“An investment in knowledge pays the best interest.” – Benjamin Franklin
During the waning years of the Obama presidency, the future of for-profit education (FPE) looked rather bleak. One of the biggest players, ITT Educational Services (ESI, Financial), the operator of the ITT Technical Institutes, was forced to close down entirely under the weight of repeated legal actions at the state and federal levels. Other big names, such as Apollo Education Group (APOL, Financial), Adtalem Global Education (ATGE, Financial) and Grand Canyon Education – which manage the University of Phoenix, DeVry University and Grand Canyon University, respectively – faced various degrees of financial and legal headwinds as well.
The Obama administration’s moves to clamp down on FPE included stricter regulation, mounting legal action, and efforts to close off the tap of federal student loans – the core revenue source and lifeblood of these schools. With the prospect of a President Hillary Clinton turning the screws even harder, things were not looking good at the end of last year. Education stocks had been falling sharply since the Obama attacks began and the pain looked set to continue.
Then The Donald happened.
FPE loves Trump
The market response to Trump’s election was immediate. On election day, Apollo Education, Adtalem and Grand Canyon closed at $8.73, $23.50 and $47.90, respectively. A week later, they were at $9.43 (up 8%), $27.90 (up 19%) and $55.82 (up 16%).
Expectations were clearly high in the wake of Trump’s victory, and the new Republican administration has not disappointed. The education department under Betsy DeVos has made a concerted effort to roll back Obama era regulations and policies, giving FPE companies a far freer hand. Should we have expected anything less from the owner of the embattled Trump University?
While many of the gripes about FPE are spurious, such as their relative performance against nonprofit alternatives (only 38.1% of community college students completed a two-year or four-year degree within six years of enrollment, which compares unfavorably to the more than 60% completion rate at two-year FPEs), some are genuine. The accusations of misleading sales tactics and other abuses are not without merit. Such activities have marred the entire industry and turned many people off FPE for good. Removing regulations cannot turn back the clock.
Redefining the FPE value proposition
The reality is that relaxing regulations now will be no guarantee of future success. With warier customers and the perpetual threat of a hostile administration returning to power, sticking to the old methods is not a sustainable long-term strategy for FPE companies. They have to adapt. The ones that do it best will have an opportunity to build a genuine value moat.
Grand Canyon stands out immediately as a leader working to disrupt FPE and to redefine the industry’s core value proposition.
Most fundamentally, Grand Canyon University has made major strides in enrolling students into on-campus programs, a major break from the traditional FPE business model. While other for-profit colleges place overwhelming emphasis on online study as a way to reduce usage and overhead costs on facilities and instructors, Grand Canyon has moved in the opposite direction to some extent.
Grand Canyon’s shift to brick-and-mortar education is not fueled by altruism, but by sound business reasoning: On-campus education provides opportunities to charge higher tuition as well as other fees, including housing, facilities and supplies. The fixed cost and cost-per-student is higher, but on-campus students still offer superior margins to online students. On-campus students also tend to be more invested in their education, making them less likely to drop out. Compared to the traditional FPE business model of pumping up enrollment and largely ignoring churn, Grand Canyon offers a more stable and profitable alternative.
Online education still plays a vital role for Grand Canyon's business. These students provide significant revenues at low cost. But it is how those revenues are deployed that makes for another shocker: They allow Grand Canyon to keep on-campus tuitions flat. In fact, Grand Canyon hasn’t raised tuition in years. In a world of constantly rising college costs, in the for-profit and nonprofit spaces alike, Grand Canyon is a bizarre outlier. But by reinvesting online education income into expanded and improved on-campus offerings that attract ever higher enrollment. Grand Canyon has used a synthesis of online and on-campus education to create a virtuous circle that sets the company on an entirely different level from its peers.
Investment thesis
Grand Canyon is a great company that continues to have enticing upside potential. Even after a strong run since November that has seen the company’s share price rise to around $90 (up 55% year to date), there is still value for investors – albeit with less upside than for those who got in post-election.
In its Q2 2017 report, published in August, Grand Canyon showed an impressive 10.5% increase in enrollment, beat earnings expectations by 15 cents per share and made an upward revision to forward estimates. Investors clearly love the spring in Grand Canyon’s step and expect continued impressive growth, given the price-earnings ratio of nearly 25 at which it now trades. Compared to Adtalem, which trades at nearly 19 times earnings, Grand Canyon does look a bit dear. But, Adtalem’s DeVry University is a dinosaur by comparison, and has done little to enhance its value proposition. A comparative premium should be expected.
Furthermore, Grand Canyon investors are also exposed to the potential benefits of a buyout at some stage in the future, albeit of an unusual kind. Specifically, the company has explored transitioning into a nonprofit which would, were it to occur, require buying out shareholders at a premium. Accreditation officials scotched that notion in 2016, and the higher market capitalization today might make it a challenge, but it remains a possibility to be aware of – and a potential hedge against a return of more aggressive anti-FPE policymakers (though with an alumni network of satisfied customers and a virtuous approach to for-profit college, Grand Canyon should have little to fear from regulators or grandstanding legislators).
Given its product differentiation, great potential for further enrollment expansion (on the main campus, online and on proposed satellite campuses), and strong earnings and margin expansion, Grand Canyon still looks like a buying opportunity.
Disclosure: I/We have no position in any of the stocks mentioned.
