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Corinthian Colleges - The Case for Growth
Posted by: batbeer2 (IP Logged)
Date: November 26, 2012 05:01PM

Here’s an established, geographically diverse business with high margins, low cyclicality and a defensible market position in a rapidly growing industry. It trades at 2x FCF — a 50% yield.

There’s a very good reason for this. The market mistakenly believes the cash flow is unsustainable — this business is toast.

The Company

Corinthian Colleges Inc. is a large American entry-level, post-secondary career education company. The company serves some 100,000 students from 100 schools in the U.S. and 16 schools in Canada. Corinthian's top market is California (roughly 25% of total).

The main program area is health care. Other programs include criminal justice, business administration, information technology, vehicle maintenance and construction.

The company has 16,000 employees, including 6,000 faculty of which 1,750 are full-time.

The company was founded in 1995 and has been publicly traded since 1999.

Shares trade on the Nasdaq at $2.20, for a market capitalization of $185 million.

The Growth

Traditional, state-funded, colleges are turning away millions of students. Specifically for the health care industry, there is a massive, acute and growing shortage of trained professionals. Historically, health-care professionals were trained at state-funded community colleges.

While states are required to provide primary and secondary education to children, they are not required to provide post-secondary education to adults. As state budgets have come under pressure, this has led to a significant reduction of funding for community colleges.

In California alone, the state’s 112 community colleges have turned away 300,000 students since 2008. There are almost 2 million students within the California Community Colleges system training to be nurses, welders, auto mechanics, airplane mechanics and construction workers. New students were turned away for no other reason than the fact that the state’s colleges had insufficient funds and capacity.

As a result, students have no option but to take a loan from the federal government and enroll at one of a handful of schools that comply with the standards that make them eligible for title IV funding.

Why Has There Been No Growth Recently?

Until 2010, Corinthian Colleges basically signed up anyone and everyone. The government assumed adult students loading up on federal loans to pay for their tuition would work hard to get a diploma, land a better job and repay the loans. Government was wrong.

While it lasted, the for-profit institutions took the business. It was easy money. If students didn’t show up, the institutions could simply pocket a portion of the fees without providing a meaningful service.

Then, the Department of Education (ED) changed the rules. Now the schools are accountable for outcomes and the default rates on the loans. Any institution whose cohort default rate equals or exceeds 25% may lose participation eligibility in the guaranteed loan program. Its students will be denied access to the federally guaranteed student loan programs.

In response, Corinthian Colleges stopped enrolling at-risk students. The result is a step change in student population.



The at-risk students were replaced by an increasing number of quality full-time students who were turned away by the traditional state-funded colleges. Default rates on the loans have been decimated. There has been a dramatic improvement in the retention of students (57% to 80%). Less churn should have an impact on profitability going forward.

Now that the company has brought outcomes in line with the new rules, Corinthian Colleges can once again start enrolling the growing number of students that are being turned away from state-funded schools. This market opportunity is many multiples of current revenue.

Management

In November 2010, Jack Massimino returned as CEO to whip the company into shape in response to the new regulatory environment. Prior to this re-appointment, Massimino served as chairman of the board. Jack Massimino had previously served as CEO from November 2004 until July 2009.

He took on a lot of extra work. He took on some extra responsibility. He declined to take a raise.



Much of the incentives came in the form of stock options. They have double-digit strike prices. Massimino stands to lose millions of dollars unless the company’s stock trades at double-digit prices within a few years.

As is usual, the board has set minimum stock ownership guidelines for the CEO. Massimino is expected to own an amount of stock worth at least 3x his annual salary.

Including the options, Massimino owns 2 million shares (2.2%). At current prices, that’s roughly 5x his base salary. Nevertheless, like other insiders and most recently Ruane Cunniff, he is accumulating more stock.

Specific Risk

Market risk. I was bullish on this stock at much higher prices. The thesis then was that the company should be able to earn 55 cents per share, assuming the company could stabilize its student population at 100,000. After two years, I stand by that thesis. As is my experience with any stock I like, the mere fact that I believe it’s a bargain doesn’t prevent the market from cutting the share price in half.

Political Risk. It is a popular pass-time for members of congress to bash for-profit institutions. A lot of proposed legislation is leveled at the for-profits while ignoring the inefficiencies at the traditional (not-for-profit) state-funded colleges. Some of this stuff may actually stand up to the scrutiny of the courts.

Compliance. COCO needs to comply with a lot of regulations. Including the new regulations from the ED. Many of COCO's programs are less than one year. Unlike the competitors offering multi-year programs, they can react quickly. They can test new programs and teach-out underperforming ones in months. That is precisely what they are doing. Of course, the regulations also form massive barriers to entry. There is a reason most of the traditional colleges don't apply and their students have no access to the federal loans.

Corinthian has been operating succesfully in Canada (Ontario) for many years. In Ontario, the Ministry of Training, Colleges and Universities has a policy whereby the government will only guarantee defaulted student loans to a certain capped amount (25%), beyond which the applicable private career college is responsible for guaranteeing repayment. This is much tougher than any of the new US regulations but it does not prevent Corinthian from making money in Canada.

Value

Back in 2010, I estimated earnings power of $50 million on a hopefully stable student population of 100,000. That’s a profit of $500 per student, or $0.55 per share.

Over the last 12 months, the company generated $100 million of FCF ($1,000 per student) while its student population grew. As we have seen, churn has declined. The company is retaining its students. This should have a positive impact on both the student population and administrative overhead going forward.

Since 2010, the company has:
  1. Shed some $200 million of goodwill.
  2. Depreciated PP&E at $75 million per annum. That’s pretty steep for PP&E with a book value of $600 million.
  3. Spent the better part of $200 million on capital expenditures. Again, they did that on property that was worth $600 million to begin with.
The non-cash charges cause GAAP earnings to temporarily understate FCF and IMO owner earnings too.

Based on the information available today, I believe my estimate of earnings power of $0.55 per share is still pretty pessimistic. Current FCF points to a figure that’s twice as high.

Disclosure

This is not a recommendation to buy or sell anything. I own shares of Corinthian Colleges Inc. and the Washington Post company. I have no position in any of the other stocks mentioned.

Any and all questions welcome as usual.

Read more

Community colleges turning away students
Community colleges failing to train nurses despite heavy demand
Bill Gates talks about education and state budgets
A feeble attempt at a writeup (2010)
Recent Proxy
Recent 10q
Bill Gates talks some more.



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Re Corinthian Colleges - The Case for Growth
Posted by: jasonfrey33 (IP Logged)
Date: November 26, 2012 07:28PM

Thanks for the article. I am reviewing the regulatory compliance. Last reported 3 year default rate at 27%, I know they expect improvement in 2012, but this is a high rate. I believe they also have 35/101 campuses not at gainful employment placement rates goal. COCO also has 328 million in guaranteed 3rd party off balance sheet student loans. I would expect a high default rate on these loans, possible 100 mil of bad debt expenses going forward. The $37.6 mill in cash will help to cushion these loan losses along with any lawsuits they may face going forward. It would seem to me that the company is worth at least $400 mil. even if all the cash is used for lawsuits, bad debt expense. Why this stock over ESI, APOL or DV? I have reviewed STRA, they are still not cheap enough for my taste. EDMC has repriced all their options a few months ago, combined with the heavy debt load and variable rate revolving credit lines I would not touch them. CECO will likely burn through its cash this year to pay for campus closings. Still some potential in that company. Devry is in my opinion best buy for the price.




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Re Corinthian Colleges - The Case for Growth
Posted by: batbeer2 (IP Logged)
Date: November 27, 2012 12:09AM

Hi Jasonfrey33,

>> Why this stock over ESI, APOL or DV?

Three reasons:
- I know more about COCO than about the others. I've been following it longer.
- They are at the entry level with programs typically lasting less than one year. This means they can react quickly to the changing environment by adjusting the composition of the student population.
- I already own Kaplan in that space.

At the end of the day I believe a collection of schools with 100,000 students, each paying about $15,000 per annum to get an education, should be worth a bit more than $2000 per student. Especially if the number of students is growing.



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Re Corinthian Colleges - The Case for Growth
Posted by: buynhold (IP Logged)
Date: November 27, 2012 04:08AM

Batbeer,

Thanks for another interesting writeup! Couple of thoughts:

1) Isn't current owner-earnings more like $50 mil or so, once you take out the unlikely to be repeated working capital improvements (they detracted from FCF last year, look at these over a few years and you'll see)?
2) Here's an article on a big reason behind the default rates going down:
[higheredwatch.newamerica.net]

If this is indeed the case, it could very well be that the improvement isn't sustainable over time, maybe just long enough for Massimino to cash in on his stock options (i.e., a cigar butt investment) :)?



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Re Corinthian Colleges - The Case for Growth
Posted by: varunfriend (IP Logged)
Date: November 27, 2012 04:22AM


Capella (CPLA) is another interesting company - its a regionally accredited, exclusively online postsecondary education company. It offers bachelor's, master's, and doctoral programs in behavioral health and human services, business management and technology, public service leadership, and education. More than 80% of students are enrolled in master's or doctoral programs. Capella serves roughly 39,000 students.

No debt
Generate abt 1180$ FCF / student
Almost $10 / share in cash
FCF / share = $3.6
FCF Yield = 13%

The risk with for profit sector is regulatory and in the present polarized environment looking for scapegoats that could be the telling factor in terms of what happens in the industry.

Another way of playing this could be to just buy the basket of for profits .. that will certainly do well over time.



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Re Corinthian Colleges - The Case for Growth
Posted by: batbeer2 (IP Logged)
Date: November 27, 2012 05:05AM

>> The risk with for profit sector is regulatory and in the present polarized environment looking for scapegoats that could be the telling factor in terms of what happens in the industry.

Yes. They won't kill the for-profits though. In the end, the for-profit system is better for the budget.

- The federal government borrows money at 2% (10 year treasuries) and lends it to students at 3%.
- Students look for a school that caters to their needs (open market).
- The schools are responsible for managing the portfolio of loans and keeping default rates low.
- If they do all that and still manage to make a profit, the profit is taxed.

That is a lot cheaper than simply handing tax dollars to traditional community colleges and universities.

This driver is not going away despite a lot of noise by politicians. It's a good thing the government is regulating this industry but again, it is not going to kill it.

>> Another way of playing this could be to just buy the basket of for profits .. that will certainly do well over time.

Yes. For me, picking individual stocks keeps me honest (thinking and acting like an owner not a stock renter).



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Re: Re Corinthian Colleges - The Case for Growth
Posted by: batbeer2 (IP Logged)
Date: November 27, 2012 06:09AM

Hi Buynhold

Thanks for the kind words.

>> 1) Isn't current owner-earnings more like $50 mil or so

$50 million is fine by me. I've dug into the FCF more than I've talked about in the article.
Mine's a bit higher ($ 75m) because I think they've been spending a lot (more than run-rate) on Capex.

>> 2) Here's an article on a big reason behind the default rates going down:

I was aware of the article you point to. It neglects to mention retention is up (churn is down). That's not just paper trickery. It supports my thesis that the business has fundmentally improved.

From the article:

To accomplish a lower reported default rate, Corinthian hired three contractors. One was General Revenue Corporation, which devoted 60 full-time employees to call former Corinthian students who were late making payments but not yet in default. The company also hired two firms, ROI and TEAM Enterprises, to send out 30 or more people to knock on former students’ doors to secure ‘cures.’ This same document reveals that students in late stages of delinquency but not yet in default -- a period during which they are the biggest threat to Corinthian’s default rate – could be contacted up to 110 times per month. Another internal document shows that, in order to achieve the company’s desired default rate, the call center run by General Revenue Corporation would make between 2 and 2.5 million calls a year, or 429 calls per employee per day to former Corinthian students


So here we have a private company fighting to reclaim some of your tax dollars from people defaulting on federal loans. The author of that article thinks that's bad (unsustainable?). IMHO this is precisely how the broken banks should have managed their loan portfolio. Also, I presume Corinthian Colleges now has a pretty clear picture of who is likely to service their loans (or not). That's pretty valuable information when enrolling (or not) new students.

From the article:

A numbers game, indeed. By pushing former students to get forbearances and deferments on their loans, Corinthian has been able to artificially lower its schools’ rates and make sure that these institutions continue to receive hundreds of millions of dollars in federal student aid funds each year.

In short, even if you take a dim view of these practices (I think it's fine but that's just some Dutchman's opinion), the result supports the thesis.



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Re Corinthian Colleges - The Case for Growth
Posted by: jasonfrey33 (IP Logged)
Date: November 27, 2012 06:19AM

Regarding the 90/10 rule. Many for-profits claim they cannot lower tuition without violating the 90/10 rule. This creates an environment that fosters competition on items aside from price. My understanding is that a lower cost to attend a college would result in the student obtaining all funding from federal loans. A higher cost results in students meeting the cap on federal loans and forces the student to take out private loans in addition. It looks like the 90/10 rule protects non-profits and for profits from price competition. Thoughts?




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Re Corinthian Colleges - The Case for Growth
Posted by: batbeer2 (IP Logged)
Date: November 27, 2012 07:50AM

>> It looks like the 90/10 rule protects non-profits and for profits from price competition. Thoughts?

Corinthian is lowering its tuition rates as we speak. As you point out, rates were previuosly raised to comply with 90/10. It seems they are happy with the 90/10 revenue split within the current student population. If they weren't, they wouldn't be lowering rates.

Schools have some operating leverage. Attracting 25% more students with 10% lower rates will always make business sense. Even for the public schools. For the for-profits, 90/10 will counteract that somewhat. The days of opening the floodgates are over.



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Re Corinthian Colleges - The Case for Growth
Posted by: buynhold (IP Logged)
Date: November 27, 2012 12:39PM

>> So here we have a private company fighting to reclaim some of your tax dollars from people
>> defaulting on federal loans. The author of that article thinks that's bad (unsustainable?). IMHO this
>> is precisely how the broken banks should have managed their loan portfolio.

I would say the author there is correct in saying that the reported drop in default rates (from 25% to 3%) is not sustainable, since deferment will only prevent defaults where there is a liquidity problem (same goes for the broken banks - it won't fix solvency issues with the defaulters; IMO the banks should have made their bondholders take a haircut when faced with solvency problems (and not the taxpayer)).

However, I do agree with you that the information COCO gets through this process can be used to drastically (and sustainably) reduce actual default rates so they can keep qualifying for federal funds (without the need to play numbers games to satisfy changing regulations).

APOL has a similar valuation, and I really like the fact that the Sperlings own a huge chunk of it, but as you point out, COCO should be more nimble in the face of changing regulation. Tough call (for me!).



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