Are These Education Stocks About to Fail?

If you are among the people out there who follow my articles, you know I'm not a fan of for-profit education. 

The industry has boomed over the past decade. Schools have raked in record profits, while leaving students crippled under the burden of debt, unable to find gainful employment with their degrees.

That being said, I have set out to discover whether we can find a diamond in the minefield that is the for-profit education sector. I am doing this by examining three risks facing schools.

  1. Shrinking new-student enrollment.
  2. School funding.
  3. Student-loan defaults.

Having covered the enrollment numbers yesterday, I will be focusing today on how schools are funded.

The 90/10 rule
This rule, policed and enforced by the Department of Education, states that for-profit schools can derive no more than 90% of their yearly revenue from Title IV funds. These funds represent the bulk of government aid granted for the purpose of attending college (public, private, and for-profit), and are more commonly referred to by their specific names: Stafford loans, Perkins loans, Pell grants, etc.

In other words, to make sure an organization isn't just swindling the government, students collectively must cover 10% or more of the school's revenue without assistance from the government.

The rule itself shows how much risk investors take on when investing in for-profits. When so much revenue is derived from one customer (here, the government), schools are at the mercy of that customer.

The lower a school's numbers in the table below, the better position it is in. Here's how the companies currently stack up, according to their Securities and Exchange Commission filings.

School

90/10 standing

Corinthian Colleges (Nasdaq: COCO  ) 89.8%
Apollo Group (Nasdaq: APOL  ) 88.0%
Bridgepoint Education (NYSE: BPI  ) 85.0%
Strayer Education (Nasdaq: STRA  ) 78.0%*
Education Management (Nasdaq: EDMC  ) 77.0%
ITT Tech (NYSE: ESI  ) 59.0%
American Public (Nasdaq: APEI  ) 19.0%

Source: SEC Filings. *For 2009.

The danger zone
The numbers above represent the total weighted amount of revenue that comes from Title IV. But instead of using this measure, the government goes on a campus-by-campus basis. This could spell doom for some schools.

Take Corinthian, for example. While it was able to collectively pass the 90% rule by a razor-thin 0.2%, 42 of its 49 campuses exceed the 90% threshold, meaning that these campuses will lose federal funding if they don't get their act together within two years. Even more suspect is the fact that Corinthian recently raised tuition, forcing students to pay more through private loans, in order to duck beneath the 90% threshold.

Apollo and Bridgepoint have also publicly stated that, because of recent increases in Title IV grant and loan limits, they will be flirting dangerously close to the 90% threshold during this fiscal year.

The rest of the pack
While Strayer, Education Management, and ITT seem to be safe for now, they are subject to the same pressures that all industry players face.

The company that stands out, though, is American Public Education. Functioning primarily as an option for officers in the military to obtain their degrees, it has been able to avoid getting into potential trouble with the 90/10 rule.

That may not, however, be the case for very long. Some members of Congress have stated a desire for money from the Department of Defense's tuition assistance program to count toward the government assistance total. As of now, such funding does not count against American Public. Because its students are predominantly from the armed forces, such tuition assistance accounts for a large portion of overall revenue. There's no specific timeline for when such changes may even be discussed.

Foolish takeaway
As you can probably see by now, when free-market economics become entangled in government regulation, it can be difficult to project into the future with any level of certainty. It remains to be seen whether the Department of Education will follow through on closing campuses that exceed the 90% rule. It would surely put hundreds of school staff out of a job, and that's the type of action that government agencies are loath to take.

We're more than halfway to finding our diamond in the rough. Though today didn't yield any clear leaders, American Public is attractive with the funding rules as they are today.

Check in tomorrow. I'll be discussing what I see to be the most important metric to evaluate: student-loan default rates.

In the meantime, if you have specific thoughts on the for-profit education industry, leave a comment below and help us form a fuller picture of the challenges facing the industry.

Fool contributor Brian Stoffel does not own shares in any of the companies mentioned in this article. Motley Fool Options has recommended a call spread position on Bridgepoint Education. The Fool owns shares of American Public Education, Bridgepoint Education, and Strayer Education.

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  • Report this Comment On May 19, 2011, at 2:50 PM, Houqua wrote:

    For sure, there are bad actors in this space, with a government funding model that allows and even encourages abuse and churning of students. In effect, the government has been funding failure, given the low graduation rates as measured over a 6-year period. However, this is also true in the non-profit world. Graduation rates are even worse at community colleges, and not much better at non-profit public and private universities.

    What is also true is that most of the innovation and advances in teaching (especially online) and in the development of curriculums with meaningful application in the workplace in recent years have been made in the for-profit sector, which focuses on working adults.

    It is the debt burden on working adults, who face many headwinds when trying to attain a college or graduate degree while working and raising a family, that creates the societal problem (low graduation rates and high loan defaults). Non-profit colleges and universities are subsidized with taxpayer funds and endowments, so less of the burden falls directly on college age (18 to 25) students who also get help from their parents and rely less on government loans.

    There are companies in the for-profit sector that will do well over time, because the demand for better working adult education will remain high. If a spotlight was shone on the non-profit sector, the results wouldn't be pretty. At the non-profits, research, publishing, and the care and feeding of the faculty and administrations tend to take precedence over teaching. The non-profits move very, very slowly and have not been innovative when it comes to teaching.

    What this says to me is that there is a temendous national need for better adult education that is not and will not be filled by and large by the non-profit world. Yes, the bad for-profit actors will fail or go away, but companies like Strayer, Capella, and American Public Education are credible education companies that will continue to grow. The funding problem is a profound one that must be addressed. But so is the country's education gap.

    In my view, the innovative for-profit companies may see their margins decline over time as they spend more to improve graduation rates, but they will grow on an absolute basis as they serve the unmet need for working adult education, a need the non-profit sector has shown little interest in meeting. At current prices, you will make decent returns in some of these names (STRA, CPLA, and possibly APEI, to name a few) over the next five years.

    The debate, led in part by Senator Harkin, has been too directly focused on the for-profits. The country (this is directed to you, Senator Harkin) needs to look at all of the providers of college and graduate education and develop a grant and loan program that makes investment sense for the country, for students, and for investors. It is not easy to get a college degree, and it is even harder for adults who are working and paying mortgages and taxes and raising a family. The time and energy put into "gotcha" finger pointing by Harkin and in most cases (but not all) a go-along media that isn't doing much original reporting, where the focus is purely on abuse rather than larger goals to achieve better outcomes, is mostly wasted.

    It may be that, given our poor secondary education results, the best opportunity is in remedial education to better prepare students for college work, which might help to improve graduation rates. The for-profits are probably best positioned to meet this need. The demand is certainly there. Assuming education is a high priority for the country, the better for-profits will survive and thrive. It will take some time, for sure, but they will survive and thrive.

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