Investors Are Giving Colleges an A+


By Eric Wahlgren Looking for a recession-proof investment? For-profit, post-secondary education may be a textbook case. As the job market continues to stagnate, enrollment at universities run by publicly traded companies has swelled -- by as much as 76% in the last year at one outfit. That's because "when the economy weakens, people start to pay attention to whether their skills make them competitive in the job market," says Natalie Walrond, a research analyst at Pacific Growth Securities, a San Francisco investment bank.

Unlike the nonprofit Harvards and Yales of the world, many of these money-making institutions attract working adults who want to buff up their resumés. Indeed, much of the enrollment growth in the past year has been from online education programs, which allow employees to earn degrees, including MBAs, while holding down full-time jobs. "The ability to go back to school from their kitchen table is appealing to [many people]," says Trace Urdan, a senior analyst at ThinkEquity Partners, a boutique investment bank in San Francisco.

HEALTHY RESULTS. The strong growth of the education business hasn't escaped Wall Street. As of Sept. 13, the index of about a dozen post-secondary educators that Urdan covers was up 20% year-to-date on a market-weighted basis (with larger caps names counting more than smaller caps). This compares very favorably with the 22.5% drop in the benchmark Standard & Poor's 500-stock index over the same period.

The run-up means some of these stocks have become a little expensive. Phoenix-based Apollo Group (APOL), the name behind the University of Phoenix and the biggest in the class, with enrollment topping 148,000, trades at about 40 times 2003 earnings. By comparison, the S&P 500's current price-earnings (p-e) multiple is a more modest 14.5, according to earnings-tracking service Thomson/First Call. With the for-profit educators, "there could be more risk on the downside than on the upside," says Peter Cohan, a financial consultant and executive in residence at Babson College in Babson Park, Mass.

Analysts say for selective investors, it's a risk worth taking. Over the next few years, the education sector is expected to crank out annual earnings growth of 20% to 25% on revenues that could increase 10% to 15% a year, Urdan says. Profit growth will exceed revenue growth because the schools can spread out overhead costs as they expand. And unlike other many other industries these days, the educators have pricing power -- they're raising tuition by 5% to 6% a year. Also, most of the outfits have little debt and lots of cash flow.

BIG POTENTIAL. Furthermore, they have plenty of room to expand. Urdan's group of private, for-profit universities has only a 2.2% share of the estimated $260 billion post-secondary market at this point, so the schools could make huge sales gains by adding just a point or two to their market share. The sales pitch, especially to students at big state universities: Smaller classes and more personal attention.

Another plus is that private-school students often are eligible for government loans, just like their counterparts at state universities. "There's a huge amount of upside," says Urdan, whose outfit has no investment-banking relationships or holdings in the companies he covers. "I think every growth investor should be exposed to this group at some level."

University of Phoenix Online (UOPX), which is Apollo Group's tracking stock for its Internet business, is a current favorite among analysts. By fiscal year 2002's third quarter, ending May 31, enrollment at the fully accredited online university had surged 76%, to 45,200 students, vs. the previous year.

ONLINE LURE. Although the virtual school's expansion will ease a little, Pacific Growth Securities' Walrond predicts that enrollment will continue to climb at more than 50% a year over the next few years. She suggests that investors overweight the stock. "The main reason is that online is such an attractive option for students because of the convenience factor," says Walrond, whose firm has no holdings in or investment banking relationship with Phoenix.

In its fiscal 2002 third quarter, which ended May 31, Phoenix' net income rose 100%, to $2.4 million, or 16 cents a share. Revenue came in at $91 million, 69% higher than the same quarter in 2001. The stock rose 32% this year before its four-for-three stock split on Apr. 26. At $32.59 on Sept. 24, it's now about 4% off its post-split high at a time when the general stock market has been tanking.

Trading at 42.7 times 2003 estimated earnings, the stock is pricey. But Greg Cappelli, a Credit Suisse First Boston analyst in Chicago, believes Phoenix has strong enough fundamentals to appreciate 10%, to $36, in the next 12 months.

PRICEY BET. Phoenix parent Apollo Group also trades at a premium, but the stock still has its fans. Michael Jaffe, an analyst with Standard & Poor's equity research in New York, awards Apollo, which runs the University of Phoenix network of some 63 bricks-and-mortar campuses, an accumulate rating. Apollo rose 28% before a three-for-two stock split on Apr. 26. At $42.23, it's 3% off its post-split high.

Jaffe sees the stock continuing to outperform the broader market, largely because of what he expects will be 20%-plus annual earnings gains for the next several years. "They're the largest, have the most financial muscle, and are probably the biggest name," Jaffe says. Apollo was added to the S&P 500 earlier this year in a nod to its rising profile.

Slightly cheaper is Career Education (CECO) in Hoffman Estates, Ill., one of the most diversified post-secondary educators, providing degrees in culinary arts and visual design in addition to more mainstream programs. Massimo Santicchia, another S&P analyst, rates Career Education accumulate.

The stock, which has a p-e multiple of 27 against 2003 estimated earnings, has risen 33% so far this year, to $45.44 on Sept. 24. Santicchia sees more gains ahead, largely because Career Education's placement rates are among the highest in the industry -- 93% of its graduates find jobs within six months.

CHEAPER ALTERNATIVES. Other analysts see opportunity in Corinthian Colleges (COCO), a smaller niche player in Santa Ana, Calif., with total enrollment of about 34,000. It offers diploma programs and associate degrees in industries such as health care, a sector that's holding up in the weak economy. Its shares are up 31%, to $35.92, since a two-for-one split on May 28. "We continue to believe that COCO is a good place to put money in a choppy market like we're experiencing today," says Cappelli in a recent research note to investors.

Alternative investments, says Urdan, are two battered technology-oriented educators that could be due for a rebound: DeVry (DV) in Oakbrook Terrace, Ill., and ITT Educational Services (ESI), based in Indianapolis. Hurt by the tech slump, DeVry, at $28.45, and ITT Educational, at $17.70, both carry p-e multiples of only about 18. But Urdan says placement rates of graduates from these institutions -- 85% at DeVry and 77% at ITT -- haven't dropped dramatically. "The truth is, companies need graduates from these kinds of schools," he says. Enrollment could turn before the economy does, he says, sending these stocks higher.

Of course, even those two bruised stocks are pricey compared to the overall market. "Investors will want to do their own analysis [to] see if the stocks are properly valued," cautions Cohan. But many may decide that investing in education could be good for their future as well as for their portfolio. Wahlgren covers financial markets for BusinessWeek Online in New York


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