ITT Educational Services (NYSE:ESI) is a company in the for-profit education services industry, and appears on GuruFocus’ Buffett-Munger screener. This screener can be used to find companies with high quality businesses at undervalued, or fairly-valued, prices. Businesses on this screener are able to consistently grow revenue and earnings, maintain and expand profit margins while growing, and incur little debt during growth.
To be sure, the entire for-profit industry has received negative press in addition to vilifying attacks from both critics and regulators. However, ESI distinguishes itself from the typical for-profit educational firm--it has a long history of providing post-high school technical education services.
As of March 30, 2012, the company traded around $66, has a market cap of $1.622 billion, and has the following price multiples: P/E=5.9; P/B=10.4, and P/S=1.1.
Let's take a quick, broad look at the company to see why you might be interested in it.
What Do They Do?
ESI is a leading proprietary provider of postsecondary degree programs in the United States based on revenue and student enrollment. As of December 31, 2011, they offered master, bachelor and associate degree programs to approximately 73,000 students across 144 locations (including 141 campuses and three learning sites) in 39 states. They also offered one or more of their online programs to students who are located in 48 states. They design their education programs, after consultation with employers and other constituents, to help graduates prepare for careers in various fields involving their areas of study. ESI has provided career-oriented education programs since 1969 under the “ITT Technical Institute” name and since June 2009 under the “Daniel Webster College” (“DWC”) name. Beginning in 2011, ESI began operations at 11 new ITT Technical Institute campuses and discontinued operations at one learning site. Their programs cover: Information Technology (IT), Electronics Technology, Drafting & Design, Business, Criminal Justice, and Breckenridge School of Nursing and Health Sciences.
How Do They Make Money?
ESI sells educational services by collecting tuition. Most of the tuition is via Title IV Federal student aid, which includes traditional student loans (Stafford, Direct, and Perkins) and Pell Grants.
ESI competes with many other for-profit ventures, including:
- Other for-profit educators, such as: Strayer (STRA), Apollo (APOL), DeVry (DV), Capella (CPLA), Corinthian Colleges (COCO), and Career Education Corporation (CECO)
- Traditional colleges/universities
- Community colleges
Sales, EBITDA and Earnings
ESI has steadily increased revenue and earnings. In the last decade they've grown revenue at 20.8%; EBITDA at 34.4%; FCF at 22.5%, and Book Value at 8.5%.
Gross, Operating, and Net Margins
From the chart below, we can see that over the last decade ESI has steadily wrung out extra costs, increasing gross, operating, and net margins. No doubt this is due to their scalable business model. Once a site's infrastructure is in place, the incremental cost to educate an additional student is low, which drives large margins.
As Buffett has taught us, a CEO's main job is efficient capital allocation for shareholders, and it looks like ESI meets that test. As we can see from the chart below, they handily exceed an ROC of 15%.
ESI has been returning capital to shareholders through their share buyback program hand-over-fist. Since 2001, they've reduced the share count 43%, and it looks like they've accelerated the pace within the last two years.
Lastly, because of the negative perception the entire industry has received, prices in this sector have been absolutely pummeled. ESI now trades at the lower end of all of its historical valuation bands: P/E, P/B, and P/S.
- Guru ownership and avg price: ESI owned by Hussman ($76.15), Weitz ($75.32), and Greenblatt ($73.29)
- Over 35% of shares are short, potential short squeeze
- Stock buyback plan: ESI reduced outstanding shares by 19% yoy at the end of the 4th quarter. They repurchased 370K shares in 3Q11.
- The business model is scalable; the incremental cost to educate each additional student is low, leading to high margins
- ESI acquired Daniel Webster College, giving them a regional accreditation which they can use to broaden their reach in online classes
- High costs of education, in general, rightly or wrongly attract government intervention and could squeeze margins over time. Total student debt surpassed credit card balances, and sits at $1 Trillion as of the end of 2011.
- Subject to compliance with Dept of Education's 90/10 rules, which states a college can't collect more than 90% of revenue from students participating in federal loan programs.
- Cohort Default Rate (CDR): for-profit colleges must monitor the federal loan default rates of students who graduate or leave the school. If a school's CDR exceeds 25% for 3 consecutive years, or 40% in any one year, its students won't be eligible for federal financial aid.
- ESI competes on quality of product which is measured by graduation rates and ability to secure employment. For 2010, 70% of ESI graduates got employment in positions using skills taught in their program of study within 1 year. As of Oct 2011, this rate was 600 bp higher. The average annual salary reported by employed 2011 grads was $32K, compared to $32.4K for 2010 grads.
- With an improving economy, there's a potential ESI would see declining new student enrollments
- Over 35% of shares are short
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Disclosure: Long ESI
DISCLAIMER: This review/analysis is provided for informational and entertainment purposes only and is the opinion of the author. The information and content contained herein should not be construed as a recommendation to invest or trade in any type of security. Neither the information, nor any opinion expressed, constitutes a solicitation of the purchase or sale of any security or investment of any kind. Conduct your own research and due diligence.