Less than two weeks ago, shares of Grand Canyon Education (LOPE -1.53%) took a huge hit when the Department of Education announced that students in California would not receive financial aid if they were enrolled in online programs at out-of-state, not-for-profit schools. Since the main school Grand Canyon Education services -- Grand Canyon University -- is located in Arizona, and people in California are students, that obviously had investors worried.
On Tuesday, Grand Canyon Education reported second-quarter results, and investors got another dose of news.
Grand Canyon Education (GCE) and Grand Canyon University (GCU) used to be one and the same. But the two separated last year, with GCE providing services to GCU and receiving 60% of tuition in return. The company is also free to pursue other partnerships in online program management (OPM). As I'll cover below, management teased lots of details about this in the conference call this week.
Let's sort through all the news to get a better picture of everything that happened.
Grand Canyon results: The raw numbers
Before we dive into the details, let's look at how Grand Canyon performed on the headline metrics. Because the company was both school and service provider in Q2 last year, I've adjusted the numbers in the table below to present results as if it were just a service provider, which gives a more apples-to-apples comparison.
|Metric||Q2 2019||Q2 2018||Change|
|Revenue||$175 million||$142 million||23%|
|Free cash flow||$108 million||($20 million)||N/A|
Even after presenting these adjusted numbers, there's still a lot to unpack. Technically, free cash flow did explode during the quarter, but there's an important caveat: It doesn't include the cash that GCE is lending to GCU for its own capital expenditures. Though the money is to be paid back with interest, this is an arrangement that the company will have in place for the next two years.
If we include that loan, then free cash flow actually swings to a loss of $32 million -- more than the same time last year. On one hand, this is important, as it reflects the reality of what's happening on GCE's balance sheet. On the other hand, viewing this "adjusted" free cash flow gives investors a better view of what cash flow will look like once GCU is up and running on its own.
From an operational standpoint, Grand Canyon continues to benefit from the leverage provided by not having to run a physical campus or pay academic staff anymore. Even though spending on academic services increased 111%, coupled with much more modest growth in counseling and marketing spending, overall operating expenses still plunged 31%.
A look at enrollment trends
With any education-focused company, enrollment figures are the most important metric to watch. On that front, Grand Canyon continues to do well -- both at its namesake school and with its recent acquisition of Orbis, which partners with schools to offer degrees in nursing.
|School||Q2 2019||Q2 2018||Change|
It's not surprising to see faster growth at Orbis, as it is working off of a much smaller base than Grand Canyon. That said, Orbis is outperforming even the most optimistic expectations management had when it made the acquisition.
Speaking on the conference call, CEO Brian Mueller said Orbis -- which already partners with 19 schools throughout the country -- expects to add two or three more by year-end. Additionally, in 2020, Orbis plans to open six to nine new sites. Crucially, six of those sites will be with new partners, while the potential for three more will come from existing partner schools expanding their capacity. Mueller said, "This represents more than the necessary amount of activity to achieve a greater than 35% enrollment growth rate in programs serviced by Orbis Education in 2020."
And when it came to questions surrounding the Department of Education's mandate, Mueller made it sound like nothing to worry about. When asked if there would be any adverse affect on enrollment, he said, "No. We will be fine." He added later in the conference call: "[GCU] took the risk on its own balance sheet that the Department of Ed and the State of California would come to a reasonable conclusion on this, and that financial aid would be disbursed. And so that's why there is really no impact on GCE, and frankly, other than a short-term cash impact on GCU there was no impact on GCU." Mueller serves as both the CEO of GCE and the president of GCU.
Investors should keep an eye on whether the ruling has any effect on enrollment trends at the school in the future.
Perhaps the most interesting tidbits of information on the conference call came from Mueller providing color on the type of schools GCE expects to sign contracts with in the coming year. Here are some of the characteristics of the schools -- there are currently three GCE is talking to -- that could sign contracts soon:
- They will be private institutions.
- They will be located in the Midwest and/or Northeast.
- They will have a desire to scale to 5,000 to 7,000 students over five to seven years.
- They will be differentiated based on brand, geography, and program mix so as to avoid cannibalization.
- The earliest GCE would start enrolling students at these partner schools would be the fall of 2020.
Management also provided guidance for the third and fourth quarters, which looked like this:
|Q3 revenue||$192 million||24%|
|Q4 revenue||$214 million||20%|
Investors shouldn't be too worried about the predicted earnings slowdown, as much of it is due to the aggressive reinvestment in Orbis discussed above. If the company can consistently hit 35% enrollment growth over the next year, it will certainly be money well-spent.