For-profit educators have enjoyed booming business in recent years -- but the arrival of the Obama administration could signal greater scrutiny and regulation of the industry.
For-profit education has grown rapidly in recent years, boasting a total market capitalization of more than $25 billion. But its dependence on government financing and part-time non-union teachers may increase its vulnerability to an administration that seems to have greater sympathy for unions than its predecessor. A recent report from the American Federation of Teachers, which has long criticized for-profit schools, bemoaned a drop in tenure-track teachers in higher education as a "troubling" sign.
The bullish case
Companies like Apollo Group (NASDAQ:APOL), whose University of Phoenix provides post-secondary training and degrees, are attracting soaring numbers of students dissatisfied with the alternatives provided by public education. Though still small relative to overall spending on education, for-profit schools in some markets have taken a meaningful share of some of education's fastest-growing segments.
The case for the for-profit sector rests on the advantage of a college degree, which has never been more obvious. As detailed in the government's April jobs release, unemployment for those holding less than a high school diploma is 14.8%, compared with 9.3% for those with only a high school diploma, and just 4.4% for those with a bachelor's degree or higher.
At the same time, the income disparity between different levels of education has also increased. Census Bureau data shows that college graduates earn some 80% more, on average, than those with only a high school diploma; over a lifetime, those with a college degree will out-earn those without higher education by $1 million.
The U.S. economy is demonstrably shifting toward knowledge-based products and services, demanding more education and training. Yet only 29% of the U.S. population over 25 holds a bachelor's degree; not even half of those enrolled in college complete their degree. One private equity firm that has invested in the highly fragmented sector projects growth of better than 9% through 2013, offering plenty of potential to well-funded participants.
This growth outlook, combined with the tendency of workers to go back to school during recessions, made for-profit schools one of the few Wall Street winners last year. Market leaders Apollo, DeVry (NYSE:DV), and ITT Educational Services (NYSE:ESI) were each slightly up in 2008, against a market collapse of 39%.
These companies, along with Corinthian Colleges (NASDAQ:COCO), Grand Canyon Colleges (NASDAQ:LOPE), Strayer Education (NASDAQ:STRA), and American Public Education (NASDAQ:APEI ) also benefit from excellent operating leverage. Once a school's infrastructure is in place,the incremental cost of adding each new student is minimal.
Accreditation requirements provide meaningful barriers to entry, and for-profit schools can easily change focus and add or subtract degree offerings as demand shifts. The for-profit companies compete by teaching marketable skills; in short, they promise graduates they will find jobs, and they help them do so.
Cloudy skies ahead?
Lately, investors have rotated out of the sector, looking for companies that might better benefit from an economic recovery. Year to date, Apollo and DeVry are off 20% or more, while ESI is modestly ahead.
The pullback in the stocks has been fueled by concerns about shifts in student lending, and by the high cost of the degrees offered by the University of Phoenix and similar institutions. These expenses can saddle graduates with a heavy debt burden, often rivaling the cost of attending a prestigious nonprofit college. As at private colleges, tuitions in the for-profit sector have risen faster than the rate of inflation, plumping up margins, but straining students' capacity to pay. As many of the schools have stepped in to supply needed financing, they have taken on a new risk.
Some investors and analysts are also beginning to focus on the possibility that the Obama administration will intervene in the industry. A report from Credit Suisse analysts late last month discussed the possibility of "more Washington oversight," which could take the form of more frequent reviews by the Department of Education … or more serious measures.
The report mentions the appointment of Robert Shireman as deputy undersecretary of education. Shireman founded the Institute for College Access and Success, which in turn sponsors the Project on Student Debt. A recent report by that group says that a disproportionate number of students at for-profit colleges take out private loans.
While 14% of all undergrads borrow privately to finance their education (up from 5% in 2003-2004), 42% of those enrolled in for-profit colleges do so (up from 13% in 2003-2004.) The Project considers these loans a bad bet, arguing that they are more expensive and offer fewer options for repayment.
The Foolish bottom line
While protecting students from crushing debt is a noble goal, I believe greater regulation would not only hamper the for-profit education sector, but also seriously reduce the ability of many Americans to enhance their job skills. If the Obama administration does cast a sharper eye toward for-profit education, investors' returns could suffer.
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