This article analyzes Strayer Education, Inc. (NASDAQ:STRA), a business with high predictability.
Strayer is an education services holding company. Its primary business is to operate Strayer University, which has a 119 years history focusing on high education for working adults.
As of December 31, 2010, company operates 84 schools in the US, 13 of which were opened in the 2010. Company also offers classes on the internet through Strayer Univeriversity Online.
In 2010, Strayer graduated 8300 students, about one-third received graduate degree and the rest received bachelor’s and associate degrees. For the year, the company enrolled an average of 56,000 students.
Strayer’s revenue comes from tuition and fees paid by, or on behalf of students. A significant number of students receive loans or grants directly from the Department of Education. In the 2010 fall term, approximately 73% of Strayer University’s students participated in one or more so called Title IV programs.
Strayer’s expenses include salaries, leases, advertising and marketing, equipment and suppliers.
The beauty of Strayer’s business is that the business generates a significant after-tax cash flow from operations. The capital expenditure to keep it existing school running is roughly equal to depreciation expenses. The investment capital required to fund growth is not major. As a result, the company’s entire operating income becomes almost distributable free cash flow.
The end result is that the company has sustained a long period of growth:
According to the National Center for Education Statistics (“NCES”), in 2008-09 there were 2,719 four-year degree-granting institutions in the United States, including 652 public colleges and universities, 1,537 not-for-profit colleges and universities, and 530 for-profit institutions.
The market for post-secondary education is large and highly fragmented, and has experienced significant growth in the past decade. The U.S. Bureau of Labor Statistics has reported that approximately 61 million working adults in the United States do not have more than a high school education and approximately 32 million people have some college experience but no college degree. There are reasons to believe that the demand for post-secondary education will continue to increase as a result of demographic, economic and social trends, including:
· increasing demand by employers for professional and skilled workers;
· approximately 18% annual growth in the number of high school graduates from 2.8 million in 2000 to 3.3 million in 2010;
· college degree holders owns more and less likely to get fired.
· budgetary constraints at traditional colleges and universities.
The industry, including Strayer, has continued growing despite the downturn in the economy, but can be and recently has been negatively affected by the uncertainty associated with legislative and regulatory proposals. Also, the industry is heavily dependent on continued availability of funding for Title IV programs and concerns about potential reductions in such funding also can reduce the level of growth.
Title IV Loan Uncertainty
The Title IV Loan Uncertainty cast a cloud on the entire industry.
The U.S. Federal Government supports post secondary education by making grants and loans available to students under the Higher Education Act of 1965. The grants, known as “Pell Grants” after Senator Claiborne Pell, are only available to available to students whose family income is below to a certain level. These grants are outright grant and do not need to be repaid. The loans, now made directly by the Federal government to the students of any income under the authority of Title IV of the 1965 act, are known as “Title IV Loans”.
Previously, the Title IV loans could be made by banks with most of the principal guaranteed by the Federal government, by the government eliminated private bank participation in Title IV lending in 2010.
These actions by the government provide a subsidy that allows students to finance their education. The added funds lower the cost of education and enable more people to attend college, which in turn makes them more competitive in the job market. The cost to the taxpayer is offset by the value of having a more educated workforce to stimulate the economy.
Over the past several years, for-profit colleges and universities have come under increased scrutiny and criticism for high-pressure recruitment, deficient instructional programs and a poor record on employment placement that has made it difficult for students to pay off their college loans. The debt load for students at for-profit schools is, on average, more than twice that of traditional schools.
To address some of these concerns, the U.S. Department of Education is looking into strengthening some rules on the use of federal financial aid under the Higher Education Act. The most controversial of the rules is so-called “The gainful employment rule”, which says that that vocational or career programs must “prepare students for gainful employment in a recognized occupation” to be eligible for federal grants and loans. “Gainful employment” means that the graduate will be able to earn enough of a salary to pay back any loans that were obtained to pay for college. The Department of Education would require for-profit institutions to show that graduates with a typical student debt are able to pay their loans in 10 years without taking more than 8 percent of their expected earnings.
The U.S. Department of Education’s “gainful employment rule” met significant comment from all parties involved. Therefore, the Department delayed adoption of gainful employment rule first until November 2010, then till January 2011, and since then until an undetermined date.
The Gainful-Employment Rule continues to be a hot topic for debate in the US Congress. More recently, Chronicle.com has this piece on the topic. Without going into details of the debate, it is sufficient to say that rules are far from being set.
Hence, the uncertainty.
Strayer’s Position in the Regulatory Compliance
Robert Silberman, the Chairman and CEO of Stayer Education, Inc. spent 4 pages in his annual letter to shareholders to discuss the one single important regulatory issue. You can read the history of the issue and how he as the head of the company coped with various requirement and demand arose from the issue. Initially he felt confident that his company would pass the both the repayment rate test and its debt to income ratio test easily, but late he discovered that he discovered that the evil is in the details. Namely, the Department of Education and the company measure the debt repayment rate differently.
On August 13, at 5:00PM, the Department posted on its website data which purported to show the performance of various universities alumni in paying down the principal on their student loans, and that the posted data showed Strayer Alumni performance on repayment to be much worse than universities which had significantly worse cohort default rate.
The school is working with the Department to reconcile the results, according to the CEO’s letter.
In the mean time, the new rules have already impacted negatively on Stayer. On March 31, 2011, it was announced that two of its program may be ineligible for US aid, according to this Reuters report.
STRA Stock Action
The stock traded above $250 less than one year ago. Its 52-week high is $262 and 52-week low is $113.
STRA stock fell from above $200 on August 13, 2010, on the day the Department of Education posted its debt repayment rate, to $163 close on August 16.
The 52-week low was achieved on January 10, 2011, when the company announced lower new-student enrollment for the winter term, which began Jan.3.
In the same announcement, Strayer said that if new-enrollment declines continue on pace with winter term, overall enrollment could fall by 5% for the year. Based on that assumption, the company said 2011 per-share earnings could be as low as $7.50 to $7.70, with revenue declines of up to 1%.
In the recent weeks, stock price climbed to above $145 level, about 30% above its 52-week low.
In the past 10 years, STRA has grown its earning at 15.3% per annual. Giving forward, it will be far-fetched if the company can maintain a 15.3% growth, with the regulatory issue hanging over their head. Using company’s guidance of $7.6 per share, assuming a growth rate of 15.3% for the next 10 years, a terminal growth rate of 4% after that, and a discount rate of 12%, one can calculate the fair value by using DFC Calculator to be $144.
If one uses a lower growth rate for 10% for the next decade, the fair value drops to $112, close to the 52-week low.
One can also use the analyst’s estimate in place of the $7.6 company guidance. The 16 analysts estimate an average of $9.01 per share, and still assuming a 15.3% growth rate, one reaches an fair value of about $169.
You can play with the discount rate and terminal growth rate anyway you want, I feel the 4% and 12% assumption to be reasonable given the risk involved in this industry.
Strayer is good company that has been very well managed and provides an essential service to the society.
Despite the price drop in the past year, the recent climb of the STRA stock price deemed it no longer a bargain. Investors are paying for a growth rate that is as if there is no regulatory risk.
At its current price, there is no margin of safety.