Shareholders in for-profit education player Career Education (NASDAQ:CECO) received a rude awakening after poorer-than-expected profitability in the company's latest financial update led to a sharp subsequent drop in its share price. The company reported another operating loss that continued a stretch of red ink that dates back to 2012; it was hurt by a double-digit drop in its student enrollment rolls and this trend has affected most of the industry's top players, including Education Management (OTC:EDMC).
On the upside, though, Career Education's market valuation approximates its net cash position because the company sold its international operations in 2013; this makes it the ultimate value play, assuming that it can eventually find its way to profitability. So is it a good bet at current prices?
What's the value?
Career Education is one of the largest for-profit education companies, providing post-secondary education services to roughly 55,000 students across the country. Like other for-profit players, Career Education focuses on curricula that are of interest to its mostly part-time student base, which include business, health care, and the culinary arts. High student demand for degrees in those areas led to strong enrollment trends and operating profitability for Career Education until 2011, when the government started aggressively investigating the industry, ostensibly due to high student loan default rates; the government blamed these on questionable recruiting practices and high student dropout rates, among other factors.
Not surprisingly, the cloud hanging over the industry has negatively affected Career Education's total enrollment levels, which have been on a generally downward trajectory of late. The company has anecdotally been hurt by negative publicity, as well as the need to close certain campuses, due to its inability to meet the increasingly stringent operating criteria of its regulators and accrediting agencies. Combined with rising administration oversight and student services costs, the net result for Career Education has been severely reduced operating profitability, highlighted by a large operating loss in its latest fiscal year.
Misery loves company
Of course, Career Education isn't alone in its current quagmire, as competitors like Education Management are generally in the same boat. Like Career Education, Education Management has been unable to satisfy more stringent operating criteria at certain of its campuses, which has led to select closures and a similar downward trajectory for its enrollment rolls.
Fortunately, Education Management's larger geographic diversity and overall size -- it has twice as many enrolled students as Career Education -- has allowed it to remain profitable on an adjusted basis, as well as cash-flow positive. On the downside, though, the company's ill-advised leveraged buyout in 2006 by a private equity group led by Goldman Sachs saddled it with a hefty debt load, a definite negative as it deals with the prospects of reduced operating profitability in the future.
No price too low
While Career Education is undoubtedly cheap, as it sells for roughly its net cash position, it is hard to forecast when the company will find its way back to profitability, given the government's evolving rule-making activities in the education area. As such, investors looking for gold in the for-profit education sector would probably do better with an operator that has a more diversified business mix, like Graham Holdings (NYSE:GHC).
The former owner of the iconic Washington Post newspaper has been busy restructuring its operations lately; it has sold off most of its newspaper assets and reinvested the proceeds in potentially higher-return businesses, much like what former board member Warren Buffett might have done. That being said, the company is heavily committed to the education space, which Graham Holdings primarily participates in through its Kaplan post-secondary education and test preparation units. More importantly, while Graham Holdings has been likewise hit by the costs of higher regulations in the education space, its international diversification has allowed it to find a path to profitability; this is evidenced by a small profit for its education segment in its most recent fiscal quarter.
The bottom line
Companies selling for their net cash balances often make good investments, and value investing legend Benjamin Graham pointed this out in his book The Intelligent Investor. However, with the government targeting the for-profit education sector with as yet undetermined new rules, Career Education's path to profitability might be a long and winding road. As such, investors are probably better off letting this opportunity pass by.
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