A Long Slog in For-Profit Colleges

 | Jul 23, 2013 | 12:00 PM EDT
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Shares of some for-profit colleges -- Capella Education (CPLA), ITT Educational Services (ESI) and American Public Education (APEI) -- have performed well since early spring. However, most of these companies are still adjusting to the new challenges of an evolving higher-education paradigm. In particular, students and parents question are now increasingly questioning the value of a college degree, and Washington has been forcing the industry to defend for-profit colleges' disproportionately high defaults and low graduation rates. Reputations of these colleges have been tarnished as a result.

Compound all this with a cutthroat competitive environment, courtesy of the Great Recession, and the result has been an industry at ever lower highs and lower lows.

Are the stocks now bottoming? Well, for-profit colleges are bound to play a vital role in the education system of tomorrow, and we're likely to see helpful checks on the Obama Administration's constraints heading into next year. However, top analysts contend that the prop schools may still represent a near-term value trap.

The good news, at least on the policy front, is that for-profits have already been exposed to the Administration's almost lethal dose of focus on "educational outcomes." Also, the regulatory risk picture has been looking better, as I'll discuss below. But companies ranging from Strayer (STRA) to Devry (DV) have radically altered pricing in order to keep seats filled, while industry giant Apollo Group (APOL) has refrained from this strategy -- only to see its enrollment starts drop by 20%. 

Meanwhile, all of these colleges are feeling pressure to invest in order to improve quality of instruction and bolster attendees' "persistence." The result could potentially be enough to mitigate or reverse the industry's tainted reputation over the long term.

At the same time, though, the companies are implementing deep discounting as enrollment declines. That, in turn, may continue having negative implications for revenue per student, as a top analyst has told me. So it will likely be difficult to get comfortable with long-term financials anytime soon. Without a resurgence or at least stabilization in enrollment, it will be difficult to make the case that the stocks are "investable" again.

That said, we've certainly seen constructive events in Washington and in the courts. The Obama Administration has been fighting against for-profit vocational schools for two years now, having produced "gainful employment" rules in 2011 that have imperiled for-profits' future access to federal student aid. But, in June 2012, a U.S. District Court invalidated the seemingly arbitrary 35% repayment threshold that lay at the core of the Education Department's enforcement mechanism, and another ruling came against ED this past March.

That said, the prop schools now confront a mixed -- yet arguably improving -- picture in Washington. The Administration has said it wants to work toward a goal of using graduation, employment, and debt-level metrics to weed out bad actors -- and to ensure that students and taxpayers are getting more of their money's worth out of the for-profit space. At the same time, House Republicans and one senior Democrat recently introduced legislation to block ED from implementing gainful-employment regulations, among other things.

Looking ahead, the next two years' deliberations over the Higher Education Act reauthorization should be less about the for-profits' past sins and motives and more about the trend toward massive open online courses (MOOCs), a disruptive force against classroom teaching.

As this debate unfolds, I think the not-for-profit colleges and universities may face at least the same level of risk, compared with that of for-profits, from MOOCs and broad policy changes. That's especially so if HEA deliberations lapse past 2014 into the next Congress -- as I'd suspect -- and if Republicans retake the Senate. 

Bottom line: The added allure of prop school names as "red stocks" could make for a more compelling factor bet down the road.

For the time being, thoug, this industry continues to face lousy fundamentals. Don't allow the recent general uptrend in stocks, or a seemingly improving policy backdrop, draw you in at this juncture. On top of all this, a very passionate short-selling cohort has made a fortune betting against this industry's performance, if not its survival, for nearly four years.

So, for now, buyer beware, regardless of your ideological or political sympathies. The group never did get a lasting bounce from its "red stock" status in 2010, nor even after the sharp diminishment in the GE rules before their final publication. Industry stalwart Apollo did enjoy a 50% climb between late 2010 and early 2012, perhaps partially due to hopes of GE-related pushback from the (then) newly reelected House. But the story has been different ever since.

An analyst recently described Apollo as "unanalyzable." That's just as hard to pronounce as "investable" -- though, actually, this stock is quite the opposite.

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