$CECO - Research
One of the most unloved and despised sectors of the market is for profit education. After all, everyone knows that if for profit education doesn’t already have two feet in the grave, one foot is in and the other foot is dangling over it ready to join its partner. But the question is whether it’s in fact true that for profit education will go the way of buggy whip manufacturers.Career Education Corp. (CECO) is an idea for those willing to be true contrarians. It’s near its 52 week low and has seen its share of bad news. The problems can be divided broadly into regulatory concerns and business concerns. Even with all the problems CECO it's arguable that a lot of the issues are already priced in, consider the following:Market cap of $472m against cash of $441m, with an Enterprise value of $31m (no debt)The business generated an average of $263m in operating cash flow over the last three years.Past three years average free cash flow of $151m.EV/FCF of .2xRegulatory IssuesThe for profit education sector has tremendous headwinds at the present time. Essentially, many of the for profit schools were accused of being nothing more than diploma mills. That is, they take in tuition funds and churn out diplomas without any consideration for a “good” education or future job prospects. There is some truth to this and there have been some egregious practices. Congress has made a point of showcasing the issues and coming down on the for profit schools. Various regulatory schemes have been enacted over the years to “fix” the problems. The regulatory schemes are in many ways onerous and quite difficult to comply with. Before listing those out, it’s important to understand that for profit schools receive the vast majority of their tuition funds from students who have received aid under Title IV. That is, students typically take out government funded or sponsored loans to pay their tuition. When they can’t repay their loans, it becomes the taxpayers’ burden. Student loans have been in the news lately as they’ve reached the $1 trillion mark and with loan resets coming up on the horizon it could be a heavy burden.The key to understanding the regulatory regime is that for each different scheme failure to comply can result in various consequences – anything from probation to fines and, the ultimate death penalty for for profit education, curtailment of Title IV funds. Thus, in the event of the “death penalty”, these schools would be prohibited from receiving government funded or sponsored funds and that would essentially mean game over.As for the major regulatory schemes:1. 90/10 Rule – this rule provides that no more than 90% of a school’s funding can come from Title IV funds. As with most of these rules, it is tested both on an individual school level and in the aggregate for all schools a company owns. 2. Cohort Default Rule – this rule provides that no more than a certain specified amount of students who are in their loan repayment period can be in default. These rules have been changing of late.3. Gainful Employment Rule – this rule is new and provides that after graduating from a program for each student in repayment mode only a certain amount of their income can be used towards the repurchase of the loans. I have thought and thought about this and have no clue how it will be applied in practice as it will require self-reporting from the individuals. In any case, while it is currently in effect, there are no ramifications for a couple of years or so.4. Accreditation – in order to receive Title IV funds each school must be accredited by the applicable accreditation provider.Business Issues Due to the regulatory headwinds and the poor economic environment, for profit schools have seen enrollment plummet. But in many cases, students who attend for profit education schools would not usually be attending a four year university. That is, for profits provide a useful skill for many people looking to improve their situation.So this has been a lot of background. CECO has suffered tremendously from all of these issues. Enrollment is down and there have been problems as well with their accreditors. Last year, CECO received a “show cause” directive from their accreditor as it related to their reporting of placement rates. At the same time, CECO’s CEO resigned over some improprieties and the new CEO pledged to clean things up. He immediately hired an outside law firm, Dewey & LeBouef, to audit their placement rates. Upon receiving the report, they sent it to the accreditors and promised to rectify the situation. The show cause directive was hanging over their head and they just received word that other than 4 schools being put on probation, there are no ramifications.In terms of the various other regulatory schemes, what to say? It would seem to be priced in at this point. In my experience, take it for what it’s worth, Congress is a lot of bluster and not a lot of bite on these points. That is, a lot of noise is made, but Congress isn’t really inclined in my view to shut down businesses that aren’t “harming” anyone, physically at least. So while there will much wringing of hands, probation, fines even, etc., to receive the death penalty (i.e. not be able to obtain Title IV funds) would essentially mean that thousands of employees are put on the street and hundreds of thousands or even millions of students are left with a worthless education. I don’t see that happening, but it’s possible of course.ValuationThe best valuations are the most simple valuations. As I write this the stock price is around $6.80. Book value is $11.93 and tangible book value is $6.72. The market cap is around $472 million and enterprise value is about $31 million; there is a lot of excess cash and no debt, although there are operating leases.Interestingly enough, with all of these headwinds (and note too that much of this isn’t really new, but has been ongoing for quite some time), revenues have been fairly stable for the past 8 or 9 years. The 4 year average is approximately $1.87 billion and the 8 year average is about $1.86 billion. So more stable than one would think. Free cash flow margins have been relatively stable as well, although have been nipped a little bit recently with all of the overhang. The FCF margins for the past 4 years have averaged about 8.6% while for the past 8 years it has averaged about 9.7%. Using a value destroying multiple of 8, the stock on a FCF basis would be worth somewhere in the $21-23 neighborhood. There is a lot of margin of safety in that. Think revenues will plummet? Cut them in half. The stock is still worth in $12 area. Margins will come way down? Cut them in half along with half the revenues and the stock is probably worth around what it’s at today, but if the multiple was higher obviously that could still work out.At the end of the day, the stock is being priced as if it is going under. If one thinks that’s the case, it isn’t worth an investment at any price. But if they survive, it will almost certainly be in somewhat the form they currently are in. This isn’t a stock without risk and a lot of it. No recommendation is being made as to whether CECO or any other for profit education company should be purchased, held or sold. Do your own due diligence and speak to whichever experts you feel is necessary.
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