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.
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.
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.
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.