The for-profit education industry is becoming a contrarian hotbed after the Department of Education’s initial round of rule-making for the industry was not as strict as many investors had anticipated. However, the companies’ reliance on Title IV funding is sure to sink them in the long run.
Paid by government, controlled by government
Title IV of the Higher Education Act of 1965 governs federal student financial aid. Students who receive Title IV funding, and institutions those students attend, must qualify for federal aid under the act. As a result, changes to the requirements may prompt some institutions to change in order to stay in compliance. This is de facto regulation of institutions that are heavily reliant on Title IV funding.
As it happens, for-profit education institutions derive the vast majority of their revenue from Title IV; it accounts for 85% to 95% of total revenue for Corinthian Colleges Inc (NASDAQ:COCO), Capella Education Company (NASDAQ:CPLA), and Apollo Group Inc (NASDAQ:APOL). Non-compliance would devastate these companies, which is why the federal government can require them to do just about anything it deems necessary.
The government’s intention to make stricter Title IV rules is not without reason; as with the government’s dubious loan program for sub-prime mortgages, its large exposure to highly indebted, jobless students to whom no private companies are willing to lend will inevitably lead to massive regulation so that the blame falls on the educational institutions instead of the politicians who encouraged the program.
Government regulation + industry competition = losses for shareholders
Being regulated out of existence is not the industry’s only concern; the growing popularity of internet-based courses is putting intense pressure on margins.
Only about 30% of students at Corinthian Colleges Inc (NASDAQ:COCO) take classes exclusively online, but Capella Education Company (NASDAQ:CPLA) is completely online. Corinthian Colleges Inc (NASDAQ:COCO) has been forced to close several campuses in an attempt to rebuild profitability, while Apollo Group Inc (NASDAQ:APOL)’s enrollment and margins have declined as a direct result of online competition. Even Capella Education Company (NASDAQ:CPLA), the leader in online degree programs, faces stiff competition from up-and-coming online rivals.
Although all three companies have unique brands and specialize in distinct niches (e.g., mid-career professionals), for-profit education is becoming a commodity product. No hint of prestige is attached to the degrees offered by any of these institutions and there are many for-profit colleges that have high job placement rates. As a result, the companies ultimately compete on price, which will lead to lower margins over time.
The U.S. government should be concerned about the for-profit education industry’s abuse of Title IV loans; the industry is known for racking up student debt and churning out students who cannot possibly hope to pay back the loans. As a result, the government may eventually make it so difficult for institutions to qualify for the program that for-profit institutions will have to completely change the way they do business.
In addition, the commoditization of the product and the move online will shrink margins and lower returns on invested capital to normal levels. The result of government regulation and increasing competition will be a cyclical industry with low returns on capital. This is not an industry anyone should want to invest in.
The article Big Government Will Destroy Investors in For-Profit Education Stocks originally appeared on Fool.com and is written by Ted Cooper.
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