Bloomberg News

School Operator Seen Swapping Debt: Corporate Finance

May 09, 2014

(Corrects story published May 8 to remove the reference to Goldman in the headline.)

Education Management Corp. (EDMC:US)’s loans are dropping the most in the U.S. market this month as signs emerge that the for-profit college operator with declining enrollments will seek to swap its debt for equity.

The company, partly owned by Goldman Sachs Group Inc. and Providence Equity Partners LLC, will “likely not satisfy” terms of its credit accord this quarter and has hired a financial adviser for discussions with lenders, Chief Financial Officer Mick Beekhuizen said during a May 1 earnings call with investors and analysts. Pittsburgh-based Education Management has seen its $731 million of first-lien loans maturing in June 2016 tumble 8.3 cents on the dollar to 75.4 cents in May, more than any of the other 330 actively traded bank debt tracked by Bloomberg.

“This close to the likely event of a default, they are talking of a restructuring and not talking about amendment and waivers,” said David Berge, a Moody’s Investors Service analyst who cut the rating on the company’s debt two levels to Caa3 last week. “That makes us think there might be an exchange of senior debt for a junior type of capital.”

The new rating is the lowest rung in a category of borrowings considered to be of “poor standing.”

Falling Revenue

Education Management is poised for a third straight year of revenue declines (EDMC:US) as regulators investigate marketing and enrollment practices at for-profit colleges. The company has fully drawn its credit line, acknowledged that its assets are worth $500 million less than their book value and given advance notice on likely covenant breaches, all signs of an impending debt swap, according to Berge.

The college operator hired Evercore Partners Inc. (EVR:US) to lead discussions with lenders, according to a person familiar with the situation who asked not to be identified citing lack of authorization to speak publicly. Dana Gorman, a spokesman for Evercore at Abernathy Macgregor Group Inc., declined to comment.

“We are very early in the process and we can’t speculate on any possible outcome,” Tyler Gronbach, a spokesman for Education Management, said in a telephone interview.

Loans usually are secured and trade around par, or 100 cents on the dollar. Only nine of the actively traded loans tracked by Bloomberg were priced below 90 cents, and Education Management’s had the lowest price.

Credit Agreement

The company’s credit agreement mandates that its leverage ratio must not exceed 3.5 times and its interest coverage ratio must be at least 2.75 times. The leverage measure is the ratio of debt to earnings before interest, taxes, depreciation and amortization, while the coverage barometer is Ebitda to interest expense.

Long-term debt totaled $1.3 billion at the end of March. The company’s shares have declined 77 percent this year to $2.36, the most among 13 members in the Bloomberg U.S. For-Profit Education index.

Education Management had a 1.7 percent cushion against the leverage covenant, its tightest requirement, at the end of last year, according to a Feb. 24 report by Standard & Poor’s.

The company reduced the value of assets at its Art Institutes unit, according to a May 1 regulatory filing. Beekhuizen said on the May 1 call that the impairments were taken after a review of enrollment trends at all four of the company’s operating units.

Enrollment Drops

Education Management offers campus-based and online education at 110 schools under four names: Art Institutes, which offer art and design programs; Argosy University, offering education, business, health sciences, and psychology and behavioral science classes; Brown Mackie Colleges, which provide career-oriented programs in accounting and business, criminal justice and legal studies, computer technology, and health care; and South University, whose colleges teach arts and sciences, business, health professions, nursing, and pharmacy.

At the end of March, there were about 119,500 students enrolled, compared with as many as 158,300 in October 2010, according to company filings.

Revenue (EDMC:US) will slide to $2.3 billion in the year-ending June 30, a 7.2 percent decline from last year and about 20 percent less than the peak of $2.9 billion in fiscal year 2011, according to eight analyst estimates compiled by Bloomberg.

The company, incorporated in 1962, made its first acquisition with the purchase of The Art Institute of Pittsburgh, according to its website. It expanded by starting and acquiring more schools and completed a $45 million initial public offering in 1996.

2006 Purchase

The business was purchased for about $3.4 billion by investors including Goldman Sachs and Providence Equity Partners in June 2006, with about $1.3 billion in equity contributions, according to a regulatory filing the previous month. Each now owns about 33 percent, with Goldman Sachs affiliates holding an additional 11 percent, according to an Oct. 7 regulatory filing.

Education Management was taken public again in 2009, and used the proceeds to pay down as much as $316 million in debt, according to a September 2010 filing.

For-profit colleges’ marketing and enrollment practices have been under years of scrutiny from federal and state governments. Senator Tom Harkin, a Democrat from Iowa, held hearings three years ago where former students testified they incurred tens of thousands of dollars in debt, often without degrees to show for their efforts.

The U.S. Education Department said last year that 22 percent of former for-profit college students who were required to make payments on their loans during the three years that ended Sept. 30, 2012, had defaulted. That was almost twice the 13 percent rate among former public college students and almost three times the 8.2 percent at non-profit private schools.

‘Hot-Button Topic’

While for-profit colleges represent about 13 percent of the total higher education enrollment, their students account for about 31 percent of all student loans and almost half of defaults on those loans, according to the Education Department.

“The student loan debate has been a very hot-button topic,” Christopher Thompson, an analyst with Standard & Poor’s, said in a telephone interview. “The level of scrutiny has increased. Students are being more selective as to where they choose to attend school.”

A new wave of investigations began this year when the Consumer Financial Protection Bureau began looking into student lending at some education companies. The Federal Trade Commission stiffened guidelines for marketing vocational education programs, and a network of state attorneys general demanded information from for-profit colleges, including Education Management and Corinthian Colleges Inc. (COCO:US)

Corinthian said May 6 that it has retained an investment bank to help explore strategic alternatives after it breached debt covenants.

Fraud Suit

Education Management lost a bid this week to end a 7-year-old lawsuit alleging it engaged in fraud to wrongfully obtain more than $11 billion in student aid.

Lenders are unlikely to try to take control of the for-profit colleges through the courts, said Trace Urdan, an analyst with Wells Fargo Securities in San Francisco who follows the industry. The companies’ major asset is eligibility for federal student grants and loans, and any change in the control would halt access to those funds, he said.

Creditors are likely to encourage the companies to provide equity or cash in restructuring agreements, Urdan said.

“You’d be shooting yourself in the foot to press your claims,” he said in a telephone interview. “There’s a strong incentive to come to terms and figure something out.”

(An earlier version of this story was corrected because the length of the lawsuit regarding student aid was wrong.)

To contact the reporters on this story: Sridhar Natarajan in New York at snatarajan15@bloomberg.net; John Lauerman in Boston at jlauerman@bloomberg.net

To contact the editors responsible for this story: Faris Khan at fkhan33@bloomberg.net; Lisa Wolfson at lwolfson@bloomberg.net Mitchell Martin


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Companies Mentioned

  • EDMC
    (Education Management Corp)
    • $1.46 USD
    • -0.05
    • -3.42%
  • EVR
    (Evercore Partners Inc)
    • $55.97 USD
    • -1.03
    • -1.84%
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