Last week, the Senate Health, Education, Labor, and Pensions Committee held a hearing using for-profit educator Bridgepoint Education (NYSE: BPI ) as a "case study" in the business practices of the industry and the effectiveness of regulatory oversight. This was the committee's fourth hearing focusing on for-profits, and it is particularly interesting that this time the committee elected to single out Bridgepoint instead of presenting its findings on all of the biggest companies in the industry.
It's fair to say that HELP Chairman Tom Harkin (D-Iowa) has significant concerns about all of them. It was just last month that Harkin spoke on the Senate floor about his findings on industry student loan default rates, the high rates of withdrawal from school, and the aggressive recruiting practices employed to enroll students "at any cost." During his speech, he called out ITT Educational Services (NYSE: ESI ) , The Washington Post's (NYSE: WPO ) Kaplan unit, and Corinthian Colleges (Nasdaq: COCO ) along with Bridgepoint, for their high-pressure sales tactics and high rates of student loan defaults.
With an abundance of data from the Department of Education, the Government Accountability Office, and metrics from the institutions themselves, Harkin has all of the ammunition he needs to push for change in the industry. This is why it was disappointing to see him blatantly misrepresent data in the Bridgepoint hearing to push his reform agenda. I do not blame Bridgepoint CEO Andrew Clark for declining to attend what turned out to be a witch hunt.
Overstating Bridgepoint's profitability
Part of Harkin's strategy was to emphasize that Bridgepoint generates significant profits despite high student withdrawal rates and what he calls a "spectacular record of student failure." According to Harkin, Bridgepoint increased its profits from $81 million in 2009 to $216 million in 2010.
However, Harkin is playing fast and loose with the facts to make Bridgepoint look more profitable than it really is. He's using operating income as a measure of profitability. The problem is that operating income is not the true level of earnings available to the company and its shareholders. You may have heard of corporate income taxes, and the Internal Revenue Service makes sure to take its pound of flesh every year.
Bridgepoint's after-tax profits are $47 million and $128 million for the years 2009 and 2010, respectively. Don't get me wrong, Bridgepoint is quite profitable and that growth rate is exceptional. But the true earnings power of this business isn't anywhere close to what Harkin purports.
Spinning executive compensation
Harkin knows his audience and played the CEO greed card early and often. He said, "The CEO, alone, received a salary of $20.5 million in 2009 -- that's more than 20 times the compensation of the president of Harvard University." And he added, "This is all public money. It's coming from the taxpayers directly and student loans guaranteed by the federal government." More great sound bites from the senator.
Unfortunately, as with his claims on Bridgepoint's profitability, his representation of executive compensation is also exaggerated. According to Bridgepoint's proxy statement filed with the Securities and Exchange Commission, CEO Andrew Clark had a base salary of $375,000 in 2009 and $475,000 in 2010. While Clark can't plead poverty, there's a big gap between his true salary and the $20 million figure cited by Harkin. Where does the truth lie?
Harkin was correct in a sense with the $20.5 million compensation earned by Clark. However, $19.4 million of that amount is not salary and not paid for by taxpayers. This represents the fair value of stock option awards granted during 2009 plus a fair value adjustment for options awarded in prior years. Bridgepoint did not have its IPO until April 2009. It is quite common for C-level executives of privately held companies to be awarded significant option awards as part of their total compensation package, particularly when the actual salary is as low as Clark's.
If anyone has an ax to grind with the magnitude of Clark's options awards it should be Bridgepoint shareholders who are seeing their claim on the company's earnings diluted. However, Harkin is being disingenuous to assert that Clark has a $20 million salary financed by taxpayers. That is simply wrong.
Selective focus on financial performance
As part of his introductory remarks, Harkin said the following about Bridgepoint's March 1 conference call to discuss 2010 earnings: "We listened in on the last investor call between Warburg Pincus and Ashford. Nothing about students and how they're doing. It's all about profit. How much profit did they make and congratulating each other on how much profit they made."
Every conference call I've ever listened to has a section devoted to financials. This is how management communicates the company's financial performance to the analysts who follow the company and to the company's shareholders. However, there is also always a business discussion to go along with that and this is true of Bridgepoint as well.
During that year-end conference call, Bridgepoint led off with Chief Academic Officer Jane McAuliffe presenting 12 full paragraphs on topics such as alumni satisfaction surveys, the salary increases seen by graduates, the introduction of initiatives like an orientation program, and a free two-week workshop for transfer students to improve retention. All of the efforts the company is taking to address deficiencies and improve student outcomes were completely, and dare I say deliberately, ignored in the Senate hearing.
Foolish final thoughts
I do not want to see higher education institutions, for-profit or otherwise, misrepresenting the value of their education and ripping students off. It is clear that there are widespread problems across the for-profit industry, including Bridgepoint, and educational outcomes have to improve. However, when an individual as prominent as Sen. Harkin starts distorting facts to advance an agenda, I don't find that to be in the best interests of investors. Frankly, it makes me question all of the data he cites on student withdrawal rates and loan default rates.
The lesson, Fools, is to trust but verify. Not just what is presented by Harkin, but also the Department of Education, the accrediting agencies, and especially the for-profit companies themselves. I can tell you from my months of research on the industry that they are as slick of operators as you will find, and investors should not take anything at face value, including information from Bridgepoint.
The government scrutiny has not been kind to the stocks of for-profit companies, and I've been investigating the industry to identify a few opportunities. When the regulatory picture clears up, there will be a few winners. In my companion article to this piece, I share what I've learned investigating the for-profits over the past few months to give curious investors some tips as to how they should begin their research.
If you have the intestinal fortitude to take a contrarian view and invest in out-of-favor stocks, the for-profit education industry is fertile hunting ground. All four of these stocks mentioned in this article deserve to be on your Foolish watchlist for further research. You can add them easily by clicking on Bridgepoint Education, Corinthian Colleges, ITT Educational Services, and The Washington Post. Don't have a watchlist yet? Set one up now -- you'll get timely updates and a free copy of the special report "6 Stocks to Watch From David and Tom Gardner."