This article is part of our Rising Star Portfolios series.
Just a few weeks ago, I passed on American Public Education
That's never fun, but these situations make great learning opportunities. The question I must ask myself, of course, is whether I made a good decision with the information I had at the time. For the sake of Foolish education, I'd like to let you in on my reflective process.
What I liked
I was initially attracted to American Public Education after a hunt through the for-profit education industry in general. The industry has taken a beating over the past year, mostly for good reason. Many of the industry players have been or are flirting with disaster -- be it in questionably ethical recruiting practices or in bumping up against legal limits on how much revenue they can draw from federal student loan funding.
Just as in any industry, though, not all companies are created equal. The market was painting the for-profit sector with a broad brush, but I thought it was worth looking for educators who didn't really fit the industry mold.
That's how I found American Public Education. Unlike general educators such as industry big dogs Apollo Group
What I didn't like
The one part of the American Public Education's business I didn't like was its recent foray into catering to what it calls "public service" students. These are publicly employed civilians, such as police officers, firefighters, and teachers. It seems to me that the expansion into this market has been fueled by a desire to keep growth near its recently explosive levels; as the company captures more and more of the military market, less potential growth remains there.
The problem, though, is that American Public Education doesn't have any real edge in this "public service" market. I disagree with management that it is a natural extension of the business. Public service students aren't having their degrees funded by the military, the costs of recruiting these students are higher than for military students, and there is a ton of competition in this space, from Apollo to Strayer Education
If the goal was to keep growth high, so far American Public Education has succeeded. In 2010, course registrations increased 31%, which was the big news that caused the pop last week. But I wonder how sustainable that is, and I would rather have the company accept slower growth and devote its resources to strengthening its position in the core military market.
The nail in the coffin
On the whole, I like American Public Education's business. I'd rather it stay out of the public sector, but at the end of the day, the majority of its students are military, the company is well-run, and, with $81 million in cash and no debt, the financials are clean. For me, the straw that broke the camel's back was the company's valuation.
According to my model, the business had to double its student base between 2009 and 2014 just to justify its stock price. In other words, if the company didn't grow that fast -- but still grew -- the stock should drop in value. Doubling in five years entails pretty aggressive growth. True, the company has been adding students at a breathtaking rate over the past three years, averaging 41% annual growth since 2007. But that was off a much smaller base -- 30,000 students in 2007 versus 83,700 today -- and the company has done such a good job signing up military students that there is a diminishing opportunity for growth going forward.
Also, as the company has already picked much of the low-hanging fruit in the military market and branches out into the public service market, the cost of recruiting new students is climbing. The cost of signing up a new student has already jumped from $226 in 2007 to $410 in 2010 and should continue to rise. The company has great benefits of scale -- that's what almost entirely online operations will do for you -- but this selling cost should combat the margin gains associated with scale. In fact, 2010 was the first year since 2005 that operating margins decreased, in large part due to higher selling costs.
It's never pleasant to watch a stock you passed on reach for the stars, especially just a few weeks after you made your decision. But there is always something to be learned from these scenarios. A 24% pop in one day is mouth-watering, but it's a very short-term outcome. This company's strategy has some minor imperfections in my book, but overall it's a great, well-run business.
Ultimately, I decided it was simply too expensive. Every model you (and I) build is inherently flawed, but even in various scenarios, I just couldn't justify paying the price. Only time will tell if my decision was a good one -- and it is good to compare the outcome to what I did buy -- but for now, I believe my decision was a solid one.
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