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FPA Capital Comments on Apollo Education Group

January 27, 2014 | About:

As for Apollo Education Group (APOL), the situation is different than Centene's in that the For - Profit Education industry is currently experiencing a declining enrollment environment, v ersus the large growth in new members for Medicaid services. However, despite all of the negative news on the education industry in general, and Apollo specifically, we are highly encouraged with APOL's current profit level and its ability to generate abun dant free cash flow.

Long - term investors will recall that we highlighted the education services sector as the worst performing industry group in the US in 2012. Nevertheless, we ended up investing in two companies in that industry: Apollo and DeVry. Both of these companies p ass our criteria of investing in market leading companies with a history of profitability and pristine balance sheets that are run by capable management teams. The main question to answer is a simple one: will we need education in the future? If yes, who will deliver this education and how will it be delivered.

APOL operates the online school called the University of Phoenix (UoP) as well as several international schools. UoP generates more than 90% of Apollo's revenue but 100% of its operating earning s. That is, the international schools are losing money, which we estimate was roughly $60 million in 2013. With a new management team now running the international schools, we could envision this division potentially earning $50 million in operating profit s over the next few years. This would be a swing of approximately $1.00 per share in operating profits should the turnaround occur. To put that into perspective, APOL earned nearly $3 a share in fiscal 2013, before considering restructuring charges.

The c ore operation for Apollo is UoP, which is the largest independent online university in the US. UoP was the first For - Profit company to offer online degrees over thirty years ago. The University of Phoenix is a well - known brand, but one that is in the proce ss of being upgraded. The company has embarked on a new determination to be more selective in choosing students who enroll at UoP. The main goal is to find students who will persist through every semester until they graduate rather than to fill the classro om every semester just to find a replacement when that student drops out.

Most investors, analysts, media, and government officials say this should always be the goal, and they are right. However, UoP's typical students are not the eighteen year olds grad uating from high school figuring out whether they should attend a private or public university. UoP's typical student is single, twenty - eight years old, a minority single - mother, first in her family to attend college, and someone who is 3 Centers for Medicare & Medicaid Services (CMS) via WellCare Health Plans, Inc. 2012 Annual Report on Form 10 - K trying to improve h er career skills and compete in today's fierce labor market. Among the biggest obstacles for this cohort is keeping their child, or children, healthy and in school so they can finish school themselves.

The company has re - invested a tremendous amount of ca pital into superior software programs not only to educate students, but also to provide a more timely feedback loop to professors who are teaching classes. The company is also spending more money per student on student advisors, to intervene earlier and pr ovide help when a student is in danger of withdrawing from the program.

APOL is also aggressively courting businesses not just to place their graduates in a well - paying job, but to partner with them and tailor a certificate program, for example, that prov ides students with skills specific to an individual company or industry. Many CEOs will tell you that there is not a jobs problem in America but a skills problem. That is, many traditional, not - for - profit universities in America are not educating students and imbuing them with skills for the 21 st century global labor marketplace. APOL is now working with hundreds of companies to deliver graduates, whether they are fully credentialed students or students with a narrower certificate degree, to businesses that are looking to hire qualified people.

These initiatives will take time to fully implement and for shareholders to see tangible benefits. In the meantime, APOL management is cutting expenses to reflect the lower enrollment numbers, like marketing and recr uiting, to maintain healthy profits and free cash flow at the company. On the most recent quarterly conference call, APOL's CEO announced that the company upped its total fixed costs cuts to a minimum of $675 million, $350 million of which has already been cut from the budget.

While we are pleased we were able to accumulate a full position below the $19 level, pleased that APOL appreciated nearly 50% in 2013, and pleased the stock is up another 25% during the first three weeks of 2014, we believe there is still a lot of upside potential in the stock should the company ever be able to monetize its software investment.

Currently, the Department of Education does not allow universities to share Title IV funding revenue dollars. Title IV funding is essentiall y the government guaranteed loans students use to finance their education. If this restriction is removed, APOL would be in a very strong position to forge relationships with the thousands of universities and colleges in the U.S. and effectively become the on - line outsource partner for these schools. The long - term trend in education is toward more distance or on - line learning, and APOL has the some of the best technology to deliver the highest quality service to millions of potential students. Today, this s oftware technology is an inexpensive call option for shareholders, but one that could be worth a lot of money down the road should this archaic restriction be eliminated.

From FPA Capital’s fourth quarter 2013 commentary.


Rating: 5.0/5 (1 vote)

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