The market's been singing some Pink Floyd lately -- specifically, "We don't need no education!" It's music to my ears.
Everyone and their alma mater hates for-profit universities. An index of the sector is down 46% from its April highs, as investors seem to be bracing for sweeping reforms and draconian regulations, whether from Congress or the Department of Education.
At the same time, think about these numbers:
- Unemployment among bachelor's-degree holders: 5.1%
- Unemployment among high-school graduates: 10%
- Unemployment among those without high school diplomas: 15.7%
Roughly 67% of the U.S. population above the age of 25 -- 88 million people! -- lacks a college education. President Obama has set the ambitious goal for the United States to reclaim its status as first in the world in college attainment; we currently rank 12th, and estimates find us 13 million-16 million graduates short. To meet our goals, we're gonna need a bigger classroom.
Given such opportunities, I'd rather be opening up the Louis-Charles University. (It has a nice ring to it, eh?) However, I estimate that my Rising Star kitty of $17,000 leaves me a bit short of getting my name emblazoned on a college library anytime soon. So for now, I'll settle for a 7% position (roughly $1,200) in a relatively young upstart, Bridgepoint Education
Why this one? Bridgepoint is an extremely profitable operation run by seasoned industry veterans, offering investors a ton of GULP -- growth at an unreasonably low price. But even though Bridgepoint offers one of the most attractive reward-to-risk investments in the space, it was still difficult to pick only one winner. So don't be surprised, especially if the sector stays beaten-up, to find me adding a few more educational names to my eponymously named ALOHA portfolio.
Say ALOHA to our little for-profit friend
Since I hear mnemonics are popular with studious college kids these days, I thought it apropos to roll out my ALOHA checklist on this pick. ALOHA is an acronym I use to remind me of the five key questions I ask of all my investments. Let's put Bridgepoint to the test:
Asymmetric: Are we being appropriately compensated for the risk we are taking?
Bridgepoint currently trades for 2.74 EV/EBITDA; it has no debt and 28% of its value in cash; and it's still growing by leaps and bounds. I've estimated an intrinsic value range for Bridgepoint of $45-$60 per share. Even if the company suddenly stopped growing, I still estimate the value of the shares at $24. To reach Bridgepoint's recent 52 week lows, you have to believe that its free cash flow will be roughly cut in half. Even using this dire scenario as my low estimate, and $45 as my high estimate, I arrive at a reward-to-risk ratio of 10-to-1.
Leveraged: Is there a natural edge or strategic advantage embedded in this investment?
In five years, Bridgepoint has grown from approximately 322 students to 77,179, while expanding gross margins from 31% to 74%. The online education model is highly scalable, and upon reaching critical mass, it's ridiculously profitable. Add in Bridgepoint's strategy to accept high levels of transfer credits (it's the only private-sector institution to accept up to 99 approved credits), partner with community colleges, and pursue growth though military and corporate channels, and you have a company with seemingly limitless potential.
Opportunity: What's the opportunity, why does it exist, and can we capitalize on it?
While a rising tide in for-profit education industry has lifted all boats for the better part of a decade, it also meant that both yachts and dinghies profited alike. Now that the tide is coming in, we're about to see which universities are truly seaworthy. I believe that Bridgepoint isn't simply fit to sail -- I think it's a speedboat with miles of calm ocean ahead.
Bridgepoint's repayment rates and graduation rates not only appear to comply with potential Department of Education requirements, but also consistently rank at or above those of more established for-profit universities. Additionally, with Warburg Pincus -- a very successful private equity firm -- as its largest shareholder, I see Bridgepoint potentially picking up some attractive pieces if and when its competitors implode.
Has a catatlyst: What crucial tipping point will affect this stock, and how soon?
The biggest catalyst for Bridgepoint is regulatory clarity. The Department of Education is expected to publish its final regulations early in 2011. The new regulations were originally expected to be published in early November, but the department is taking more time to "consider comments [they] received". The for-profit lobby is out in full force, and I expect that the initially proposed regulations will be somewhat tempered.
While the effects of these regulations will not kick in for six-12 months, the smarter institutions have already begun to adjust their operations. I believe it will be clear how the new regulations affect Bridgepoint's growth potential within three to four quarters.
Allocation: How big a position does this investment warrant?
Besides the cash and two campuses, Bridgepoint's value lies in its brand and earning power. Regulations could hurt its ability to grow enrollment, and headline risk jeopardizes the entire segment's reputation. However, if Bridgepoint is able to absorb the regulatory changes, and the media's appetite for this storyline fades, I expect this investment to be a two-to-three-year multibagger.
The Foolish bottom line
Rarely, if ever, will you find a debt-free company with 30% operating margins, growing revenue at 50%, which sells for less than eight times trailing earnings. Bridgepoint Education is one of those rare opportunities and I look forward to its matriculation in my Rising Stars real-money portfolio.