3 Ways to Play For-Profit Colleges


In less than five months, the federal government’s regulations regarding its “gainful employment” rules at for-profit colleges take effect. Investors are lining up on both sides of the argument.

For-profit post-secondary institutions will have to do a better job preparing students for the real world or they’ll be out of business. Since the subject first reared its ugly head in 2010, higher-education stocks have been running for cover. Over the past three years through March 14, the education-and-training-services industry has lost almost 8% on an annualized basis, compared to 25.2% for the S&P 500.

Investing in this space has been an unmitigated disaster. But if you’re a value investor, this could be the contrarian play of a lifetime. Here are three ways to do so:

Straight Up

Invest in the company with the strongest chance of thriving amid the chaos. We’re talking about a business that will remain profitable regardless of the changes coming down the pike and also happens to trade at a significant discount to fair value.

The stock I have in mind is Apollo Group (NASDAQ:APOL), one of the world’s largest for-profit education companies. It operates the University of Phoenix, an institution that graduated more than 100,000 students in 2011. Since August 2006, Apollo Group’s stock has seriously underperformed both the S&P 500 and its peers.

A $100 investment in Apollo Group in August 2006 was worth $93 five years later. The same $100 was worth $104 for the index and $110 for Apollo’s peer group, which comprises five companies: Career Education (NASDAQ: CECO), Corinthian Colleges (NASDAQ:COCO), DeVry (NYSE:DV), ITT Educational Services (NYSE:ESI) and Strayer Education (NASDAQ:STRA).

Year-to-date, Apollo Group’s stock is down 22%, which is understandable given its February 28 guidance for fiscal 2012. Management expects revenues of $4.1 billion, with an operating profit of $625 million. Only two years ago, revenues were $4.9 billion, with operating profits of $1 billion.

In the span of two years, operating margins have shrunk 520 basis points, to 15.2%. Based on a 44% tax rate, its earnings per share in fiscal 2012 should be at least $2.67, which is a P-E of 16.

Hedge fund manager Lee Ainslie of Maverick Capital owns 5.4% of Apollo Group and is its second-largest shareholder behind founder John Sperling. Ainslie believes for-profit schools do a good job of serving minority communities that are underserved. I’ll take his word for it. For me, it all comes down to the fact that Apollo Group is one of the oldest and most profitable for-profit institutions in America, yet its enterprise value is just 3.5 times EBITDA. That’s an offer I can’t refuse.

In The Side Door

If you’re a disciple of Warren Buffett, this might appeal to you. The Washington Post Co. (NYSE:WPO) has owned Kaplan Inc. since 1984. In those 28 years, the education provider has grown to revenues of $2.5 billion, or 58% of the Post’s overall business. It didn’t have a great year in 2011 in terms of profitability, but it should bounce back nicely in 2012 as its restructuring plans kick in.

For investors unsure about putting cash into a Washington Post, whose newspaper business that hasn’t been doing so well of late, an alternative would be to buy Berkshire Hathaway‘s Class B (NYSE:BRK.B) stock. Buffett’s holding company owns 27% of the newspaper chain, which in addition to Kaplan and the newspapers, owns cable television and television-broadcasting businesses.

The Back Door

Although I’m hesitant to recommend anything remotely related to Goldman Sachs (NYSE:GS) after former Managing Director Greg Smith discussed his reasons for leaving the bank in a recent New York Times op-ed, I’ll throw it out there all the same.

Goldman Sachs owns 39% of Education Management Corp. (NASDAQ:EDMC), one of the largest post-secondary providers of education in North America based on enrollment and revenue. Goldman Sachs is one of 15 banks that passed the Federal Reserve’s annual stress test. Operating a diverse group of financial businesses that Smith says care only about profits and very little about clients; if you can stomach owning a soul-sucking, truly evil enterprise, this might be an equally viable alternative.

The bottom line: Given the continuing volatility of for-profit higher education stocks, the best offense is a good defense: Only invest in the strongest of these businesses.

As of this writing, Will Ashworth did not own a position in any of the stocks named here.

Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia.

Article printed from InvestorPlace Media, https://investorplace.com/2012/03/3-ways-to-play-for-profit-colleges/.

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