Description

I recommend Apollo Group as a short.  Apollo is the largest for profit educational service company in the country, with its largest entity being University of Phoenix.  It is funded largely (77% of revenues) by Federal Government sponsored title IX student lending.  The short thesis is based largely the availability of this funding being less available to Apollo in the future, which would have a material adverse effect on their business.   While this is not a certainly, I will attempt to provide some opinions that may play into this possibility. 

While Apollo does provide educational benefits to some students, it is easy to question that the overall bang for the government buck is suspect.  Many students after incurring $30,000 to $60,000 in debt do not find themselves much more employable than beforehand.  Some companies, such as Intel, have a ban on hiring University of Phoenix graduates.  You can Goggle University of Phoenix and then complaints or lawsuits and spend the rest of your day reading if you like.  

The formula for Apollo's growth and increase in profitability over the past several years has been as follows: increase enrollment counselors 1000%, increase enrollment 200% while at same time, limit the faculty increase to 100%.   Support this growth with an easy source of revenue-- US Government subsidized student loans,  Additionally, support the counselors with a hard sell.... sales program that would make a back room wall-street boiler house stand up and take notice.  Never-mind that such sales practices are illegal for institutions receiving title IX funding. 

The US Department of Education under the Obama Administration may scrutinize the $2.5 billion a year in government sponsored loans going to degree granting machine such as Apollo.  The new Secretary of Education, Mr. Arne Duncan, has promised to reform education.  Apollo, the largest "customer" of student loans in the country has come under increased scrutiny by both the government and the legal system for its poor performance record of accomplishment and dubious practices. 

The largest growth for Apollo is in its associate degree program, which grew at a rate of 33% last quarter and now totals 170,000 students, compared to 150,000 bachelor program students and 70,000 master degree students.  Associate degree students default at a high rate, 27% in 2006 (most recent year for which data is available).  Of associate degree students who have never attended college before, Apollo's graduation rate is 4%, (the overall graduation rate in the range of 16%).   One could question the value of government money going to support this type institution of higher learning.

So why are they so successful at growing enrollment?  Let's get back to that 1000% increase in enrollment counselors.   There is Qui Tam lawsuit in process against Apollo.   A Qui Tam lawsuit refers to a whistleblower that brings charges against someone for committing fraud against the government.  It is illegal for "for profit" education companies to financial incentivize enrollment counselors for performance.  

There is a large body of evidence indicating that Apollo has run a boiler room sales operation rather than counsel prospective students.  Among the thousands of pages of documents you can pursue in the case include 1) those containing incentive pay schedules, 2) internal emails instructing managers to refrain from putting anything related to incentive compensation or counselor "performance" in any documentation that might be reviewed by the Department of Education audits, 3) documentation referring to counselors as salespeople, 4) memo's on how to use harassment tactics and lies to get people to enroll or to call back.   The trial is currently set for March 2010. 

Even pre Obama, the Bush administration, in which the highest-ranking official overseeing for profit education, Sally Stroup, was an Apollo lobbyist for eight years, had to stand up and take notice of Apollo.   In fact, Apollo's Title IX eligibility certification expired in June of 2007.   While Apollo currently continues to provide the Department of Education with additional information as requested, eligibility for Title IX funding has been on a month-to-month basis for the past twenty-two months.  What??   77% of Apollo's revenue, hinges on a certification that is month to month???!   I could not find one other "for profit" education company on a month-to-month basis. 

Besides the Qui Tam lawsuit, another item that may be raising some eyebrows at the Department of Education is a lawsuit filed in December 2008 by a group of former students who allege that regarding students that dropped out shortly after enrolling, University of Phoenix improperly returned the entire amount of student loan funds to the lender. 

Why would Apollo return more money than required to the lender and try to collect the money themselves instead through collection agents and other tactics.  Once explanation might be that if the loan was fully refunded, it's not a defaulted loan.  Default rates are one criterion that can jeopardize an institutions Title IX accreditation.  The lawsuit contends that through the above-described actions that it is trying to deceive students, the Department of Education and investors through manipulation of their reported numbers.   The lawsuit states "By returning the money to the government, they are effectively prohibiting that person from being factored into the cohort default rate.  This manipulation is a clear violation of the mandates of HEA". 

What might the impact of these items be?  I am not suggesting that no one has received an education at University of Phoenix or that it does not serve some in a useful way, but its appears by the record that greed, lack of morals and mediocrity has set in, and maybe too.. Apollo's perfect storm. Obama, lawsuits and the ongoing DOE review.  All while management cashes hundred millions in stock.   Are they telling us something? 

Current Valuation

The current stock price is $62.  Apollo has a market cap of $10 billion and an EV of $9 billion, with trailing twelve month EBITDA of $1 billion.  Current year earnings (ending August 09) are projected to be approximately $4.00, with estimates for fiscal 2010 in range of $4.80. 

Catalyst

Clearly, this is not a short based on the current business model, current expected growth or earning power.  The short thesis rests on some disruption of the current business model and growth rate through the DOE setting higher level of requirements for a student to qualify for Title IX funding at University of Phoenix.  This in turn could have anywhere from a minor to dramatic effect on enrollment rates and revenue depending on the severity of any change.  Of course, it is possible no changes occur and business goes on as usual.