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Outlook for Education


J A M E S

M A H E R

T H I N K E Q U I T Y

L L C

JAMES MAHER joined ThinkEquity in 2005 and is a Senior Analyst focused on education.
Prior to joining ThinkEquity, Mr. Maher co-founded a quantitative marketing analysis
consulting firm whose clients included Charles Schwab & Co. and Wells Fargo Bank. He

Controller at OffRoad Capital. Mr. Maher holds a B.S. with honors in computer science
from Seton Hall University and earned an MBA from The Haas School of Business at the
University of California at Berkeley. He is also a designated CFA.

SECTOR EDUCATION & TRAINING SERVICES


sures of that is the new student population for the schools. The new
(AAP806) TWST: Please give an overview of the sectors within
student-starting programs jumped substantially in the September and
education that you cover, naming specific companies.
especially the December quarter last year. The growth has remained
Mr. Maher: We do cover forreally robust ever since. I think some of
profit education and, principally, if you
that is simply that when you are looking
are talking about companies in the pubat the alternatives for people who either
Highlights
lic sphere, that is postsecondary. And so
have lost their job or realized that in a
what that means is companies like
stressful economic time they are lookJames Maher, explores trends in the
Apollo (APOL), DeVry (DV), ITT
ing to improve their skills, going back
post-secondary, for-profit education
(ESI) and others in that sort, which are
to school is a nice alternative.
sector, noting several factors that
these days increasingly online, either as
TWST: That seems to be a
suggest growth in this industry may be
a significant share of the population or
common theme. However, are there
sustainable: a prolonged recession,
exclusively online. I do follow some
any education segments that are
employee dislocation in this economy
12
other companies outside of that K
struggling due to the economy? Or
and budgetary pressure on state and
Inc. (LRN), which, as you might exhave the majority of companies been
community schools. Mr. Maher says
pect, operates in K-12; Princeton Reinsulated all this time?
that what we will probably see from the
view (REVU) and there are some other
Mr. Maher: I think most of
public companies is a lot of continuation
companies in education services. But
the schools are actually doing pretty
of what we've seen in the last year or
principally I follow companies that are
well because of the combination of
so, which is acquisition of smaller
involved in instruction, whether its
facts that this is not simply a down
private
or
especially
global
postsecondary, primary school or like
economy. They get more growth on the
organizations.
Princeton Review in test preparation.
revenue side because of more students.
Companies include: Apollo Group (APOL),
TWST: How are these comHow many companies are growing the
DeVry (DV); ITT Education Services (ESI);
panies faring in this economy?
top line at 20% organically last year?
K12 (LRN); Princeton Review (REVU);
Mr. Maher: On a macro
Because of the growth that these comCapella Education (CPLA); American Public
level, many of the companies, especially
panies are getting, they are experiencEducation (APEI) and Grand Canyon
the postsecondary ones, are actually
ing minimal inflation if not outright
Education (LOPE).
very favorably responding to this cirdeflation in their principal purchases,
cumstance because they are countercywhether its advertising, technology or
clical to a degree. And so when you look
recruiting new employees. So they are
at the last year or so, when unemploypossibly coming down, and the strucment really started to rise sharply and especially to rise sharply
ture of the companies is such that theyre typically paid in advance
among those without a college degree, you see that the interest in
because postsecondary education in the U.S. is a financed activity,
enrolling in programs jumped significantly. And one of the best meaand the U.S. government is the principal financier. Looking at these

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programs, the students get their loans, the companies are paid in
the recession and the competitive shift in terms of what the state
advance, so they are growing rapidly. Their costs are shrinking or
programs are up to, I think the for-profit schools are going to confairly stable as a percentage relative to
tinue to be able to grow enrollment
price terms, and they get paid upfront
for some time, just at a slower pace
so their cash flows are very strong. So
than they currently are.
the group in general is very strong
TWST: The degree to
right now. Half the companies I follow
which state schools and community
are buying back stock.
colleges can compete with for-profit
If you look at the last 30 years, the
TWST: Given that educacompanies is limited due to budget
postsecondary tuition has risen at
tion tends to be countercyclical, how
pressures. However, could the forroughly twice the rate of inflation for
much more upside can we expect to
mer become more formidable comdecades, and it's simply not sustainable.
see? What type of growth do you
petition in a few years?
predict over the next year, and when
Mr. Maher: I think theyll
might we see a deceleration?
certainly want to. And if they fully
Mr. Maher: I think in perrecognize that the demand is there for
centage terms, we are going to start to
people who are changing careers or
see slower growth heading into the
who are seeking new skills and I
September and especially the December quarter, simply because the
think the schools are certainly trying to adapt and prepare themcomparisons are going to become very robust to last years substanselves for that. But in the near term, the budget constraints are very
tial growth. That said, I think there are a couple of factors that sugtight and in lot of cases they have significant physical plats, which
gest that the growth can be sustained. First of all, as you mentioned,
requires a decent amount of capital expenditure. Or just simply
who knows how long this recession is going to last. And this isnt
maintenance expense that something like say Capella (CPLA) or
the old, typical variety, this is deep and dark. Prior to this one, they
American Public Education (APEI), that are fully online, or for
were relatively short and shallow at least by post-World War II
that matter Grand Canyon Education (LOPE), which is princistandards. As a result of it, there is also a global difficulty. I think
pally online, they dont have some of those same constraints. They
this has been as much structural shift economically as weve seen in
can be more flexible in terms of what they offer and how rapidly
a recession really going back to the early 1980s, with the corporate
they scale up. They of course also have the ability to access capital
sector and the consumer deleveraging, and the federal government
the retained earnings to make the investments that they need to
really has a deficit running. I think there is an enormous amount of
make, and they are doing so. They are growing, I think, in many
dislocation in the economy. Manufacturing of course is suffering
cases about as rapidly as they can while providing and maintaining
substantially. Retailers are having a hard time. There are a lot of
the service quality, the same educational standards. But for the state
things peoples perspectives on their employment and obviously
and community colleges, I think in the near term its going to be
financial services as well. They are suffering. If you look at where
very tough. And many of them already experienced budget cuts for
people have been working and where they will probably be best
this most recent school year and are looking at new ones going into
able to find work, that translates into where the schools are most
the back-to-school season here starting up in September.
likely to find their prospective students. I think this change in the
1-Year Daily Chart of DeVry Inc.
composition of the economy favors the idea that people will continue to seek schooling and improve their skills even in other areas
from what they had previously been pursuing. If you look at most
of the schools in the postsecondary space, they had good programs
in education and in health care as professions. According to Bureau
of Labor Statistics, those are two of the best growth opportunities
for employment for the next 10 years or so. And I think thats one
of the things that differentiates between the traditional not-for-profit
either state or private university model, and the for-profit model. As
a client of mine put it: These are schools that are not teaching degrees of passion as much as degrees of purpose. Its a very explicit
intent at the conclusion of the program to improve your economic
competitiveness. I think that with the major changes we are seeing
Chart provided by www.BigCharts.com
as a result of this very deep recession, I do think that there will be
a continued demand for the types of programs these schools offer.
And then even if you look at them again compared to the principal
TWST: Whats on the horizon in health care and educompetition for the group, other than each other, I think you are
cation programs? How quickly could a company like Capella
looking at state schools and community colleges, and those proget a new program up and running?
grams are under enormous budget pressures as states cope with
Mr. Maher: I think that they can still continue to grow
falling tax receipts. By the structural shift perspective in terms of
within the spheres of what they are offering today in terms of the

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programs with education and health care. And part of the reason for
history of these schools operating under the prior administration.
that is the economics of it is very straightforward. In education you
And the new administration is struggling with a very different ecoare dealing frequently with working adults; and for teachers, people
nomic environment and certainly is taking, as I think is typical with
who are already in there, in the profession and are looking simply
the change in administration and the change in party, perhaps a difat more advanced degrees. A masters degree triggers a pay raise in
ferent perspective. I dont see that there will be substantial changes
many of the school systems throughout the country, so its contracto the regulatory requirement that the schools would be unable to
tually part of their benefit. So the arithmetic is very easy to do, and
adapt themselves. So I think if there is greater scrutiny, whether it be
if you say, If I pursue the masters
reporting requirements or reviews, or
degree, Ill get a bump, and it could
those types of things, many of the
be $15,000 annually, to a teacher that
schools are asking, as always, that
is real money. Then that makes the
there is clarity on what it is that is
decision of back to school much easbeing measured and the types of
ier. I think similarly in health care
things that the regulators want to see.
The for-profit schools are now making
there are accreditations or other reThen they are perfectly fine with that.
up 7% or 8% of total post-secondary
quirements in order to achieve promoThey are going to adapt themselves to
enrollment in the country.
tions, and other levels that require
it. For that matter, if you look at someadditional education. So I think those
thing either like the proposed change
two will remain robust. I think the forfrom the administration in the student
profit schools can roll out new prolending process going to direct
grams relatively effectively and
lending instead of using the FFEL
quickly, but it still takes time to ramp
program by and large, the schools
up those programs. You have to put the curriculum in place, the
have said that theyre prepared for the change. And there will be a
faculty in place, and then once you build the foundation, then you
little bit of an administrative change and an administrative overhead
start to introduce it into the market and let people know you have it.
if we move to direct rather than the FFEL program that worked perSo I would say its still the better part of two years, even once you
fectly. Many have already been participating in the direct program,
are really ready to roll before you start to see a significant impact
and they are fully intending to be ready well in advance of next sumon the business. I think Capella was recently talking about their
mer, which is the target should the change take place.
public service leadership programs, which they are now offering.
TWST: Are there any other challenges the industry
But really dont look for probably another six quarters before you
could face over the next year or so?
start to really see substantial material changes or contribution, I
Mr. Maher: There is always the concern about the
should say, for those programs.
growth rates are those sustainable, as we talked about. But I
think there is also the perception of for-profit education, especially
1-Year Daily Chart of Apollo Group Inc.
online education, and whether or not that is a high-quality value,
and whether or not the students are actually learning. I think that the
perception is always something that the schools wrestle with a little
bit, especially if theyve gained share over the last decade or so. I
think the for-profit schools are now making up 7% or 8% of total
postsecondary enrollment in the country. My office here is in San
Francisco and during the dot-com boom, there was endless enthusiasm for any company that was online, typically if it was an Internet
company, whatever that meant it was wonderful. That contained
enormous opportunity, but I think theres somewhat of an exact opposite perspective that if a school utilizes online technology and
theyre educating, that somehow is something that is second-grade
or is not as competitive. I think that over time, weve seen recent
Chart provided by www.BigCharts.com
studies, I believe from the Department of Education, that are indicating that a combination of physical and online can be very advanTWST: So the industry is doing well, not like many
tageous. I think its simply a matter also that for a lot of students,
others in this economy. What are some challenges that compathe physical requirement of being in a particular place at a particular
nies are facing? Are there any obstacles related to the change in
time is too onerous; their lives require some flexibility. So if they
presidential administration or new regulatory issues?
are going to study, they need the asynchronous online capability in
Mr. Maher: I think there is a perspective in the markets
order to make that happen. I would think that over the next decade
that with the new administration there may be greater scrutiny of the
or so, the idea of any postsecondary institution having a program
programs, and many of these programs actually came into the pubthat is exclusively offline I just dont see that happening. I think
lic arena during the previous administration Capella went pubthat this is a technology that is going to increasingly become part of
lic, Grand Canyon, American Public Education. There is a
the delivery of information and the interaction of people in many

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ways. And 10 years from now, lets say that the program has nothing
Mr. Maher: I think right now, when you look at the
online it will be like saying that the program doesnt have a teleschools and on what they are doing, they are growing very rapidly.
phone. Its only a technology; its a tool for teaching, and its not a
Their enrollment top line is growing in some cases 20% or better.
replacement or something that is funThey are continuing to expand their
damentally different.
programs, meaning they are hiring
TWST: How can compafaculty with the case of those that do
nies differentiate themselves in the
a reasonably large amount of their
As far as the group, itself, the domestic
marketplace, and whos doing well?
instruction face-to-face, like say
players are all growing pretty nicely,
Mr. Maher: I think that
Apollo or ITT. They are adding
solidly profitable, cash-flow positive,
they are attempting to do a couple of
physical space, classroom space and
very nice cash flow. So I think the
different things. One is the issue of
also student services. There has been
difficulty for consolidation domestically
cost effectiveness. I think if you look
a lot of systems infrastructure that is
is that we've got a room full of buyers
at the last 30 years, the postsecondary
geared towards supporting students,
and not a lot of interest in selling.
tuition has risen at roughly twice the
and streamlining and building better
rate of inflation for decades, and its
understanding of the process. Capella
simply not sustainable. So when you
implemented a new ERP system over
look at the programs and you have to
the last two years that enabled them to
say, Are these affordable and how can they remain affordable?
have a much more coherent view of the student, an end-to-end view.
that is, I think, something that the for-profit schools have the capaDeVry is implementing a large system, its something that as all
bility of doing because they are leaner in terms of their capital reof the schools are increasingly focused on trying to understand their
quirements, and they simply dont do a lot of things that generate
students more clearly, and in so doing service is getting better and
expense. They dont buy a large school campus, the sports teams,
they make better choices along the entire process.
the dormitories. A lot of the expensive service provisions, theyre
1-Year Daily Chart of Capella Education Co.
simply in a much leaner footprint, and so I think theyre able to do
that. Theyre focused on the economic outcomes of their students
because they are looking at what percentages of students get placed
after graduation and if theyre in their field earning a good living.
For example, DeVry has had what they refer to as 90/40 for a while
now, where they want to see six months after graduation at least
90% of the students working in their chosen field making at least
$40,000 in annual compensation. I think most recently, if Im not
mistaken, the numbers were around 92% and $45,000 annually. So
its a value proposition where they can say to the students many
of whom are nontraditional in the sense that these are not high
school kids graduating and going directly into college, but rather
adults who are returning to school after an absence, in some cases,
Chart provided by www.BigCharts.com
a decade. And thats a very different profile of someone who wants
to make a fundamental change in his economic opportunities. I
think that is where that focus on the value and the economics of it
TWST: When you look at the companies in this space,
are important for these individuals. I think another thing you
what would you say are the markers of a really solid manageasked about how they are competing. Some of it is simply focusing
ment team for a company in this industry?
on their core competencies and their domain expertise in terms of
Mr. Maher: In some of the cases, what we are looking at is
what they teach. American Public Education through their Amerimanagement. Capella was founded by Steve Shank, who has been
can Military University teaches a lot of programs in homeland secuthere from the beginning and had this vision from years before K12.
rity and emergency management, and things that are just courses that
Similarly, the founding entrepreneur said, In education the questions
are not readily available at most of the traditional liberal arts univeris, is there a passion for educating? With some of the new managesities. Capella has emphasized education and health care as their
ment thats come onboard in some of the other companies in part
two principal programs, but more than 80% of their students are in
because of some stumbles that companies ran into in prior years I
graduate programs. So they are geared toward helping working
think its a clarity of purpose. In my view, especially with a larger oradults, and their average student is 39 years old. So they are targeting
ganization, one of the primary tasks for any executive in a large orgaa particular population of working adults who are seeking advanced
nization is to dispel ambiguity, to set priorities and let everyone know
degrees in their field to help them with their careers. I think those
clearly what is expected what is and is not the objective of the
types of things of selecting a niche has been one of the ways that the
company and to keep people understanding what direction they
group is looking to compete.
should be going in and accountable for doing so. So what I look for is
TWST: What are the for-profit companies doing with
are they clear communicators of the objectives of the organization?
the cash theyve been accruing?
TWST: What type of consolidation do you anticipate

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to see during the next one to two years?


Mr. Maher: I think what we will probably see from the
public companies is a lot of continuation of what weve seen in the
last year or so, which is acquisition of smaller private or especially
global organizations. And principally I would say were talking about
Apollo. As far as the group, itself, the domestic players are all growing pretty nicely, solidly profitable, cash-flow positive, very nice cash
flow. So I think the difficulty for consolidation domestically is that
weve got a room full of buyers and not a lot of interest in selling. Just
because the organic growth is quite good at most of the programs
management is able to drive high returns on investments on all programs they dont need to acquire growth, and they certainly dont
have the need for capital. So I dont see that there is going to be a
significant consolidation. But rather theres been a continued acquisition of programs that support the direction of the company.
TWST: Are you seeing a lot of new smaller, private
players come on the horizon right now, as this is viewed as a
great opportunity given the economy?
Mr. Maher: I think we have seen a model recently of
schools that have run into financial distress. Traditional not-for-profit
organizations have run into financial distress, which have become recapitalized and repurposed as for-profit organizations that are then able
to grow rapidly and especially if they develop online programs.
This was the model since weve been acquiring; Canyon followed and
I think there are other organizations looking to emulate that.
TWST: Whats your advice in general to investors who
are interested in this space?
Mr. Maher: When I look at any investment opportunity
or any business, I really principally start with two questions: The
first is what is the sustainable opportunity for growth of operating
earnings? What is the trend and the sustainable opportunity for operating earnings? That in some ways is a measure of the market size.
Can they grow for a long time? The second question, which I think
is equally important, is how efficiently can that growth be delivered? What is the return on invested capital? It really doesnt matter
so much whether a company is in retail, energy or education. I think
those two questions are pretty fundamental. So in looking at education, I think there is a necessity to know that it is a heavily regulated
industry. And if you look at the stock charts for the last two years,

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you can see very vividly when the credit pinches took place. The
group will very much move with perceptions of the credit markets,
but its also a group with characteristics that are very favorable. Its
a very large market there are 19 million students in the U.S. in
postsecondary, give or take. There is big growth and it has created
some very large companies. But as a group, for-profit is still less
than 10% of the total, so there is a large market opportunity and its
a high return on investment, and they are businesses generally with
very nice cash flow characteristics. So theres a lot thats attractive
about it. On the other hand, its absolutely necessary for any organization to remain compliant with their accreditation requirements
and with other regulatory concerns about profitably, compensating
their enrollment counselors and staying attuned to the fact that there
is a significant amount of public money involved in it taxpayers
money, whether it be from clients or loans, or other programs. If
youre looking at a school, be sure you understand as best you can
whether or not the folks have sufficiently emphasized compliance,
because if they havent it could be a very unpleasant experience.
TWST: Is there anything else you would like to add?
Mr. Maher: No, I think those are the big ones. Ill say one
other thing about the group is that there is a lot of headline influence
because it is a regulated industry, and because it is certainly countercyclical. So perceptions of pending regulatory changes or improvement, or lack of improvement in the economy will certainly
move the stocks around a little bit. So it can be volatile, but I think
over time the for-profit companies will have a significant role to
play on the education of the American workforce.
TWST: Thank you. (MES)
Note: Opinions and recommendations are as of 07/29/09
JAMES MAHER
Senior Analyst
ThinkEquity LLC
600 Montgomery Street
San Francisco, CA 94111
(415) 249-2900
www.thinkequity.com
e-mail: info@thinkequity.com

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