For-Profit Education's Bullish Future
It's been a rough year for the country's for-profit colleges and universities. Fifteen publicly traded education companies have seen their stocks decline by 33% on average since December 2009 compared with a 5% increase for the S&P 500. The media abounds with allegations of improper practices at these companies, including marketing misrepresentation and fraudulent reporting of placement rates. Twenty state attorney generals are investigating for-profit institutions.
Despite all of this, I still believe that for-profit education in this country is actually undervalued. Why am I so confident regarding the sector's long-term opportunity? Simply put, it has become apparent that our country's non-profit university system cannot meet student demand.
The State of California just spent over $1 billion on a new campus in Merced that will serve only 45,000 students. Sounds great -- until you know that the state turned away 400,000 qualified applicants this year alone. Given state budget crunches, rising pension costs, and intransigent faculty and staff unions, it is hard to imagine how public colleges and universities are going to solve our high demand for a skilled workforce. Meanwhile, traditional private non-profits dependent on the old model of alumni donations with dwindling endowments continue to increase tuition to fund existing operations.
It doesn't take much for investors to see how the current system is flawed. When parents, taxpayers, and regulators hear that more than 100 non-profit colleges in the U.S. are now charging over $50,000 a year for tuition, room and board, they inevitably ask "How long can this go on?"
This is where the education innovators -- those who do well while doing good -- enter the picture. Some of that innovation was on display yesterday at the BMO Capital Markets 11th annual "Back to School" conference for investors in New York. Almost 60 public and private education companies were represented. Two of these, Grand Canyon Education and Bridgepoint Education, were founded by my partners and me over the past decade and have grown to over $1.7 billion of market cap with less than $64MM invested.
From what I can see, the future of this sector is looking bright. Representatives of these firms and other even newer ones presented models for higher education that include remarkably lower tuition than existing market participants, global access, increased academic quality measured by student outcomes in the real world, better leveraging of technology, more funding for faculty development than nonprofits, and a big focus on customer service. While there is inevitably a larger demand for education in an economic downturn, these entrepreneurs (in partnership with academic experts) are looking beyond the near-term to ensure that consumers are making the right decisions to go back to the right degree program at the right school.
Students will soon know more than ever about the institutions to which they are applying. For-profits are being pushed into reporting more data and being more transparent about their admissions, enrollment and payment procedures. They will be able to do more side-by-side comparisons when they are looking for the school that best suits their needs. Competition drives choice, which will lead to reduced tuition. All this is good for the student and good for the economy.
But what about the new regulatory environment? Won't it cut into the profits of these institutions? In the near term, perhaps, but in the long term what these companies wanted was transparency and certitude about what standards would be applied to them. Now that those standards are in place, companies can use this information to improve their business model and their competitive edge. In fact, since the regulations have made it harder to transfer accreditation from one entity to the next, it is more likely that the companies will be truly committed to the educational product rather than just in the sector for a quick financial flip.
Higher education in the United States is now a $400 billion industry, serving 20 million students. Currently, most expenditures come from fatigued taxpayers. However, in an environment of increased fiscal austerity by governments worldwide, we are likely to see a vast privatization of the education sector over the coming years. It is my prediction that for-profit education will exceed 50% market share of all education globally by 2025.
Where should savvy investors be looking? They have an unparalleled entry point to see better-than-average returns driven by scandals at select institutions that now have depressed valuations. The good news is that the increased regulatory oversight has had the benefit of cleaning up the sector from bad actors. Transparent, consistent rules for the industry with greater oversight will help all of the stakeholders sort the wheat from the chaff. (One can only hope that the government will turn its attention now to the question of quality in the non-profit sector.)
Meanwhile the schools that have been well-managed allow along are looking even more valuable long term. There is no better time than now for investors to follow students' feet.
