Wall Street Transcript
Education and e-Learning Stocks Analysis
Wednesday August 20, 9:10 am ET
67 WALL STREET, New York--August 20, 2003-- In an in-depth (8,400 words) Roundtable Forum, Gary E. Bisbee III, a Vice President and Senior Research Analyst at Lehman Brothers, Gerald Odening, a Managing Director of Jefferies and Company and Jeffrey M. Silber, a Managing Director and Research Analyst at Harris Nesbitt Gerard, examine the outlook for the sector and share specific stock recommendations. This interview excerpt is part of an in-depth Roundtable Forum from our 65-page Education and e-Learning Issue featuring in-depth interviews from six analysts and top management from eight sector firms discussing pricing trends, enrollment growth, fear of cyclicality, problems of Edison Schools, market share gains, degree programs, industry consolidation, financial assistance programs, companies with online operations, companies with international exposures, tuition price inflation, new programs in business and management, regulatory outlook, staffing issues, K-12 space, stocks to avoid, stock recommendations and more.
TWST: Gerry, what has gone on over the past year in the education space that's of import?
Mr. Odening: Most of the questions coming up about this group, which has performed superbly, have generally been about whether we are at a top in terms of valuation. My feeling is that the stock prices and multiples in the education group for postsecondary will continue to rise. This is in contrast to last year when a number of holders of the stocks were concerned that many people would be selling these stocks in 2003 when technology and more cyclical sectors began to rebound. That didn't happen, because year to date the postsecondary group is up over 60%.
The other question that comes to mind is whether the law of large numbers, although anticipated by a number of us following the industry, drive stock prices down when ultimately the reported enrollment growth metrics slow and become more reflective of a long-term sustainable level. My answer really is that I don't believe that these companies or the stocks are either countercyclical or cyclical. I believe, in terms of the growth metrics, that they are quite sustainable at these kinds of levels for at least three or four years. I'm cognizant of the fact that for a very specific metric such as online enrollments the percentage growth will have to slow down in the next year or so. In terms of bricks and mortar enrollment, I think they'll continue to do well at the current pace.
TWST: Gary, what do you see as the key drivers in this space over the next couple of years?
Mr. Bisbee: I think the drivers will continue to be similar to the drivers we've seen over the past couple of years. Due to the positive demographic backdrop, including a projected 15%-20% increase in total student enrollment over the next decade, I think you'll continue to see most of the publicly traded postsecondary companies adding somewhere between 5% and 10% new units per year. You're going to see new campuses open in addition to acquisitions. I agree with Gerry that we'll continue to see a lot of those.
On top of new schools, I think the pricing environment continues to look strong, again, due to the state and local fiscal issues that we talked about earlier. So I think we should see a continuing trend of new campuses and also active strategies to grow the existing campuses. When combined with pricing and margin expansion I think the model will be 15% student growth plus 5% pricing, which will give us 20% internal top-line growth, and with a bit of margin expansion 20%-25% earnings growth.
Big picture drivers for the industry and these stocks continue to be the demographic outlook, the state funding issues that are leading these companies to gain market share, and the online trend. As Gerry said, they've done a great job of attracting nontraditional students, or students who were not successful in the traditional school system. So I think that another driver for these stocks will continue to be the online opportunities that they have. While the growth rates probably are unsustainable at the current levels, I think that a lot of people have looked at the top line and haven't focused enough on both the profitability and capital efficiency benefits of the online business model versus the campuses. Over time, I believe that the stocks can maintain their current multiple as people realize that the business model continues to improve.
So in general I think the drivers will continue to be things that have driven growth in the past, which are good competitive positioning, gaining market share, and continuing to innovate with online and other delivery methods.
TWST: What share of the market do the for-profits have at this point, and where can it go over the next few years?
Mr. Bisbee: That's a good question. By my estimate the for-profits have about 5% market share in 2003 as a percentage of enrollment, and that number is up from about 1% in 1980. So there have been steady gains. My expectation is that 5% can grow to be 8%-10% over the next decade, if not sooner. I think that the gains will be driven by pure market share gains (mostly from the community colleges), in addition to the for-profits' ability to continue to attract nontraditional students. Today, about one in four Americans over the age of 25 has a bachelor's degree, so there are somewhere on the order of 70 million people in the US work force who don't have a bachelor's degree. While most of these people are nontraditional students, I believe that the for-profits have demonstrated that they focused on this group and can offer a more convenient solution to these people. So I think they will continue to gain market share in part by attracting this nontraditional group that can certainly benefit from postsecondary education.
TWST: Gary, what are you telling investors to do in this postsecondary space?
Mr. Bisbee: Our strategy in looking at the group over the last few quarters, and certainly over the next year, has been to focus in on the companies that will be able to exceed estimates by the largest amounts going forward. Trading at 28-30 times calendar 2004 earnings on average for the group, we're not expecting significant multiple expansions from these levels. So I think the way to make the most money in this group is to own the stocks that will have the largest upward earnings revision.
On its own, that's not enough, so I think some of the attributes we've looked for are companies that have had a strong track record of meeting and/or exceeding consensus estimates, companies that are well diversified and also companies that we think are well positioned in terms of the Internet because successful online strategies will be the largest driver of both growth and financial performance for this industry over the next several years.
Specifically to our picks, over the next 12 months, we continue to think that Career Education is a great opportunity, despite what has been a pretty tremendous 80% or 85% run year to date. We think the company is positioned to exceed estimates by as much as or more than anyone. We think it's the most diversified company in the space and we believe that the timing with their Internet business, having just turned profitable and really in a strong growth phase, will lead this stock to outperform the group over the next 18 months.
We continue to think that Apollo Group is the gold standard in this industry and that the company will continue to show strong growth. In their most recent quarter, management guided for 50% growth in their online business for 2004, which was above our expectations and I think significantly above consensus as well. I think that if they follow through with that guidance, there continues to be upside to earnings estimates. So Apollo is a company that we continue to recommend that investors own.
Lastly, I would mention Corinthian Colleges for two reasons. Corinthian is the company with the largest exposure to the healthcare industry and we believe that health care is an area that continues to show robust trends. We would also note that Corinthian is somewhat cheaper than the group average right now; they're just under 26 times earnings, with the group just over 28. Given its strong track record of faster growth and rapid profitability gains, in addition to improving cash flow trends in the last couple of years, we think the company deserves to trade at or above the group average. So I would be focusing on those three names today.
TWST: Are there other names beyond Apollo that you're recommending today, Jeffrey?
Mr. Silber: Career Education is our favorite name. Again, you've got to be opportunistic. The stock had had a great run. It has been pulling back recently, but I would echo a lot of things Gary said about the company. We've also got an outperform rating, which is our highest rating, on Corinthian for a lot of the same reasons Gary mentioned.
Another company we like is Education Management. We typically group the "consolidators" together, which are Career Education, Corinthian and Education Management. EDMC tends to be a bit more of a conservative consolidator. I don't want to say that they're a follower, but I wouldn't call them one of the more aggressive consolidators. So if you want to stay a little more conservative but like the benefits you get with a consolidator, I would probably play an EDMC as well.
This interview excerpt is part of an in-depth Roundtable Forum from our 65-page Education and e-Learning Issue featuring in-depth interviews from six analysts and top management from eight sector firms discussing pricing trends, enrollment growth, fear of cyclicality, problems of Edison Schools, market share gains, degree programs, industry consolidation, financial assistance programs, companies with online operations, companies with international exposures, tuition price inflation, new programs in business and management, regulatory outlook, staffing issues, K-12 space, stocks to avoid, stock recommendations and more. This issue is available to subscribers by telephoning 212-952-7400 x1799 or through The Wall Street Transcript .
The Wall Street Transcript does not endorse the views of any interviewees nor does it make stock recommendations.
