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We believe Career Ed can continue to achieve significant internal growth in enrollment, revenue and profitability at its existing 51 campuses. Over the last five years, revenue growth has been driven by a combination of same-school population growth, tuition increases, and a shift towards higher-priced programs.
GEOGRAPHY LESSONS. Career Ed has grown by acquiring new schools in the U.S., Canada, France, the U.K., and the United Arab Emirates and then applying its expertise in marketing and school management to increase enrollment, revenue, and profitability at those schools. We expect that this process will continue to be an important element of its growth strategy.
By acquiring new schools, Career Ed is able to realize economies of scale in terms of management information systems, accounting and audit functions, and employee benefits and insurance procurement, thus improving operating margins. We believe the recent acquisition of Whitman College represents an outstanding platform for Career Ed to penetrate the fast-growing market of health education.
Career Ed has opened four start-up branch campuses (two in 2002 and two in 2001) and expects to continue to establish branch locations of existing institutions. We believe that opening branch campuses enables it to capitalize on new markets or geographic locations that exhibit strong enrollment potential and the potential to establish a successful operation in one of its core curricula areas. Also, Career Ed has developed an expertise in migrating established programs and curricula from one campus to another. These "program transplants" should allow for leveraging of development, education, and marketing costs.
ONLINE ACADEMY. In February, 2001, Career Ed began enrolling students into full degree-granting online programs within American InterContinental University-Online. As of Apr. 30, 2003, AIU-Online had a total student enrollment of approximately 4,100, vs. just 300 a little more than a year earlier.
While we expect that its current campus-based school operations will continue to provide the large majority of its revenue in the near term, we believe that online education is Career Ed's greatest growth opportunity. We expect AIU to generate about $120 million in revenues in 2003. Career Ed's management projects $200 million to $300 million in revenues for 2005.
While in the short term the company's investment in its online programs is constraining overall profitability, we believe that in the long-term AIU will be one of the major drivers of increasing earnings power and higher return on capital. As the revenue from AIU increases as a percentage of total revenue, we believe Career Ed's operating margin will be more in line with that of industry leader Apollo. This in turn will, in our view, significantly boost Career Ed's return on capital.
We expect Career Ed to pursue international opportunities in private and for-profit postsecondary education and to continue its marketing efforts in selected countries to increase international student enrollments at its domestic schools. We believe the February, 2003, acquisition of the INSEEC Group, a postsecondary education company with nine campuses in France, provides Career Ed with a platform for additional expansion in Europe.
REVENUE RAMP-UP. S&P expects revenue and earnings growth at existing operations to be driven by new student enrollment, a projected 50 curriculum transplants in 2003, and new campus openings. We also see higher revenue per student due to online education growth, tuition increases, and optimization of acquired schools. We project revenue of $1.143 billion in 2003 and $1.48 billion in 2004.
Operating margins should widen slightly, on better operating leverage, increased offerings of advanced degrees, and growth of the online education division. After taxes projected at a rate of 40.5%, we see 2003 EPS at $1.07 and $1.39 for 2004. Our estimates do not include potential acquisitions. We project Standard & Poor's Core Earnings of 93 cents per share in 2003 and $1.22 in 2004, which are about 13% below our operating EPS estimates, due to option expensing.
In 2002, Career Ed generated free-cash flow of $47 million, and we project $64 million for 2003. Our 12-month target price, based on discounted cash flow analysis, is $58. The model assumes a compounded growth rate of free cash flows of 29% over the next five years, a gradual decline in the growth rate to 3% over the next 15 years, a 3% perpetual growth rate (in line with the 3% estimated long-term growth rate of GDP), a cost of capital of 8%, minimal long term debt, and an equity risk premium of 6%.
FEW NEGATIVES. The shares are trading at a well-above market multiple of 46 times our 2003 EPS estimate of $1.07. However, as we indicated above, we expect earnings growth to average 30%-35% over the next three to five years, driven by both student population growth and tuition increases. Also, in light of Career Ed's position in the for-profit postsecondary education market, and what we see as barriers to entry, annual revenue visibility above 60%, stable retention rates, increasing return on capital, and a consistent history of beating expectations, we believe such a premium is warranted.
In the long term, we believe that if Career Ed is successful in improving its operating margin through economies of scale and by growing the online business, its return on capital will increase and its shares' market multiples will consequently expand and trade more in line with industry leader Apollo.
Key risk factors, in our view, that could affect the company's operations and prevent Career Ed from achieving our target price include: failure to effectively execute growth initiatives; increasing competition that could raise prices paid for acquisitions; and declining placement rates that would be detrimental to new student population growth.
Analyst Santicchia follows emerging growth stocks for Standard & Poor's
All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure
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