ESI - ITT Educational Services

[Phoenix01]

Sanjeev had a great idea to start a company specific board.  This will be very useful for exchanging ideas.

 

I have moved over the ESI specific information from the general board.  Does anyone one the board have the for-profit education system inside their circle of competence?

 

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I have just loaded up on ESI.

 

The critiques against the industry are justified and relate to the shady operators that have been finding sub-prime students, loading them with government loans in order to fill up their schools.  I have not researched Apollo in detail, but they seem to be one of these.

 

ESI is runs more conservatively and has a much lower portion of students using government loan (70% versus 90%+).  They have been bunched up with all of the others, but I think that is a mistake.  25% of the executive bonuses are based on the student success (i.e. finding gainful employment after graduation).

 

As far as being good operators, ESI has the highest margins in the industry and is generating a ton of cash.  They are using most of this cash to buy back shares.

 

The shorts have been all over ESI, and accounted for 7.7M shares.  There are only 33.5M shares outstanding and the institutional investors own 36.2M shares.  The insiders also own 3.8M shares, so there are at least 16.3M shares missing without considering the buybacks and the non-institutional players.  This feels like Fairfax all over again.

 

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A nice thing about ESI is that Columbia Acorn owns a small portion of it.

 

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On VIC, even if you just have a guest account you can read the write up for EDMC which serves as a comprehensive look at the industry as a whole and the headwinds that they face. ESI is one of the companies that is described in the write up as facing substantial headwinds.

 

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The article has an interesting approach to analyzing the situation.  It is mechanical and misses some of the finer points that set ESI apart from its competitors.  The base assumption is that the enrolment will shrink because a portion of the students will no longer be able to get access to the loans if the costs are too high.  However, ESI enrolment has continued to increase enrolment in Q1 & Q2 and the management has addressed this issue in the past by providing alternative financing and also bursaries and other fiscal incentive for student with good grades.

 

The alternative financing is through a joint venture with other investors to create a trust that provides the loans.  ESI is on the hook for the defaults above a specified level.  This is shown in the balance sheet as restricted cash and is a negligible sum.  A quick look at Apollo shows that they have significant restricted cash that keeps increasing.  I am assuming that a similar financial set-up was put in place for Apollo but with different results.  The bursaries and incentives costs are rolled into the SG&A and shown in the Income Statement as student services and administrative expenses.

 

ESI management seems very aware of their responsibility towards providing the students with gainful employment and have stayed well below the mandated levels.  I do not foresee any significant impact of the new rules on their long term performance.  If anything, the cleaning of the industry bad apples may provide further opportunities.   If I have missed something, please let me know ASAP!!!!

 

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The impact of the regulation seems to be over blown.  Secretary Arne Duncan from the U.S Department of Education gave the following telephone interview.

http://www.ibj.com/proposal-links-subsidies-for-itt-educational-peers-with-performance/PARAMS/article/21290

 

While most education companies provide valuable training and skills, high-cost education programs that lead to low-wage jobs are harming students, leaving them with hard-to-pay debts, Duncan said.

 

“We want to hit the ones at the bottom, those that simply aren’t working for students,” Duncan said in the press briefing. “The 5 percent would frankly be the bottom of the barrel.”

 

ESI is not that 5%.

 

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From the ESI annual reports

 

If an institution’s FFEL/FDL official cohort default rate is 25% or greater in any of the three most recent federal fiscal years, the ED may place that institution on provisional certification status. The ED may more closely review an institution that is provisionally certified, if it applies for approval to open a new location or offer a new program of study that requires approval, or makes some other significant change affecting its eligibility. Provisional certification does not otherwise limit an institution’s participation in Title IV Programs.

 

Below is a list of the ESI cohort default rate.

 

Federal Fiscal Year

FFEL/FDL Cohort

Default Rate Range

2008 (a) 3.6% to 15.5%

2007 (b) 2.7% to 15.2%

2006 1.7% to 12.9%

2005 1.3% to 12.6%

2004 5.8% to 12.7%

2003 4.5% to 10.2%

2002 2.1% to 12.1%

2001 4.9% to 12.7%

2000 4.5% to 17.5%

(a) The most recent year for which the ED has issued FFEL/FDL preliminary cohort default rates.

(b) The most recent year for which the ED has published FFEL/FDL official cohort default rates.

 

6. Financial Aid Programs

We participate in various Title IV Programs of the HEA. In 2009, approximately 70% of our revenue determined on a cash accounting basis under the calculation of the provision of the HEA commonly referred to as the “90/10 Rule” was from funds distributed under these programs.

We administer the Title IV Programs in separate accounts as required by government regulation. We are required to administer the funds in accordance with the requirements of the HEA and the ED’s regulations and must use due diligence in approving and disbursing funds and servicing loans. In the event we do not comply with federal requirements, or if student loan default rates rise to a level considered excessive by the federal government, we could lose our eligibility to participate in Title IV Programs or could be required to repay funds determined to have been improperly disbursed. Our management believes that we are in substantial compliance with the federal requirements.

 

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Blum Capital Partners currently hold over 10% of the outstanding shares and is adding more on the weakness.  Is anyone familiar with Blum?  Do they have a good track record?

[shalab]

I think some of the negatives here are as follows:

 

1. Economy- will pople spend money on pvt education

2. Loan for pvt education - issues; support by govt for traditional institutions

[Phoenix01]

The Apollo group actually has a really good presentation on the need for education going forward.  I think there is a tremendous need for better and cheaper education and the for-profit sector is desperately needed by the government to help fulfill the void.

 

http://www.apollogrp.edu/Investor/Presentations/BMO%202010%20Presentation%20FINAL.pdf

 

[snailslug]

2 interesting facts about Blum Capital:

 

1. Richard Blum is married to Dianne Feinstein

2. Richard Blum is on the University of California board of regents and was recently the chairman of the board

 

And, an interesting article on Richard Blum:

http://www.berkeleydailyplanet.com/issue/2010-06-22/article/35661

[Phoenix01]

That article really makes Richard Blum look like a scummy guy.  It makes me appreciate Prem & Co that much more.

 

How does this impact ESI?

1) Blum is the largest shareholder is trying to tilt the industry in the favour of for-profit colleges. -- Not ethical, but favourable to ESI.

2) Blum has been involved in the for-profit industry since 1987 and has profited handsomely by buying on the lows (such as now) and selling at the peaks. -- Extra attention must be taken if/when Blum starts to sell.

3) Hopefully Blum will be removed from his conflict of interest position. --  Point #1 is cancelled.

 

The influence that Blum has on the company needs to be assessed.  None of the board members are from Blum Capital Partners, or even come from the investment industry, other than David Nierenberg who joined in 2010 and serves on the board of Whitman College (private college with 3 defaults out of 659 loans over the past three years).

 

Other than the board of directors, does anyone have any ideas how else Blum can influence the ESI management?

 

 

[stahleyp]

phoenix, you may just be on to something with this one!

[Ross812]

From an excel program I created using smf-add-in. Look at that revenue deviation! 

[Phoenix01]

In order to consider all sides of the debate, I got the chance to review the Steven Eisman presentation (Thank you Omagh for pointing it out).

 

In general, I agree with him, but when he extends his argument to ESI, there are subtleties that are missed.  The main argument surrounds the 90/10 rule, and that is what took down Apollo.  The 90/10 rule stipulates that when a for-profit school gets 90% or more of its revenue (on a cash basis) from Title IV funding, then it is put under review.  If they do it two years in a row they lose the right to the funding for at least two years.  Apollo has all of its U of P for-profit schools under one single entity, so if they default, every single school will be affected.  This is the nightmare that Apollo is facing.  The % of non-Title IV revenue was decreasing at a CAGR of 19% while Title IV revenue was increasing at a CAGR of 30% from 2006 to 2009.

 

ESI on the other hand has increased non-Title IV revenue at a CAGR of 7% while Title IV revenue was increasing at a CAGR of 29% from 2006 to 2009.  The ESI ratio is around 70% but the presentation shows it as 85% because some of the Title IV funding is excluded under a sunset clause.  I was not able to find out more about when the sunset clause expires, but ESI management is keenly aware of the 90/10 rule and is continually taking steps to make sure that they are in conformity.

 

 

 

 

 

 

[jasonw1]

I'm puzzles by the demand for for-profit education schools, for roughly the same amount of cost, who in their right mind will choose to go to these schools? Are their certification recognized by general public and empolyers? I haven't yet met anyone who's a graduate from these kind of schools and have a decent career.

[Phoenix01]

I'm puzzles by the demand for for-profit education schools, for roughly the same amount of cost, who in their right mind will choose to go to these schools? Are their certification recognized by general public and empolyers? I haven't yet met anyone who's a graduate from these kind of schools and have a decent career.

 

They are serving the segment of the market that does not traditionally get the opportunity to obtain post-secondary education.  The price is high, but it is an opportunity that would otherwise not exist.

[Myth465]

I dont know I just dont buy it. Here in Houston there are plenty of cheap community colleges to go to.

[stahleyp]

I'm puzzles by the demand for for-profit education schools, for roughly the same amount of cost, who in their right mind will choose to go to these schools? Are their certification recognized by general public and empolyers? I haven't yet met anyone who's a graduate from these kind of schools and have a decent career.

 

 

I'm with you, jason. the stocks seem cheap, but they are certainly morally gray...to say the least.

[hyten1]

folks,

 

i'm curious as to what people think.

 

i don't see why a for profit educational service shouldn't or couldn't exist. Conceptually i don't see a reason why higher education should only be non-profit. would love to hear what everyone's thought is on this topic.

 

now for me, i have answer the above question for myself (my answer, i think a for profit edu industry can exist) then the next question is can the current form of for profit exist and how big/small can this be, and in what way or area of education would be good for for profits. I definitely think certain profession/trade, for profit is the way to go, like trade skills (i.e. mechanics, etc).

 

after you get some idea for the above i then dive into individual situations as well as paint potential scenarios base on how new legislation could affect these companies. coming up with some reasonable worst case senarios.

 

 

[watsa_is_a_randian_hero]

I dont know I just dont buy it. Here in Houston there are plenty of cheap community colleges to go to.

 

Cheap because they are subsidized.  Without state, federal subsidies to the schools directly and through research grants, their tuitions would be comparable to non-profit and for-profit private schools.

 

I did my econometrics paper in school with the thesis that government subsidies play a large role in the reason price of education has risen faster than general inflation (artificially boosting demand).

 

My general feeling is that our country is over-educated; half the people in college have no business being there  (drink/smoke way through school) and should go to trade schools or apprentice programs right out of high school.  It is a huge waste of society resources, and they largely end up in debt and burdened for the rest of there life.

 

College is not for everyone; my sister and I both went to school (in addition, she is in a top 5 bschool program right now, I have CFA charter).  On the flip side, my brother dropped out after a year, and is doing just as well or better with entrepreneurial endeavors he has undertaken.   

[stahleyp]

I dont know I just dont buy it. Here in Houston there are plenty of cheap community colleges to go to.

 

Cheap because they are subsidized.  Without state, federal subsidies to the schools directly and through research grants, their tuitions would be comparable to non-profit and for-profit private schools.

 

I did my econometrics paper in school with the thesis that government subsidies play a large role in the reason price of education has risen faster than general inflation (artificially boosting demand).

 

My general feeling is that our country is over-educated; half the people in college have no business being there  (drink/smoke way through school) and should go to trade schools or apprentice programs right out of high school.  It is a huge waste of society resources, and they largely end up in debt and burdened for the rest of there life.

 

College is not for everyone; my sister and I both went to school (in addition, she is in a top 5 bschool program right now, I have CFA charter).  On the flip side, my brother dropped out after a year, and is doing just as well or better with entrepreneurial endeavors he has undertaken.   

 

watsa,

 

I agree with this too. I'd think for profit schools could be just as lucrative as the traditional programs someday. However, they currently tend to those who normally wouldn't go to college. As you said, there are a lot of people in college that college isn't where they should spend their time or society's resources.

 

I've heard the reason college is so expensive because the governement subsidizes it. The schools know how much money is available from grants, aid, loans, etc, and go after it. The government sees that other students need funding and then dishes out more money...and the cycle continues. The general idea is that more education makes the country more competitive. However, like you said, too many people drink/smoke their way through school for them to receive any actually benefits. I'd say the currently system works marginally, at best.

 

You'd think, that as more people go to school, economies of scale would occur. It doesn't cost much more to teach 25 kids compared to 20. Combine economies of scale with the massive increase in of profits by many of these schools, it's really amazing that education increase by the amount of inflation. it's even crazier that in can double or triple inflation!

[Myth465]

I agree with most if not all of your points but your libertarian beliefs have no place in this thread  8) JK. This was directed at Watsa.

 

More college is not the solution. There are not enough jobs, college is part of the weeding out process, and the non props have bad reps. If someone went to Houston Community College and transfer to University of Houston to finish things up - I would think they were sensible and smart.

 

If someone goes to University of Phoenix, I wonder what the hell they were thinking and throw their application in the trash. No way around that.

 

The place for for profit title 1 education is in Trades such as nursing and such. but some of the schools are so bad that graduates cant get jobs in these fields. The front-line documentary spends sometime going over this and its shocking.

 

INMO the business model is shot, over the long term and they survive off the Government tit over the short term. The government is broke, and the evidence shows these guys charge too much and dont do a great job. There is likely a diamond in the rough somewhere though. Hopefully you have found it.

[hyten1]

myth i don't think these are libertarian beliefs :)

 

on another note, that is how i usually START to think about/analyze biz/industry where a lot of people say shouldn't exist or are going alway or is a fad.

 

sometimes i agree with conventional view sometimes i don't. Its when the i don't happen (and obviously if i am right) where the big opportunties come in

 

 

[watsa_is_a_randian_hero]

You'd think, that as more people go to school, economies of scale would occur. It doesn't cost much more to teach 25 kids compared to 20. Combine economies of scale with the massive increase in of profits by many of these schools, it's really amazing that education increase by the amount of inflation. it's even crazier that in can double or triple inflation!

 

In addition, you would think technology, ie the availability of free infinite information on the internet, would reduce cost.  I'm sure you could youtube just about any topic in the world and get a tutorial in any language you wanted. 

 

I wasn't even thinking about it from that perspective though.  Thinking about it from the perspective of this false mantra that "we need more education to compete"?

 

How about we need better education to compete!  Not everyone needs to go to a 4 year program, or even a 2 year program!

 

My ideal system would have no government subsidies for student loans or school.  There would be more corporate apprenticeships.  Those top 25% of the population who are future doctors, engineers, lawyers, bankers, professors, nurses, ect go to school.  Generally they would be able to get student loans on the basis of their intelligence. 

 

Its incredible to me that no student loan underwriter asks for test scores or GPA!!!  Or major?!?!?!  One would think the 3 factors that would have the highest predictive power in ability to repay would be test scores, gpa, and major. 

 

They don't ask this because they are not worried about repayment because of government guarantees.  I find it ridiculous I have friends in medschool paying 8%+ for student loans - 400bps higher than mortgages right now!!!  Its because all of the supply is going to FFELP-backed abs, rather than helping those that truly deserve cheap loans.

[watsa_is_a_randian_hero]

They don't ask this because they are not worried about repayment because of government guarantees.  I find it ridiculous I have friends in medschool paying 8%+ for student loans - 400bps higher than mortgages right now!!!  Its because all of the supply is going to FFELP-backed abs, rather than helping those that truly deserve cheap loans.

 

As a follow up - I have other friends majoring in things like librarian sciences and sociology, and because it is undergrad they get FFELP-backed loans that are interest-free in school and then subsidized after school.

 

A helluvalot cheaper than 8%+ my medschool friends are paying!  Seems like we are subsidizing the wrong things!

[biaggio]

Watsa,

 

there's a good book called "The millionaire Mind" written from the author's PHD thesis

 

basically you would agree with a lot of stuff in it.

 

He studied famously successful people. Some interesting examples (the one I remember was of Bob Lutz, former GM Chairman--apparently had a great deal of trouble in school. School was always trying to discourage his mother/asking her to enlist him in  a trade school...but she insisted that he was going to go to college. He graduated from HS at the age of 19...you know the rest of the story)

 

-among the top 5 factors related to success would be passion, interpersonal skill, being married only once(oddly enough), supportive parents

 

- having good grades, high IQ , graduating from right college/university did not correlate with success.

 

Nevertheless I did not share this with my kids,I still want them to have a topnotch education if possible

[watsa_is_a_randian_hero]

-among the top 5 factors related to success would be passion, interpersonal skill, being married only once(oddly enough), supportive parents

 

- having good grades, high IQ , graduating from right college/university did not correlate with success.

 

I've seen studies that have shown IQ correlates with income (but with diminishing returns, obviously).  Not sure if that's one of your measures of "success."

 

[Phoenix01]

There will always be a need for structured education.  Will a for-profit school adapt quicker than a state funded one?  I would think so.  From an investment perspective, there will always be market for their product and the government will always be in a position where it must help fund their customers.  A well managed company in this environment has a very bright future, even if some other players in the market being abusive.

 

ESI released the Q3 today and they are tracking to expectations (business as usual) and expects to make $11 EPS.  That means it is trading at a P/E of 5.  There was stellar growth in the past 2-3, making next year's growth expectations pale by comparison.  Going forward they will likely be growing revenue at a more traditional rate of 6-8%.  Operational efficiency increases, lower capex and share buybacks will increase the EPS at a higher rate.

 

[Ross812]

Phoenix,

 

I listened to the call as well.  I heard basically the same thing.  I liked how they were not evasive on any of the questions asked too.  I liked they affirmed their private loan division has capacity till at least Q2 2011 based on their current budget and no shortfall is expected.  I also liked how they said the 90-10 this year would be in the mid 70's.  Their is a lot of macro talk going on for ESI.  I just cant help but think it is a little over blown.  Look at the revenue and EPS data.  This is a very well run company.  Does it deserve the P/E of 5?  I can tell you it is getting hammered because if they do have to cut tuition by 30% the market is afraid the cannot service their debt.  This just feels like the financial crises all over again on a smaller scale.  Or the oil spill this summer.  Apollo and some others may have some trouble much like BP did, but there will be some great values coming out of this.  I'm with you phoenix.  I think ESI risk/reward is favoring the later. 

[stahleyp]

 

 

In addition, you would think technology, ie the availability of free infinite information on the internet, would reduce cost.  I'm sure you could youtube just about any topic in the world and get a tutorial in any language you wanted. 

 

 

Speaking of which, but you guys should check this out.

 

http://www.khanacademy.org/

 

The Gates Foundation gave this guy some money for funding. He formerly worked for a hedge fund, but now runs this organization.

[Phoenix01]

 

 

In addition, you would think technology, ie the availability of free infinite information on the internet, would reduce cost.  I'm sure you could youtube just about any topic in the world and get a tutorial in any language you wanted. 

 

 

Speaking of which, but you guys should check this out.

 

http://www.khanacademy.org/

 

The Gates Foundation gave this guy some money for funding. He formerly worked for a hedge fund, but now runs this organization.

 

Salman Khan is an exceptional person and I applaud his efforts.  I will definitely be showing his videos to my children.

I only wish that the insanely huge bureaucracy of the education system could adopt this sort of learning method to quickly teach the children in a way that respects their individual learning styles.  After all the students are the customers!!  The time that is not wasted in frustrating students, could be dedicated to physical activity and social development.

 

However, I do not think that this will take place for a very long time.  Bureaucracies are not geared towards efficiencies, especially when they are not held accountable.  The current mode is to blame the shortfalls on the children, guilt the parents and then use fixes such as drugs and extra tutoring.

 

I can see the for-profit schools adapting some of Khan’s ideas in order to deliver more efficient solutions that will increase their margins and give the students a better education.  I can see the state run schools being forced to change their methods only if the quality of their graduates slips below that of the for-profits.  But that will not happen any time soon, since they select only the best students and those students are also able to supplement their education by viewing Khan’ videos.  In short the status quo will persist, and students will continue to supplement their education using the web, even though the quality of this supplemental learning is now better than the status quo.