Elizabeth Warren, a Democratic senator from Massachusetts, has made her opposition to the power of big banks and other hulking financial institutions a key part of her political brand. As we discussed in the first part of this research note, Warren has extended this criticism to include private equity. In July, she delivered a blistering attack on the industry.
Warren’s attention, however, along with that of other hopefuls for the 2020 Democratic presidential nomination, seemed to shift during the summer toward the more imminent threat of Big Tech. Warren’s calls to break up tech giants like Amazon.com Inc. (AMZN), Facebook Inc. (FB) and Alphabet Inc. (GOOGL) have been echoed by other political heavyweights, including Senator Bernie Sanders of Vermont.
Yet, if the private equity pros hoped that Warren and her fellow travelers had moved on to other targets, they were proved sorely mistaken last week.
Warren is back on the anti-private equity attack, this time with a narrower target in mind: private equity firms involved in for-profit education.
PE-owned education under attack
On Sep. 17, Warren took to Twitter to decry the private equity industry once again, delivering unequivocal condemnation of its behavior in the education industry:
“35% of for-profit students are enrolled in private equity-owned schools, & those schools have higher tuition, more student borrowing, & lower grad rates. Their business isn't educating students – it's sucking down federal student aid, which makes up nearly all of their revenue. In industry after industry, private equity firms have stripped companies of assets, loaded them with debt, extracted $$$ & skipped away when the bets went bad. Students & taxpayers deserve to understand the shadowy role these firms play in an industry already fraught with abuse. I’ve got a bill that would put private equity firms on the hook for the decisions made by the companies they control, including for-profit colleges. It’s long past time to hold these firms accountable for steering colleges into a ditch & scamming students.”
Warren has attacked for-profit education in the past, but her criticisms have particular traction with regard to those institutions owned and operated by private equity firms. A new working paper from the National Bureau of Economic Research, “When Investor Incentives and Consumer Interests Diverge: Private Equity in Education,” has addressed the performance of PE-owned academic institutions. The paper’s findings offer fresh ammunition for Warren and her allies.
Capturing government largesse
Leveraging data acquired from 994 schools, as well as from 88 private equity deals, the NBER study found systemic underperformance across a range of indicators:
- Higher tuition.
- Higher student debt levels.
- Lower graduation rates.
- Lower loan repayment rates.
- Lower earnings for graduates in post-school jobs.
There is just one metric on which private equity-owned schools outperform their peers: profitability.
This fits the rationale behind the industry, namely that an external operator can take over a struggling or otherwise underperforming company and turn it around by instilling discipline and re-gearing operations toward maximum profitability. Because federal grants and loans make up the vast majority of these schools’ incomes, private equity’s incentive is not to achieve maximum operational efficiency, but rather to capture maximum government funding. According to the NBER working paper, perverse incentives have led to perverse outcomes:
“In education, subsidized by the government, private equity managers go for broke in capturing government aid at the expense of student outcomes...One reason such high-powered incentives might be poorly aligned with student interests is that education is heavily subsidized. Federal grants and federally guaranteed loans comprise around 90 percent of for-profit schools’ revenue and have little if any dependence on student outcomes. We find that student outcomes deteriorate after a school is bought by a private equity firm, and reliance on federal aid and guaranteed loans increases.”
Derailing an industry makeover
Publicly traded for-profit schools have been under political and legal scrutiny for years, drawing the ire of the Obama administration in particular. Its pressure, combined with that of numerous state governments, served to drive some for-profit colleges out of business, such as ITT Educational Services Inc., while stocks across the industry were weighed upon by fears of increased political pressure. When Donald Trump was elected, the industry surged, with the likes of Grand Canyon Education Inc. LOPE surging more than 40% since the more favorable Republican administration took power.
Studies comparing outcomes for students of for-profit schools to those of community colleges show roughly equal performance overall. Columbia University found in 2015 that just 38.5% of students attending community colleges managed to complete a two-year or four-year degree within six years of enrollment. That stands rather unfavorably to the more than 60% completion rate at two-year for-profit schools.
Solid performance at for-profit colleges, combined with public commitments to a more ethical approach to business, have served to rehabilitate much of the industry. Yet, private equity-owned schools are clearly endangering that effort.
With another presidential election on the horizon, private equity’s bad behavior could weigh on the fortunes of the entire for-profit education industry. Politicians like Warren may not distinguish between well-managed, student-focused companies and those run by the “PE vampires” she decries so publicly.
Verdict
A Democratic victory in 2020 is hardly a certainty. Unlike virtually any other industry, however, for-profit education operates at the mercy of federal programs, incentives and regulations. An unfavorable administration could weigh heavily on the performance of the publicly traded companies in the sector.
Investors with exposure to the sector should consider the political dangers carefully, especially now that PE-owned for-profit schools are once again in the crosshairs of political heavyweights.
Disclosure: No positons.
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