STRA - Strayer Education

[klarmanite]

Apollo Group, which I own in my private account along with Strayer, reported FY13 numbers the day before yesterday. Apollo is a worse educator than STRA, but has an unlevered capital structure with 7 USD in net cash per share and is generating a great deal of cash flow despite the downturn.

 

I'm not invested in these companies because I think they're nevessarily great companies going forward. My main point is that it's too soon to declare their business models obsolete. My thesis is that the low valuations, high short interest and doomsday scenarios priced in together can provide a nice bounce in share prices. Which I think might be happening now. It was clear that shorts were scrambling to cover yesterday anyway.

 

New enrollment trends stopped getting worse for the first time in a while according to APOL management. One data point does not a new trend make, but it is the first positive I have seen in a long time.

 

If on the other hand this proves to be a fluke and new enrollment trends deteriorate further over the next two quarters, I will probably exit both Apollo and Strayer.

 

[mevsemt]

Here's my write up on stra from when I purchased it back in May if anyone's interested:

 

http://mevsemt.blogspot.com/2013/05/what-just-happened.html

 

-mevsemt

[LC]

Q3 Release

http://www.sec.gov/Archives/edgar/data/1013934/000115752313005149/a50740790ex991.htm

[DTEJD1997]

I wonder if this is the high water mark for "for profit" education?

 

Will this touch off a price war amongst the providers?

 

Previously, cost was simply no object.  Now, it is finally starting to go down.

 

I think there certainly COULD be a place for "for profit" educators.

 

Imagine if they provided a decent product, but at a MUCH cheaper price than state schools?  Heck, they might even work to get students placed into jobs! 

 

Looks like change is coming to the industry and STRA is leading the way.

 

Kudos to them if they improve their product and help their students!

[klarmanite]

Yes indeed. But my thesis is pretty much dead. Sharply deteriorating new enrollment, no impact from new marketing initiatives and no buybacks likely any time soon. I'm cutting my losses and moving on. May take another look if Silberman buys big in the future.

[klarmanite]

I have also realized a nice gain in APOL - where I think the easy money has been made. Overall, this was a profitable sector trade, but my assumptions were wrong. I consider myself lucky to have gotten out ahead.

[thelads]

Dumb Question. But looks like they took out $50mm per year in expenses. That should offset most of the revenue decline. If that is the case and EBIT can stabilize @ 80mm or so - isnt this a prime candidate for PE - even as a melting ice cube?

 

I hear you on frustration from enrollment - but still interesting to watch where that flat lines if it does at all. If it does, then this is silly cheap @ 37.5 no?

[klarmanite]

You ask an interesting question obviously. It could be. I don't think that will happen before enrollments stabilize though. I still think intrinsic value is quite a bit above the curent price (ran the numbers with changed inputs).

[A_Hamilton]

Dumb Question. But looks like they took out $50mm per year in expenses. That should offset most of the revenue decline. If that is the case and EBIT can stabilize @ 80mm or so - isnt this a prime candidate for PE - even as a melting ice cube?

 

I hear you on frustration from enrollment - but still interesting to watch where that flat lines if it does at all. If it does, then this is silly cheap @ 37.5 no?

 

What are you using for revenue r to get to $80 million in EBIT? Rev in 2014 at current student run rates and w/ the price cuts could be in the $375-$400 million range...and that is if enrollments stabilize..suggesting little EBIT next year.

[thelads]

TTm revenue is about $520mm. The discounts apply to new undergraduate students. Undergrads are 60% of enrollments. I was taking a quarter of that as a new starts to which discounts would apply. Lets say its 20% (a third of all undergrads) of revenues that get reduced by 20%. so a 4% decline in total revenues. Leavinf revenues @ $499mm. a 20% decline for all undergrads would result in 18% decline overall revenues (assuming no growth in enrollment) would lead to revenues of $426mm. I think you are taking 100% of revenues and dropping them 20%, but I think that misses the student mix and would argue its probably too harsh. The truth of it (absent any increase or decrease in enrollment going forward) is inbetweent the $425-$500mm in revenues. For comparison - in 2007 and 2008 enrollment was 36k and 44.5k. Revenues were $318mm and $396mm and EBIT (which I think is a reasonable proxy for FCF here) was $97.6 and $172mm respectively. In addition, revenue per student was lower back then. For sure, since then strayer has engaged in more lease activity so there is risk to that. And of course, the $440mm question is what happens to enrollments? there is operational leverage here. But I think even with the reduced revenues here - they will be offset by the $50mm in annual expense cuts. Thats how i was getting to my number. I took Revenues of $460mm (in the middle of the above range) which is a $65mm change in revenues, then $50mm in expense reduction, for a $15mm decline in EBIT Which is $76mm.

 

Hope this clarifies where my numbers came from. Apologies for being vague, and for the inarticulate description in the paragraph above.

[A_Hamilton]

TTm revenue is about $520mm. The discounts apply to new undergraduate students. Undergrads are 60% of enrollments. I was taking a quarter of that as a new starts to which discounts would apply. Lets say its 20% (a third of all undergrads) of revenues that get reduced by 20%. so a 4% decline in total revenues. Leavinf revenues @ $499mm. a 20% decline for all undergrads would result in 18% decline overall revenues (assuming no growth in enrollment) would lead to revenues of $426mm. I think you are taking 100% of revenues and dropping them 20%, but I think that misses the student mix and would argue its probably too harsh. The truth of it (absent any increase or decrease in enrollment going forward) is inbetweent the $425-$500mm in revenues. For comparison - in 2007 and 2008 enrollment was 36k and 44.5k. Revenues were $318mm and $396mm and EBIT (which I think is a reasonable proxy for FCF here) was $97.6 and $172mm respectively. In addition, revenue per student was lower back then. For sure, since then strayer has engaged in more lease activity so there is risk to that. And of course, the $440mm question is what happens to enrollments? there is operational leverage here. But I think even with the reduced revenues here - they will be offset by the $50mm in annual expense cuts. Thats how i was getting to my number. I took Revenues of $460mm (in the middle of the above range) which is a $65mm change in revenues, then $50mm in expense reduction, for a $15mm decline in EBIT Which is $76mm.

 

Hope this clarifies where my numbers came from. Apologies for being vague, and for the inarticulate description in the paragraph above.

 

Thx, and no need to apologize.

 

I don't think you are being pessimistic enough for 2014 student counts. With no enrollment growth next year you are probably at 38,000 weighted average students next year (down from ~44,000 this year).

 

 

[klarmanite]

Mr Hamilton: I think you're right(unfortunately). Management basically said they expected as much in the conf call.

[thelads]

ok - thats more than fair. Thanks for that. In 2007/2008 with lower revenues than that they still were pulling in EBIT close to $100mm. Any reason to think they cant get within 20mm of that? I realise they have added leases and employee expense since then, but surely some of the cuts from yesterday go toward reversing that somewhat?

 

May I just say, this board is great. I love the back and forth we can have here and really appreciate everyone who contributes.

[prunes]

http://www.bizjournals.com/washington/news/2013/11/22/strayer-cuts-tuition-by-as-much-as-40.html

 

Arlington-based Strayer Education Inc., hoping to curb declining enrollment, will cut tuition for new undergraduate students by as much as 40 percent.

 

Strayer will give all new students 20 percent off tuition at enrollment, and is offering a program called Tuition Awards, which will cover the cost of one class for every three a student successfully completes.

 

The new tuition structure applies to new undergraduate students beginning with the winter 2014 term. Strayer said last month it would announce a tuition reduction, a move it conceded would negatively affect next year's revenue.

 

Total enrollment at Strayer University for the fall term fell 17 percent, while new enrollments were down 23 percent.

Strayer (NASDAQ: STRA) is also reducing its workforce by 20 percent and closing 20 physical campuses within the next six months.

[DTEJD1997]

My goodness...that is a rather precipitous drop in student enrollment!

 

They are also discounting tuition substantially to "good" students.  I guess that serves a two fold purpose:

 

A). Allows them to advertise price decline

 

B). retains good students who are likely to complete studies and pay off loans.  The school wins by boosting their reporting rates.

 

Very interesting to observe.  In the recent past, cost was no consideration for an education.  It is now apparent that the golden age of "for profit" schools has come to an end.  I don't think these schools will earn anything close to what they once did. 

 

In fact, I would argue that they are going to fight for their existence.  I think word is getting out about the poor outcomes for most of their students.

 

Time will tell and we will see...

[Edward]

I would like to thank the participants for an excellent discussion. I have been reading and thinking quite a bit about the industry during the last couple of years. Some comments regarding a few issues raised here:

 

Graduation Rate (2010) : 13.9%

This number is probably highly unrepresentative of the overall student body graduation rate. Following is the right to know disclosure by Strayer:

https://icampus.strayer.edu/student-services/student-consumer-information/student-right-to-know

 

"The Student Right to Know Act graduation rate is a specific calculation that includes only the following population: full-time, first-time, undergraduate, degree/certificate seeking students who enroll at Strayer University during a fall quarter or during the summer immediately preceding the fall quarter in which the student enrolls full time. This population is identified each year and followed for up to 6 years to determine the percentage of graduating students. Because the majority of Strayer University’s students are either part-time students or transfer students who have previously attended a higher education institution, this rate represents a very small fraction of the University’s student body.

 

For the cohort of students entering Fall 2006, the graduation rate was 35 percent. The official Student Right to Know Act graduation rate pools first-time, full-time, degree or certificate seeking students for the four most recent years, for 2003 to the 2006 entering cohorts. The graduation rate for the pooled 2003 to 2006 cohorts was 13 percent."

 

My understanding is that the 13% number is relevant to a small portion of the overall student body (i.e. only first time, full time, etc. ). The overall graduation rate is reportedly 35%, not 13%. Furthermore, it has to be taken into account that a lot of students take a lot of online classes, and the graduation rate for online only students is massively lower (by 20% or so as I recall) compared with campus based. It can be seen in the Harkin report.

http://www.help.senate.gov/imo/media/for_profit_report/PartII/Strayer.pdf

 

So when comparing Strayer with traditional universities, one has to eliminate the online students from the cohort, which will probably bump the graduation rate from 35% to 40-45% or so.

 

Then one has to take into account that a lot of students are in fact part-time learners, which again means lower expected graduation rates. So I would submit that a "comparable" graduation figure when comparing outcomes with regular universities with full time, class only students is probably around 50% or maybe higher. Doesn't look so terrible anymore, does it?

 

 

As for the meaning of the student loan system, its significance to the business model, and whether it's broken:

 

After some deliberation, a friend pointed out that there are in fact examples of the same for profit education model working outside of the US, and without a system of government loans. In Australia, there is a company called Navitas:

https://www.google.com/finance?q=ASX%3ANVT&hl=en&ei=WXfBUqDmEumKwAOZ4gE

 

Navitas operates 3 different businesses, of which the largest is "University Programs". This is broadly comparable with Strayer's business. Instead of government backed loans, they have some sort of a grant system. Tuition is as high as in the US.

 

The figures are listed in page 74 in the 2013 annual report of Navitas:

http://www.navitas.com/downloadFile.php?dir=files/corporate/docs/Annual_Reports/2013&filename=Navitas_Limited_Annual_Report_2013.pdf

 

In this business line, note that the operating margin is around 25% of revenues. If you apply a 40% tax rate like Strayer pays, it means a 15% net margin. Apply this margin to say 500M$ in top line revenue for Strayer, and you get a net profit of 75M$.

 

This exercise is interesting, because in a way it demonstrates that the business model works independently of a specific regulatory framework, subsidy, and government intervention, and is viable as a business. It also shows that the US for profit industry has been somewhat abnormally profitable in the past decade or so.

 

This has led me to believe that this business is still a good business, and not a "broken" one.

 

 

 

[frommi]

The problem for me is that i don`see a margin of safety here. I can`t forecast student enrollments nor if Strayer can hold prices constant. And because it is trading at 7x tangible assets, where is the lower floor?

Perhaps the numbers stabilize with the next earnings report, but before that i don`t think about investing here. I see this more as speculating than investing, it can work out ok but its totally possible that Strayer stabilizes at a much lower level.

[Edward]

The problem for me is that i don`see a margin of safety here. I can`t forecast student enrollments nor if Strayer can hold prices constant. And because it is trading at 7x tangible assets, where is the lower floor?

Perhaps the numbers stabilize with the next earnings report, but before that i don`t think about investing here. I see this more as speculating than investing, it can work out ok but its totally possible that Strayer stabilizes at a much lower level.

There are essentially 2 arguments here:

 

1. Can't extrapolate because the current numbers are too volatile.

 

2. No book value.

 

I think the first problem can be solved by looking closer at the business and trying to understand how it should look at mid cycle instead of waiting for "stabilization" (whatever it may be defined as) and then extrapolating.

 

The problem is, as Buffett puts it, that "You pay a very high price in the stock market for a cheery consensus". By the time everything has stabilized nicely, the price will likely reflect that. It's better to form an opinion independent of the need for nice stable numbers, since that's exactly why stuff gets cheap on the stock market in the first place. Almost everyone value stability at a premium and shun volatility.

 

The second problem leads to a paradox. The paradox is that on the one hand, the perfect investment is a company with no need to invest in assets and a huge ROIC as a result, spewing tons of cash while growing with minimal CAPEX requirements. Such companies are almost always the best of investments. Google and Ebay are such companies - very few tangible assets outside of cash. 

 

On the other hand, tangible assets provide a certain perception of a "floor" to valuation since you can theoretically liquidate them. Asset intensive companies often have a low ROIC, and low growth.

 

So it seems to me one has to make his mind about what exactly he is investing in. If you want to invest in a great business, it necessitates one to break from book values because great businesses generally are not capital intensive. If you want to invest in not-so-great businesses, then you might get your "floor" (real or illusory) for the price of the quality of the business.

 

[frommi]

 

The second problem leads to a paradox. The paradox is that on the one hand, the perfect investment is a company with no need to invest in assets and a huge ROIC as a result, spewing tons of cash while growing with minimal CAPEX requirements. Such companies are almost always the best of investments. Google and Ebay are such companies - very few tangible assets outside of cash. 

 

 

Yes, but these two companies have a huge amount of brand value and a moat. I don`t really see that in the case of Strayer. They have competitors that will drive prices and margins down, because there is a low hurdle to get into this business. And Strayer can`t grow abroad either.

There is a natural limit for its growth and that is the number of americans that need education and are willing to pay for that education. I would say this last group is shrinking. So you have a shrinking market, no pricing power and no moat. And because there are no assets, i don`t see a reason to invest here.

 

[racemize]

Edward, your initial post today was very informative.  Let's do a quick back of the envelope calculation with a margin of safety and see what it spits out.

 

Assumptions:

1) Because the education industry's cost are running away and Strayer has already cut tuition for new students, I think we should take a healthy cut of revenue out (this will be part of our margin of safety). 

2) Then we can apply a 10-15% margin on it (note that recently, strayer only got 11% net margin from its revenue).  Historical net margin is between 10-20%.

3) Then put some conservative multiple on it, that doesn't assume a lot of growth.

 

So using the above, let's say we cut 2012 revenue by 25% from 562 million, resulting in 421.5 million.  10% margin is 42.2 million and 15% is 63.2 million.  Let's throw a 10 multiple on that, giving us market cap of 421.5 million and 632 million (that was some pretty tough math there).

 

Current market cap is 382.4 million, which is 90% of lower bound fair value and 60% of upper bound fair value.

 

I think we are getting to a point where this a pretty decent chance of good returns; however, we might want an even larger margin of safety to be sure. 

[Edward]

Yes, but these two companies have a huge amount of brand value and a moat. I don`t really see that in the case of Strayer. They have competitors that will drive prices and margins down, because there is a low hurdle to get into this business. And Strayer can`t grow abroad either.

They arguably had the same competition 10 and 20 years ago and their results were excellent. I think the moat here is the difficulty of establishing a credible and a regionally accredited academic program with all the bells and whistles. The proof of that is that all the recent entrants into the industry in the last 10 years did not start a new university - they bought an existing one. It's very hard to start an academic institution from scratch. So the hurdle to get into the business is fairly high (unless you go online only).

 

Also, Strayer has online only foreign non resident students, so they can grow abroad. The can also grow 4-5 times just in the US alone. There are other for profit companies such as Apollo with businesses abroad. So it's not true that they can't grow abroad.

 

There is a natural limit for its growth and that is the number of americans that need education and are willing to pay for that education. I would say this last group is shrinking. So you have a shrinking market, no pricing power and no moat. And because there are no assets, i don`t see a reason to invest here.

Personally I don't see a decline in the demand for education in the US. Sure, everyone is moaning about cost and outcomes, but at the end of the day you can look at the numbers for salaries for educated and uneducated workers in the US. The difference is huge. A Bachelor's Degree is generally a good investment, although I'm not sure about Master's etc.

 

So to sum:

 

1. It's actually pretty hard to start a new academic institution in the US.

 

2. The business has plenty of room to grow.

 

3. Anecdotal evidence aside, higher education is pretty much required to earn a decent salary nowadays. 

[yadayada]

It actually seems pretty fairly priced to me. If you look at their value proposition compared to the MOOCS, it looks really bad. Their revenue and margins are also declining. So with a 10x multiple, and a few % decline every year, there is  barely any upside here. And there is more downside if 5 years from now everyone realizes that free online education is a much better value proposition.

 

The majority of students are also much older then college students. And if you have to reschool, why not do it for cheap through an online course? Its not like the students who really want to commit are not motivated. If this was trading at 4 times earnings I would buy some. But at 7.5 x it seems almost fairly priced. Multiple is higher actually. If it is currently undervalued, then revenue needs to flat out next year. Then it deserves like a 9-10 multiple. Which implies v little upside in the best case scenario.

 

Also they didnt have competition from MOOCS 10-20 years ago. That is basicly killing their revenue, not the bad news reports. Why reschool in something for 40k a year, when that can happen much cheaper? I think education will radically change for the better over the next 10 years. Lectures will be more centralized, which will save alot of money for the students, and always offers you the best teacher in every subject.

 

http://www.bbc.com/future/story/20131029-we-can-build-the-perfect-teacher

http://www.wise-qatar.org/edudebate-moocs-disruptive-learning

 

Paying that much money for schools like strayer seems like a really bad value proposition. When those MOOCS get fine tuned in the future, and there is less stigma about having an online degree, I think expensive universities aimed at working people will be in trouble.

 

[Edward]

Current market cap is 382.4 million, which is 90% of lower bound fair value and 60% of upper bound fair value.

 

I think we are getting to a point where this a pretty decent chance of good returns; however, we might want an even larger margin of safety to be sure.

I did a similar calculation as a pessimistic scenario. One can assume no growth, low margins and infrastructure under utilization forever, and then you probably get a p/e of 10 at today's market cap.

 

The thing is that it's seems overly pessimistic to me to serve as an "expected" scenario. I think that what would probably happen is that eventually schools will be more populated (say 700-800 students per campus instead of 500-600 currently), and some sort of growth will resume. If campuses get to 700-800 students (mid cycle historic utilization), we are probably looking at a net profit of 70-80M$ before growth. In such a scenario, and even with low growth, such a company is easily worth over 1B$.

 

Just look at the multiples of companies such as Grand Canyon Education Inc (NASDAQ:LOPE) and Navitas Limited(ASX:NVT). If I were to value this company in the same way we would reach some ridiculously high valuations (2B$+), and essentially the business is the same.

 

[Edward]

It actually seems pretty fairly priced to me. If you look at their value proposition compared to the MOOCS, it looks really bad.

There is actually no issue here - Strayer has had online courses for around 15 years and you can complete a degree online only if you want to. If the model shifts to online, they are ready for it. It might even improve the economics slightly.

 

The issue with online only universities is not even the lack of proper accreditation in many instances or social stigma - these are temporary issues.

 

The big issue is that for online only students, the graduation rates are MUCH lower vs brick and mortar. This is the real problem. Students know that by going online only, they are substantially lowering their chances of getting a degree, which means they will be likely to pay significantly more to attend brick and mortar schools.

[racemize]

Current market cap is 382.4 million, which is 90% of lower bound fair value and 60% of upper bound fair value.

 

I think we are getting to a point where this a pretty decent chance of good returns; however, we might want an even larger margin of safety to be sure.

I did a similar calculation as a pessimistic scenario. One can assume no growth, low margins and infrastructure under utilization forever, and then you probably get a p/e of 10 at today's market cap.

 

The thing is that it's seems overly pessimistic to me to serve as an "expected" scenario. I think that what would probably happen is that eventually schools will be more populated (say 700-800 students per campus instead of 500-600 currently), and some sort of growth will resume. If campuses get to 700-800 students (mid cycle historic utilization), we are probably looking at a net profit of 70-80M$ before growth. In such a scenario, and even with low growth, such a company is easily worth over 1B$.

 

Just look at the multiples of companies such as Grand Canyon Education Inc (NASDAQ:LOPE) and Navitas Limited(ASX:NVT). If I were to value this company in the same way we would reach some ridiculously high valuations (2B$+), and essentially the business is the same.

 

I tend to agree, but I really want the downside covered for these types of stocks.