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Is there a Valid Short Squeeze on Corinthian Colleges?

March 03, 2012 | About:
Corinthian Colleges, Inc. (COCO) operates 122 for-profit schools in the U.S. and Canada, offering diploma programs and post-secondary degrees at the associate, bachelor, and master level. Its delivery includes both purely online and blended online/classroom models, with training in information technology, healthcare, business, criminal justice, mechanical, and trades.

The stock has been badly beaten down since April 2010, dropping from a close of $18.73 on April 22 to $4.36 on August 24. Since then, aside from a brief dead cat bounce above $7 at the end of September and beginning of October, Corinthian has drifted down inexorably. It floated in a $4 to $6 price channel from mid-October 2010 until late July 2011, when it dropped to under $3. The shares lingered there until the end of January, when it spiked to around $5. At present the price is lingering just shy of that mark.

The Education Service sub-industry as a whole is not faring well at the moment. It underperformed the S&P 1500 by almost 10% in 2011, though it seems to be recovering in 2012 and was actually ahead of the index by 1.1% through February 10. Several factors are hammering for-profit schools.

The primary negative influencer has been increasing regulatory scrutiny brought about by criticisms of the employment fortunes experienced by graduates, who typically incur hefty tuition bills (which in almost all cases translate to hefty student loan balances) by the time they receive their degree. In June 2011, the U.S. Department of Education finalized regulations designed to address this issue.

On a positive note, the final version was less stringent than many observers initially feared, but the “gainful employment” rule has the potential to end the Title IV student loan eligibility that fuels the revenue of most for-profit institutions. Under the finalized regulation, schools will face an annual assessment of their graduates. The standards are that a minimum of 35% of graduates must be paying their student loans and that those graduates must be spending no more than 12% of total income and 30% of discretionary income to do so. A school that fails this test three times in four years would lose Title IV eligibility. However, despite earlier deadlines in previous drafts of the regulations, the earliest date a school could lose eligibility is now 2015.

This gives for-profits time to assess the situation and conceivably craft solutions. Another issue that is already on the doorstep, however, is the incentive payments some for-profits allegedly gave recruiters. This is not an issue for Corinthian, though it does affect such major players in the sector as Apollo Group (APOL), parent of the University of Phoenix. Federal law prohibits the linkage of student recruiter bonuses with the number of students enrolled, since such an incentive system can lead to the recruitment of unqualified students and resultant misuse of federal aid. Since Apollo and other for-profits were required to modify their recruiting practices in 2010, enrollments across the board have dropped noticeably, and the tighter standards necessary to meet Title IV repayment rules are virtually certain to cut into those numbers even further.

As for Corinthian specifically, it has been the object of considerable short interest over the last few days. Short interest as of February 28 was 22.33% of float, with 17.2 million shares short in February, down from 22.9 million in January. By comparison, short interest for its peer group was only 5.85%. Key management effectiveness ratios also tell a sad story when compared to Corinthian’s peer group: return on assets for the trailing twelve months (TTM) was 1.25% versus 20.39% for its peer group, return on equity (TTM) was 2.36% versus 59.95%, and return on investments was 1.74% versus 34.74%.

For-profit education companies are known for stellar profit margins, but in every regard, Corinthian still falls well behind its peers. Gross margin (TTM) was 38.28% versus 59.89%, operating margin (TTM) was 1.66% versus 19.98%, pretax margin (TTM) was 1.09% versus 19.88%, and net profit margin (TTM) was 0.76% versus 11.81%.

High short interest raises the possibility of a short squeeze, which occurs when a stock with high short interest rises in price. The resulting short-covering reinforces that upward movement, at least temporarily. Corinthian has lingered at or just below $5 since February 7 after spiking from its $3.03 close on January 31 to $5.13 on February 8, so with short interest in excess of 20% it seems a reasonable candidate.

Moreover, on February 1 S&P raised its 12-month price target from $2.00 to $4.50—a tremendous jump in percentage terms. The analyst cited an apparent bottom in enrollment declines and strong cost-cutting measures by Corinthian, so it would seem the price is indeed headed up.

For some reason, though, I just don’t buy this one. While the stock could hit $4.50 in a year, on the strength of federal initiatives to increase the number of college graduates in the U.S. and continued weakness in the job market that has encouraged some people to seek refuge in school (or try to improve their competitive position), I don’t feel that there will be enough upward price pressure to fuel a strong round of short-covering. What’s raising the hairs on the back of my neck are the facts that short interest in February is noticeably weaker than in January, that the price seems to want to meander flat or slightly downward, and that there is no obvious reason for the substantial jump the stock enjoyed in the first week of February.

If you’re determined to find a play with this one, I recommend watching the stock for another week or so to see what happens as the March option expiration approaches. If Corinthian does start to tick up appreciably, jump in quickly and be prepared to exit your position with modest gains.

About the author:

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