"If you love somebody, set them free."
-- Sting
The quarter that was
Last week, Career Education (NASDAQ:CECO) reported its third-quarter results. As you'll recall from our Foolish Forecast on the subject, CEC was expected to report $452 million in revenues and $0.29 per share in profits. As it turned out, the firm fell a few cents short of its profits target (earning less than half what it earned in last year's Q3). On the plus side, CEC cleared its revenues hurdle easily, helping to spark an 11% rise in the stock price. As it also turned out, that was just the beginning.
The quarters that will be
The truly big news at CEC concerned the company's plans to reverse the above anemic (though less so than feared) results. On Wednesday, CEC announced that it is taking the drastic step of selling off a full 15% of its school base -- 13 schools and campuses in all, including the nine Gibbs campuses, both Brooks College campuses, McIntosh College, and Lehigh Valley College. That announcement drove the stock up another 8%, and sparked sympathetic rallies in the shares of Apollo Group (NASDAQ:APOL), Corinthian (NASDAQ:COCO), DeVry (NYSE:DV), ITT (NYSE:ESI), and Laureate (NASDAQ:LAUR) -- every for-profit educator save Motley Fool Hidden Gems recommendation Universal Technical Institute (NYSE:UTI), in fact.
In a press release, CEC argued that the sale was necessary to "resolve our current issues, improve our operating results, and lay the foundation for future growth." Although selling off assets that generated 10% of last year's revenues might at first seem a funny way to lay a foundation for growth, the move actually makes a whole lot of sense. Hearkening back to that Sting quote above, CEC still loves these schools, calling them "valuable and important," and promising to "continue to invest in the schools throughout the divestiture process."
Nevertheless, they had to go.
No good -- just bad and ugly
Dividing the schools to be sold into two groups -- Gibbs and everybody else -- CEC's press release described the problem in a series of stark and laconic tables, which showed that neither group was generating profits for the firm, and both groups' performance was getting worse.
Accounting for 10% of the firm's revenues last year, the schools are closer to 8% so far this year. Comprising 15% of the firm's campuses, they house less than 10% of its students. However, they inflicted damage to CEC's income statement far in excess of their size, decreasing firmwide operating profits by 40% year to date and net profits by 54%. Ugliest of all was the Gibbs division, which has sapped 47% from CEC's net profit all on its own this year.
No fish here -- time to cut bait
Faced with a choice between trying to turn around this passel of money-losers, or selling them off and focusing its efforts on schools that are actually making money, CEC chose to -- in the parlance of the day -- cut and run. From this Fool's perspective, that's the right choice to make.
Once the presumably sizeable one-time charges to earnings have run their course, CEC should see a marked rise in its margins. With its ballast still on board, the company has fallen just short of scoring a 5% operating margin so far this year -- the lowest of any of the peer schools named above. But if you remove Gibbs & Co. from the mix, CEC's operating margins would have been a much more respectable 9%. That would be far from the 30%-ish operating margins that Apollo and Strayer routinely record, but would vault CEC over the heads of similarly struggling firms like Corinthian and DeVry.
More importantly from a shareholder's perspective, CEC can finally free itself from the need to spend the copious cash flows from its "good" schools to subsidize and turn around its "bad" ones. This company generates a truly stunning amount of cash every year. With any luck, it will soon be able to use that cash to invest in improving the remaining schools' profitability, buy back shares, or institute a dividend, any one of which actions could reward shareholders richly.
Need some remedial education on CEC? You'll find it in:
- Career Education CEO Expelled
- 3 Stocks That Missed the Mark
- Foolish Forecast: Career Education's Q2 Report Card
- Career Education Gets Detention, Again!
Looking for more small caps poised for big returns? Check out a 30-day free trial of Motley Fool Hidden Gems .
Fool contributor Rich Smith does not own shares of any company named above. The Fool has a disclosure policy.
