• The Trump administration has made it easier for for-profit educational companies to turn a profit
• There are significant shifts in the education sector, with moves towards online learning and student loan accountability
• There are significant headwinds facing the for-profit companies, but if they can gain investor trust, we will see substantial growth

The average college student is faced with a significant amount of financial burden. There is market saturation in the workforce, with too many graduates and not enough jobs in their chosen field. College tuition payments have skyrocketed, for reasons not limited to increases in the number of senior administrators, increases in the construction on campus, and declines in state funding for universities.

Administrative Bloat? 

From 2001 to 2011, the number of administrators has increased 50% faster than the number of classroom instructors and has far outpaced the growth in the student body, as evidenced by this graph from the University of California San Diego. An increase in administration makes sense (to a point), as we see an increase in the number of college students, the number of administrative faculty to manage the students must increase as well.

Source: San Diego Free Press

Education is a business. That’s why the number of administrators have increased so rapidly. College students demand a large amount of resources. That’s why they are constructing million dollar dorms. That’s why tuition has increased so rapidly. It’s all about getting students to come to your college, and keeping them there.

Shifts in Education Policy: Gainful Employment

The Obama administration instated a gainful employment regulation in 2014 that worked to keep for-profit educational institutions like ITT Tech and Corinthian College more accountable. The gainful employment marks were measured by the debt students incurred and the number of students that actually got jobs with their degrees. Schools like DeVry have had multi-million dollar lawsuits over claims that they have “misled prospective students with inflated employment and earnings success rates”. Over 800 of programs failed to meet the requirements of the regulation, which included estimated loan payments of the graduate not exceeding 20% of discretionary income or 8% of total earnings.

Besty DeVos, Trump’s Department of Education Secretary, is attempting to put an end to all of that. Last month, she announce that she plans to fully repeal the gainful employment regulation, after freezing the rule two years ago, along with a debt relief regulation for the students that were misled by the institutions. The gainful employment regulation would be replaced with a ruling that requires all schools to fully provide student outcome data.Ms. DeVos is making it a lot easier on for-profit institutions to turn a profit.

LOPE: Grand Canyon Education

Grand Canyon University in Arizona was the primary arm underneath Grand Canyon Education for 14 years. The University recently sold for $875m to become a non-profit. This has been a long process for GCU, as they first announced their plans to go nonprofit in 2014, but were rejected by the Higher Learning Commission. They resubmitted their bid again in 2018, and were approved.

Grand Canyon Education will operate as the service provider for the university, and also will receive 60% of the tuition fee and revenue. Outsourcing programs, specifically online programs, has gained popularity among higher education providers. Purdue implemented something similar back in 2017, buying for-profit Kaplan University for $1.

Academic services will maintain non-profit status, whereas the non-academic services (online class platform building, professional services etc.) will shift into the for-profit. As online education continues to grow, more and more universities will be utilizing service providers such as Kaplan and Grand Canyon Education, as a platform for connecting students online, and other administrative services.

Source: Huffington Post

LOPE Financial Highlights 

For Grand Canyon Education, revenue increased +8.5% y/y to $236.8 million, driven by a 10% increase in online students and a 3.8% increase in ground students’ year over year. This most recent quarter includes the effects of the sale of Grand Canyon University, as well as the benefits of a shift from a 28% tax rate to a 23.4% tax rate.

The company uses Adjusted EBITDA as a key metric, as they consider it to be a more accurate measure of their “core performance”. Based on this analysis, the company has seen substantial growth, posting 16.6% growth over the course in 2017 in this metric, compared to 14.7% growth over the course of 2016.

Source: LOPE Annual Report

The company has outperformed the industry and the S&P 500 since 2012. The company has also beat on earnings for the past four quarters, beating Q1 2018 estimates by 9.3%. With strong fundamentals, growing enrollment, and encouragement from policy decisions, the stock is poised to perform well in the future.

The company continues to invest in their physical campus, as well their online platforms. Grand Canyon University’s shift to a nonprofit will serve to bolster LOPE’s earnings, especially as LOPE reaches out to additional universities to provide similar services (i.e. technological, counseling, marketing, financial aid processing etc).

Headwinds

ITT Tech (formerly ESINQ) is an example of this part of the industry gone wrong. All campuses were closed in September of 2016, and the company settled a lawsuit two months ago that accused two of the top executives of “concealing the “‘extraordinary failure’ of two student loan programs ITT set up in 2009”, according to Yahoo Finance.  The CEO was fined $200,000 and the CFO fined $100,000 in the face of a default rate that was higher than their graduation rate. Practices like this have created investor distrust across the industry.

Adtalem Global Education Inc (formerly DeVry Education, ATGE) is another example of a stock that has been hit due to scandal and encouraging irresponsible student borrowing. They also spend more on marketing than student instruction, which is problematic. They shed about 16% of their value after their Q4 earnings call in August, and have yet to recover (and now are down about 27%).

Source: American Progress 

Conclusion

ATGE and ITT Tech are not alone in their default rates. These companies need to figure out how to provide education to their students without pushing them into a debt-hole. Until they can earn back the trust of the public, this portion of the industry should be avoided.

Grand Canyon Education is entering into strategic partnerships with universities to provide them services that they desperately need. As state funding continues to decrease, we can expect that public universities will outsource some of their tasks to save costs.

Strayer (STRA) is another industry leader that will benefit from the DeVos decision. It recently completed a $1.9 billion merger with Capella Education company, which is expected to result in “lower corporate expenses, which the companies believe will enable them to offer more affordable programs“. Their enrollment is expected to increase 8% year over year, with strong estimated earnings per share growth.

STRA and LOPE are industry leaders in a rapidly changing industry, and have the fundamentals for continued growth. “Robust” economic data, favorable policy decisions and increasing interest in online programs should benefit companies like STRA and LOPE. STRA has already had a strong run this year, with a 70% gain in stock price, and a PE ratio of 108.58. LOPE is down 11% from its 52-week highs, but still is up 40% from it’s 52-week low, with a PE ratio of 23.6.

Neither stock is too liquid, so it would be best to purchase it and sell some calls against it to reduce your overall cost basis and increase your probability of profit. The 110 ATM short call on LOPE has a probability of profit of 65% and generates a daily theta of $4.14, with a max profit of $202.

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.