Grand Canyon Education Inc. (LOPE, Financial) was one of the first companies we ever covered for GuruFocus, back in September 2017. In particular, we mentioned the company’s distinctive business model, as well as its success in avoiding much of the controversy and litigation that weighed down other names in the for-profit education (FPE) industry.
Grand Canyon has lived up to its promise, delivering for its investors in the intervening time. Yet, major structural changes during the past year demand a reappraisal of the investment thesis.
Investing in brick-and-mortar
In our first analysis of Grand Canyon, we highlighted the remarkable qualities of Grand Canyon University (GCU), its flagship institution, especially its atypical focus on campus-based education:
“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.”
Somewhat amazingly, this alternative FPE business model proved to be a win-win. Students obviously benefited from a more conventional college environment.
Less obvious was how the company benefited: While the conventional wisdom among FPE professionals was that online education was the key to profit maximization, Grand Canyon turned this reasoning on its head. Indeed, the company’s per-student margins have been higher for GCU’s on-campus students than for online students. While the school had to take on additional fixed costs, its ability to charge students for a range of physical services more than made up the difference to Grand Canyon’s gain.
The brick-and-mortar business model became a central part of both the investment thesis, management’s stated value proposition. Until now.
Divesting of brick-and-mortar
In July 2018, Grand Canyon made a momentous change: It spun off GCU, which became a nonprofit university. This decision made sense from the standpoint of the educational institution, which had been a nonprofit at its initial foundation, before financial distress forced it to sell itself to a private investment group in 2004. But, the value of the decision for Grand Canyon the company was less obvious.
Grand Canyon has redefined itself as a high-end online program management company (OPM), with the aim of serving the needs of many educational institutions seeking to scale their online offerings. CEO Brian Mueller made the case for the strategic pivot during the company’s third-quarter earnings call in November last year, arguing that Grand Canyon enjoys a technological advantage in the back-office services segment:
“Universities wanting to get into that adult market...in an online format. The thing that attracts them… to us is the fact that a lot of the OPMs shy away from the back-office services. We consider those to be very, very vital.”
The decision to transition from a direct provider of higher education to an OPM company means that investors must revise their investment theses completely, despite Grand Canyon’s continued close relationship with GCU, which is expected to continue indefinitely -- not least because Mueller remains president of the university, despite its having become a nonprofit.
Verdict
Upon its spinoff, GCU became Grand Canyon Education’s first client as an OPM company, in exchange for 60% of the school’s tuition and other student fees. Other clients will not be nearly so generous, obviously, but the OPM business can be lucrative. Additionally, there are substantial opportunities for scale.
That being said, Grand Canyon’s transition has us somewhat worried. Profitable long-term growth is not guaranteed, while a rich valuation multiple could face pressure if the company stumbles.
While Grand Canyon’s management has proven its ability to execute in the past, investors should look to the future with far more caution.
Disclosure: No positions.
