“Morgan Stanley Securities Analyst Sees Regulatory Risks In Education Sector; Discover Which Stocks To Be Affected ...” |
| Posted: 09 Sep 2010 08:39 AM PDT On Thursday September 9, 2010, 11:39 am 67 WALL STREET, New York - September 8, 2010 - The Wall Street Transcript has just published its Education Report offering a timely review of the sector to serious investors and industry executives. This Special feature contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. The full issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online. Topics covered: Regulatory Risks - Great Buying Opportunities Among Weak Stocks - Economic Recovery and Enrollment Trends - Growth Drivers in Chinese Education Sector - Innovation in Programming and Student Development - Student Quality Over Quantity Companies include: ATA (ATAI); American Public Education (APEI); Blackboard (BBBB); Bridgepoint (BPI); Cambium (ABCD); and many more. In the following brief excerpt from the Education Special Report, expert analysts discuss the outlook for the sector and for investors. Suzanne Stein is a Securities Analyst who covers the education and analytics companies within Morgan Stanley's business services group. Previously Ms. Stein worked in equity research, covering telecom services at Goldman Sachs. Prior to that, she served as an Associate at Donaldson, Lufkin & Jenrette. She holds a dual degree in finance and communications from the Wharton School and the College of Arts and Sciences of the University of Pennsylvania, and an MBA from the University of Chicago. In 2009 Ms. Stein was named the top stock picker in specialty retailers and services in the annual Wall Street Journal "Best on the Street" survey. She was also named one of the best brokerage analysts in the consumer discretionary sector in June 2010 by Forbes. TWST: Which companies are exposed to the biggest regulatory risk? Ms. Stein: They are all exposed to regulatory risk. It is important to keep in mind that the for-profits serve a high-risk population; these students are generally lower-income, working adults, and there are many reasons they don't complete programs. Typically as you move down the scale towards the shorter-term programs, the quality metrics, such as cohort default rates and graduation rates, decline. I don't want to make predictions of failures. The market implies that Corinthian (COCO) is the one that is most at risk. It fails several of the tests; it is the lowest of its peers in terms of repayment rates; it also has a severe problem with cohort default rates. Management is taking steps to address these problems - restricting enrollments - but it is not clear that these problems can be corrected. From an investor's point of view, if you just look at the risk to the model and run the population decline and tuition cut through the model, you can see how the operating leverage in the model can reverse pretty quickly, and it doesn't take a lot to get that model to not work anymore. There is a big fixed expense component to the model, and layer on top of that the added student services cost to try to improve retention, the fact that student acquisition costs are not necessarily lower than for longer-term programs, and it's hard to imagine a scenario where this model is profitable. Other models have some more breathing room, so if companies took down tuition, you could envision a scenario where they are still profitable. TWST: You view Strayer as one of the highest-quality names in the space, yet you're still underweight on the stock. Would you elaborate on your thoughts about that company and its current valuation? Ms. Stein: Our rating on Strayer (STRA), or for any stock in our coverage, does not necessarily reflect what we think of quality; it is more of a relative valuation call. When we put the "underweight" rating on Strayer, our view was that investors were pricing the stock as if it were not exposed to the same regulatory and legislative risk as the rest of the industry, which we do not believe is the case. I guess I took to heart what Senator Harkin said, that maybe there are no good apples. Not that I agree with this statement, but I believe this is how many individuals in Congress and the Department of Education view the sector. They are not distinguishing between Strayer and its peers, and are likely to regulate for-profits as a group, and this will create headwinds for everyone. It's not just going to create headwinds for the ones that people perceive to be lower quality. We changed the rating before the repayment rates were out simply because we felt at a 17 times 2011 p/e multiple there was more risk to the downside. The stock should not have been holding such a premium to the sector. I think there is still risk to the multiple. Repayment rates are low and even if this is a result of loan consolidation, I doubt the Department of Education is going to make material changes to the repayment formula. Also the high use of Pell Grants, which for Strayer was about 30% of students, makes me wonder if its students are that much higher quality than its peers'. Frankly, I am somewhat skeptical of the income numbers management has put out there, given it represents a small sample of Strayer's students. I think management said they had a 25% response rate, and I doubt it factors in zero-earners, which will drag down the numbers, giving these estimates an upward bias. Unless the Department of Education changes the repayment formula, given Strayer is below the threshold on the repayment rates, in order to stay unrestricted they need to meet the higher threshold on debt to income. If in fact loan consolidation is the only variable dragging the repayment number down, this should correct itself over time. Consolidation has been a less common practice since the student loan crisis, so this should roll off. We don't have enough data to support this theory, but this, along with questions about actual student income levels, is enough of a risk that I don't believe the stock is worth a premium to its peer group. The Wall Street Transcript is a unique service for investors and industry researchers - providing fresh commentary and insight through verbatim interviews with CEOs and research analysts. This Special issue is available by calling (212) 952-7433 or via The Wall Street Transcript Online . 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