people! -- lacks a college education"

    Funny thing is, if you go to one of their universities, you'll STILL lack those things, as the number prove!

  • Report this Comment On May 26, 2011, at 6:31 PM, project8 wrote:

    The biggest problem I have with BPI is they are not properly educating people. Regardless of anything else. They pass people along that submit sub-par, semi-literate work to keep them in school as long as possible. All to keep the money rolling in. They have too. They have to keep the ones in that actually want to go because the smart ones drop out because they realize the classes are a joke.

    They currently employ almost 7000 employees 85% or more of them are enrollment advisors. There are at least 40 directors and each director is responsible for 10,000 new student applications per year however, the year to year enrollment is only going up by about 10,000 students. Most of the students drop before they complete their second week of school so the numbers don't count to the schools drop rate. If you subtract the 5,000 or so that are graduating roughly 380,000 students drop from there a year.

    I worked there and attended there while an employee and it was very frustrating, to see people in class that were on the Dean's list that could only write papers in broken English. There textbooks are shortened versions of real textbooks written by professors at traditional universities. (My philosophy class book was written by 2 guys from UC chino).

    Take the final exams that the professors that are writing the books BPI uses give there students at whichever school they teach at and see how many BPI students pass that test. I doubt it will be a high percentage.

  • Report this Comment On May 27, 2011, at 9:47 AM, TMFPapester wrote:

    Andy (TMFAloha) is absolutely right - he was riding this horse before any of us. Nice pick, Andy!

    http://www.fool.com/investing/general/2010/12/07/rising-star...

    Cheers,

    Alex

  • Report this Comment On May 27, 2011, at 9:51 AM, jimmy4040 wrote:

    project

    It won't do any good to bring actual reality to the discussion. For some reason MF has decided to allow promotion of a fraud in their columns. I've never seen it before, and I don't know why it's happening now.

  • Report this Comment On May 27, 2011, at 5:20 PM, ldkoehler wrote:

    BPI's current stock price of $22.43 implies that cash flows will fall by around 50% and stay there permanently.

    These are very low expectations for a company that has a 46% return on invested capital. To put that in perspective, only 68 other companies in the Russell 3000 have a return on invested capital that high.

    For more info on market-implied expectations, see this blog post:

    http://blog.newconstructs.com/2010/05/19/how-to-make-money-p...

  • Report this Comment On May 27, 2011, at 11:07 PM, jimmy4040 wrote:

    idk:

    Wonder why.

  • Report this Comment On May 28, 2011, at 12:13 AM, bhughes1001 wrote:

    I like your work overall, but I have to say that this is a rotten industry. I have taught for two of these companies, and the model is fundamentally broken. If they are ever restricted from exploiting students, they will be OOB. Wouldn't invest personally based on principle, and I think there is significant risk regardless.

    BH

  • Report this Comment On June 02, 2011, at 6:06 PM, norman08 wrote:

    Hey Jimmy,

    I don't get it either. No one cares about the actual business or education that BPI or the other for-profits is providing. Just the financials.

    I don't know why one of the agencies investigating BPI doesn't just pull the students work and see how long those students have been in school. The proof is there.

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