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Does it pay to get into for-profit Higher Education? A Study of ITT Educational Services (ESI)

August 12, 2014 | About:

We all know it pays to get an education, but not all degrees are the same. For example, a bachelor’s in accounting is more likely to land a well-paying job than a bachelor’s in philosophy. The same may be true in the area of higher education. Does it pay to get into for-profit Higher Education? Let’s look at ITT Educational Services, Inc. (ESI) and see if this may mean a potential buying opportunity.

Company history

ITT Educational Services, Inc. (ESI) is a provider of postsecondary degree programs in the United States. As of December 31, 2011, ESI offered master, bachelor and associate degree programs to approximately 73,000 students. As of December 31, 2011, ESI had 144 locations (including 141 campuses and three learning sites) in 39 states. In addition, ESI offered one or more of its online programs to students who were located in 48 states. ESI designs its education programs, after consultation with employers and other constituents, to help graduates prepare for careers in various fields involving their areas of study. ESI provides career-oriented education programs under the Daniel Webster College (DWC) name. On August 1, 2013, the Company announced that it had acquired Cable Holdings, LLC.

Website: http://www.itt-tech.edu

Financial strengths

Effective Profits:

Sales and Earnings Growth

1407778887779.png

Sales and earnings have been declining since December 2010. For-profit education has not been favored under the current Obama Administration.

Margins:

1407779089250.png

In addition, ESI’s margins have been declining since its peak around December 2010. Net profit margin is currently 5.6%. Tighter margins appear to be near all-time lows.

Efficient Cash Conversion Cycle:

1407779446253.png

Days Sales Outstanding has been declining to 31.44 days, which is a positive signal that the company is more efficient in collecting its credit sales. The company does not carry any inventory; therefore, Days Sales in Inventory has been 0. Days Payable Outstanding has declined to 55.69 days, meaning the company has been decreasing short-term financing from its suppliers, which is a good signal. Overall, the Cash Conversion Cycle has decreased signaling that the company has become more efficient at collecting and paying its bills.

Returns:

1407780046815.png

ESI’s Return on Equity, Return on Assets and Return on Capital has declined since its highs in December 2010. The company still remains to be profitable although at significantly lower levels than its peak in December 2010. As of December 2013, ROE was 29.22%; ROA was 8.83%; and ROC was 58.96%.

Management

ESI’s executive team is being led by Mr. Kevin M. Modany (Chief Executive Officer, “CEO”). Modany, age 46, has served as our chairman since February 2008 and as our CEO since April 2007. He also served as our president from April 2005 through March 2009. Modany has been a director of ESI since July 2006. Modany resigned as a director and chairman of the board of directors of ESI, effective on August 4, 2014, and he also notified the board of directors of the company that he intended to resign as CEO of the ESI, effective February 4, 2015. Does the changing of the guards signal positive changes ahead?

Compensation:

As of 2012, Total Executive Compensation was $15,867,435, which was an increase of 29.02% over the previous year. Modany’s 2012 compensation was $8,763,384. Modany currently holds 127,370 shares of ESI with an estimated market value of $1,094,108. In addition, Modany also owns 62,500 ESI options valued at approximately $536,875. Modany has an approximate 5% stake in ESI. The pay appears to be excessive. I would rather have the company pay its executive team a more modest salary with more incentive-based pay for performance.

Valuations

Relative Valuations:

Dated: 8/11/14

 

ITT Educational Services Inc. (ESI)

 

Previous Close

8.59

Trailing P/E

3.50

Trailing EPS

2.52

Dividend

-

Dividend Yield

0.00%

Sales

45.70

Book Value

8.70

Free Cash Flow

3.03

EV/EBITDA

0.17

EBITDA

191,470,588.24

MV Equity

206,360,000.00

MV Debt

140,000,000.00

MV Preferred

-

Cash & Cash Equivalents

246,943,000.00

Shares Outstanding

23,370,000.00

Operating Margin

15.82%

Net Profit Margin

5.55%

Inventory Turnover

-

Asset Turnover

8.43

ROE

35.97%

rr

100.00%

Growth Rate

35.97%

A Comparable Analysis:

 

APOL

COCO

DV

Average

Price

26.67

0.16

39.60

 

Trailing EPS

1.89

(1.12)

0.99

 

Book Value

11.01

5.49

24.10

 

Sales

28.32

17.05

29.99

 

Free Cash Flow

2.41

NA

17.50

 

Dividend

-

-

0.34

 

Operating Margin

15.57%

1.59%

11.03%

9.40%

Net Profit Margin

6.32%

-6.52%

6.97%

2.26%

Inventory Turnover

-

-

-

-

Asset Turnover

1.06

1.44

1.03

1.18

ROE

16.59%

-15.07%

10.33%

3.95%

rr

100.00%

100.00%

65.66%

88.55%

Growth Rate

16.59%

-15.07%

6.78%

2.77%

P/E

14.11

(0.14)

40.00

17.99

PEG

0.85

0.01

5.90

2.25

P/B

2.42

0.03

1.64

1.36

P/S

0.94

0.01

1.32

0.76

P/CF

11.07

NA

2.26

6.66

Dividend Yield

0.00%

0.00%

0.86%

0.29%

EV/EBITDA

3.40

1.79

7.15

4.11

A Comparable Relative Valuation:

ITT Educational Services Inc. (ESI)

           
 

Value

 

Average Factor

Relative Value

Weights

Weighted Relative Value

Earnings

2.52

 

17.99

45.33

20.0%

9.07

Book Value

8.70

 

1.36

11.87

20.0%

2.37

Sales

45.70

 

0.76

34.60

20.0%

6.92

Free Cash Flow

3.03

 

6.66

20.19

20.0%

4.04

Dividend

-

 

0.29%

-

0.0%

-

EBITDA

191,470,588.24

 

4.11

787,582,352.94

   

MV Debt

140,000,000.00

   

140,000,000.00

   

MV Preferred

-

   

-

   

Cash & Cash Equivalents

246,943,000.00

   

246,943,000.00

   

Shares Outstanding

23,370,000.00

   

23,370,000.00

   

Estimated Equity Value

     

647,582,352.94

   

Estimated Equity Value per Share

     

27.71

20.0%

5.54

         

100.0%

27.94

Comparable Estimated Relative Value of ESI is $27.94.

Better Investing Valuation (www.betterinvesting.org):

Based on a 3% Sales Growth Estimate and average 5-Year High and Low PE Multiples, I came up with a Buy Zone below $40.40. Please see my Better Investing Model at the following:

http://www.trueinvestmentresearch.com/2014/08/11/updated-itt-educational-services-inc-esi-better-investing-valuation/

Risks

Business Risks:

The future of for-profit education is cloudy. The Obama Administration has cracked down on some for-profit education institutions for failing to address concerns about its practices. Questionable job placement data, marketing claims and allegations about altered student grades and attendance records looms around for-profit education. Are there legitimate for-profit education institutions? Yes, but there are also many questionable ones. It is definitely “overcast” for these for-profit education institutions. This may mean the end of an era or may mean an opportunity to buy into a turnaround venture.

Financial Risks:

Leverage Ratios

 

Total Liabilities to Total Assets

Long-Term Debt to Capital

Long-Term Debt to Equity

Company

69.8

0.0

0.0

% Rank

61

0

0

Sector

60.4

34.1

37.6

Industry

45.6

6.6

3.3

The company is conservatively financed with no Long-Term Debt. Therefore, Interest Coverage Ratios and Payback of Debt do not apply.

Outlook

Analyst Consensus Estimates (ACE):

 

Fiscal Year 2014

High Estimate

$3.330

Low Estimate

$2.040

Standard Deviation

0.505

# of Estimates

9

Current Estimate

$2.654

Industry/Sector Fair Value:

Per Morningstar’s Fair Market Valuation of the Industry, 8/11/14’s Ratio is 1.01 indicating a fairly valued industry. The 52-Week High was 1.34; the 52-Week Low was 0.99; All-Time High was 1.40; and All-Time Low was 0.54.

See (Industry > Consumer Defensive > Education & Training Services): http://www.morningstar.com/market-valuation/market-fair-value-graph.aspx

Margin of safety

The Comparable Relative Valuation was $27.94, and closing price was $8.87, which indicates a Margin of Safety of 32%. If for-profit education does make it back to normalized PE Ratios and Earnings, then this may indicate a time to invest in for-profit education.

About the author:

nnnguyen1221
Experienced professional with expertise in financial statement analysis, value investing, and financial modeling. Past employment with the government (Internal Revenue Service), banking, insurance, and accounting service sectors. Licensed CPA with individual and corporate tax compliance experience and a 2015 Level III Candidate in the CFA Program.

Visit nnnguyen1221's Website


Rating: 1.0/5 (1 vote)

Voters:

Comments

jasonfrey33
Jasonfrey33 - 1 month ago

Thank you for the article. I would suggest adding the late filing of ESI annual report as well as the outstanding off balance sheet loans. I do not have the exact value of the loans, but close to $290 mil.that ESI is responsible for. This amount fluctuates based on default rates. I have positions in this company, but the position is hedged with short term puts in case of failure to file an audited report or loss of title IV funding due to inadequate down payment. With the hedge my downside is reasonable and upside is still very large. Without the hedge, I would be nervous to take a significant position.

nnnguyen1221
Nnnguyen1221 premium member - 1 month ago

That is a very good strategy. Maybe you can share how you actually hedged your positions. Thanks for your comments!

jasonfrey33
Jasonfrey33 - 1 month ago

My thought process is that the greatest risk for this stock is a short term cash crunch due to increased Title IV cash requirements. This problem should be clarified as soon as the 10k is filed and that is waiting on the SEC. The short term risk that the annual and quarterly report are much worse than expected with the off balance sheet loans now on balance, is exacerbated by the risk that the credit facility may tighten credit even further when ESI most needs it. However, if a lease back transaction takes place or a better than expected report is filed the stock could rebound notably, maybe 200 to 300%. There is a real risk with the off balance sheet loans that the stock goes to or near to zero in the short term due to inadequate cash to get title IV money. To hedge this short term risk I bought $6 puts for Sept and Oct. I bought 2 puts for each share I owned split b/n the two dates. I hope to ride this drop out long term, but if bankruptcy is in the picture my max drawdown is 30% for a short period. If no lease back occurs and their report is still not filed by mid October I will have to exit or buy more puts.

Fear=Fortune
Fear=Fortune - 1 month ago

I hedged using short term put options. I purchased 2 contracts for every 100 shares of ESI. I split evenly between September and October contracts at $6.00. My thought process is that the majority if risk is short term, SEC approval of how to account for off balance sheet loans and cash flow crunch/stricter credit requirements with DOE. Maybe the puts don't allow enough time, but my downside is now limited while I enjoy the 200 to 300% appreciation potential if they close a leaseback transaction or file a better than expected Qtrly/Annual statement. If it takes longer than mid October to get SEC approval of financials or arrange for DOE loan requirements, I will have to reassess if I will buy more puts or reduce position. Thank you again for the article. There is potential here for the brave hearted, especially with put option hedge.

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