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.
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.
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.
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.
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.
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:
- Shed some $200 million of goodwill.
- Depreciated PP&E at $75 million per annum. That’s pretty steep for PP&E with a book value of $600 million.
- Spent the better part of $200 million on capital expenditures. Again, they did that on property that was worth $600 million to begin with.
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.
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.
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)
Bill Gates talks some more.