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Career Education Corp. - Trades at a 43% Discount to Net Cash
Posted by: Barel Karsan (IP Logged)
Date: March 6, 2013 06:26PM
The for-profit education sector has been hit hard by the market, and for good reason. This industry utilized dishonest marketing practices and drove its enormous growth using massive amounts of federal funding that was rubber stamped by public servants asleep at the wheel. But the party's now over; new rules and additional oversight have pushed many companies in this sector into the red, causing massive losses. But has the market overreacted? Perhaps in some cases. For example, Career Education Corp (CECO) trades at a 43% discount to its net cash position!
While CECO has produced losses over the last couple of years, it has managed to avoid burning cash at a similar rate. Many of the company's losses can be attributed to asset impairments along with Goodwill and intangible write-downs. Future losses in some of the company's segments also appear unavoidable, but consider that in a year where the company had to adjust to a much lower revenue environment (due to drastically new regulatory compliance requirements), CECO's operating cash flow used only $17 million in 2012. Compare this to the company's $320 million net cash position (all cash less all debt) and $180 million market cap!
Management appears focused on stemming the losses by cutting non-profitable programs. Cuts initiated in the fourth quarter are expected to yield savings of over $50 million per year. In addition, the company has stopped marketing a number of its programs, choosing instead only to maintain operations required to teach existing students (so-called "teach outs"). Undoubtedly, this will have an effect on revenue; but these are likely unprofitable programs that were either eating cash or not generating decent returns on capital.
Admittedly, the earnings outlook for this company is murky, and there's no growth on the horizon. But CECO may make sense as a balance sheet investment if the losses are indeed curbed. With a tangible book value of about $400 million, the equity investor is paying just $180 million for a company with a strong net cash position that has time to turn things around and is currently aggressively cutting costs. Other companies in this space are also beaten down, but don't trade at this massive discount to net cash. Apollo (APOL), Corinthian (COCO), ITT (ESI), Strayer (STRA), and DeVry (DV), for example, all trade at premiums to cash, and in many cases substantially so!
There are some caveats of which investors need to be aware, however. Much of the tangible book value is made up of computer hardware/software, furniture and leasehold improvements, which are of little value if operations turn further south. But it's difficult to tell just how much these components are included as property, because depreciation numbers aren't broken down by type of capital item.
Another worry is the company's litigation situation. This company has made a lot of enemies over the years. It is being sued by students, investors, employees, the federal government, and state governments. If that wasn't enough to scare you, there is also an SEC investigation that is ongoing, and the Education Department is conducting an inquiry concerning violations of misrepresentation regulations. All of the events causing these issues occurred when this was essentially a different company; nevertheless, the liabilities are very real.
A good portion of the company's cash is also spoken for in the form of deferred revenues. As revenues fall, as they certainly will as "teach-outs" are implemented, some of this spoken-for cash will disappear and not get replaced.
Finally, the company also has a number of operating leases expiring way out into the future. These total almost $640 million, though the company is working on trimming this number. Another downturn in operations, or a lack of ability to meaningfully cut costs, would make these fixed costs loom large.
Unfortunately, estimating the final cost of these liabilities is difficult to impossible. As such, this company is far from a sure thing, discount to cash or not. Nevertheless, it is clear that Mr. Market is trading this company as if it has no future. The company's substantial cash holdings, however, suggest the upside to such an investment is higher than the downside is low. Each investor will have to come to his own conclusion about the return profile of this investment.
What do you think?
Disclosure: No position
Stocks Discussed: CECO, APOL, ESI, STRA, DV,