Description

Recommendation

We are recommending a long investment in Bridgepoint Education, Inc. (“Bridgepoint”, “BPI”, “Ashford”, the “Company”).  Bridgepoint Education provides postsecondary education services through its regionally accredited academic institutions, Ashford University and University of the Rockies.  Bridgepoint’s institutions deliver programs primarily online, however, a small percentage of their students attend the University of the Rockies (BPI’s traditional campuses).  As of December 31, 2011, we had 86,642 total students enrolled in our institutions. 

We believe Bridgepoint’s focus on efficiency, technology and innovation provide the Company with a lower cost structure.  This cost structure enables the Company to charge substantially less than its for profit peer group and generate a comparable level of EBIT per student. Additionally, the amalgamation of BPI’s: affordable tuition, high transferability of credits, an accessible educational model, and a heritage as a traditional university are key differentiators which lead to above industry satisfaction levels (Net Promoter score of 75% versus an average of 52% for peer group) that will enable the Company to continue to gain share.  The Company currently trades at 8.0x PE, 6.1x PE (ex net debt), and 3.1x EBITDA based on our forward projections.  With >50% of the shares sold short and ~8/share in cash (~31% of the market cap), the stock could appreciate quickly in the event of positive news or the Company using its cash position to purchase shares.  We value the Company with a 1 year forward price target of $34 per share or ~57% upside to the 4/18/12 closing share price.

As some exhibits from our write-up can't be pasted in here, please refer to the write-up and the model at below links for more detail/better readability.  

http://dl.dropbox.com/u/659242/Bridge%20Point%20Education%20%28BPI%29%20Recommendation%20Final%204-17-12%20Final.doc

http://dl.dropbox.com/u/659242/BPI.xlsx

Investment Highlights

Efficient Education Delivery and Marketing Platform:  BPI’s operating cost per student is about 33% below its for profit peers, we believe this is due to Bridgepoint’s focus on efficiency, technology and innovation. This low cost position allows the Company to charge lower tuition rates.  BPI generates ~$10,600 in revenue per student vs. ~$15,000 for the industry.  Affordability is one the key reasons why students select BPI.  We also believe the Company’s low cost position/price position translates into a higher conversion rate of leads into new students. This marketing efficiency is highlighted by BPI’s 2011 and 2010 sales & marketing cost per start of $2,600 and $3,300, 13% and 33% lower than the University of Phoenix, respectively.  This efficient operating model allows BPI to generate more EBIT per student despite charging materially lower prices.

Compelling Value Proposition to Students: We believe that BPI’s value proposition is differentiated in the for profit education space.  This is supported by the results from BPI’s annual alumni survey: 

• 87% of alumni agree that earning their degree from Ashford gave them confidence to pursue new job opportunities.
• 92% of graduates indicated they were satisfied or very satisfied with their Ashford experience.
• 91% of alumni agree that earning their Ashford degree was worth the time commitment required.
• Out of the 89% of alumni that previously attended a traditional institution, 92% feel the quality of education at Ashford is the same or higher than a traditional university.
• 95% of alumni said they would recommend Ashford to others.
• The Parthenon Group, as part of its 2011 private sector higher education graduate survey, compared Ashford University’s net promoter score to a group of nine other private sector schools and Ashford scored 75% versus an average of 52% for the nine school group.

We would note that these results are consistent with other third party surveys we have been exposed to over the years. We believe these results are driven by the amalgamation of BPI’s: affordable tuition, high transferability of credits, an accessible educational model, and a heritage as a traditional university:

• Low Tuition Price Point Results in a Favorable Student Proposition and Limits Regulatory Risk:  Ashford University’s tuition is ~26% less expensive than comparable publicly traded online schools and only ~6% higher than the tuition for online programs at state universities (for in-state residents). The low price point benefits Bridgepoint’s students as tuition is mostly covered by federal financial aid (Title IV), leaving only a minimal need (<1%) for private loans.  Survey data suggests affordability is the primary reason for students selecting Ashford. In addition to providing a point of differentiation vs. for profit competitors, BPI’s lower tuition better positions the Company against some of the recent regulatory changes (e.g. gainful employment) discussed below. 

• High Transfer Credit Option Provides an Additional Underserved Bachelor’s Completion Market Opportunity. Ashford University is one of only six institutions in the country, and the only for-profit, accredited to accept up to 99 transfer credits (out of 120) for a bachelor’s degree program. Approximately 18% of AU’s students transfer in more than 70 credits. As most of the company’s peers accept only up to 65-70 transfer credits, Bridgepoint benefits from access to this underserved student segment.  Transferability also has the important effect reducing the overall cost of a degree program for a student.

• Accessible Educational Model: Ashford University provides weekly start dates, and offers classes that last up to five weeks, which remains lower than many of the other online school programs available. We note that American Public University’s accelerated courses last eight weeks, as a comparison. We believe this flexibility is a competitive advantage vs. other institutions and better positions BPI with certain demographics. 

• Traditional Campuses provide heritage/culture/branding edge to online programs: Although only ~2% of BPE students attend classes on ground, we believe BPE’s on ground campuses and related resources boost its schools’ credibility with prospective students, improve students’ feelings of connection with their university, and enhance students’ in-school experiences.  

Technology Driven Culture: We believe that one of the reasons for Bridgepoint’s lower cost structure is its focus on innovation and technology. BPI’s innovative culture is highlighted by its e-books initiative Constellation (launched for students at other institutions at the Consumer Electronics Show in Las Vegas earlier this year under the brand “Thuze”).   Constellation provides web- based course materials that include both text and multimedia assets Third- party textbooks have typically cost online students $150 per course; however; Constellation materials replace those textbooks, at cost of $75 per course. As of December 31, 2011, BPI had introduced 32 courses on Constellation. BPI plan’s to include core courses in approximately 80% of degree programs over the next two years.  The Company has also developed Waypoint Outcomes, which provides learning and assessment software to K- 12 and higher education institutions nationwide (~40 traditional institutions use Waypoint). The software combines classic rubric grading scales with easy, efficient technology to help educators teach writing, critical thinking and cognitive skills. While we estimate Waypoint and Constellation respectively represented <1% and 1.8% of 2011 revenue, these technology initiatives could represent could represent new areas of earnings growth through lower costs at BPI and incremental revenue from other institutions. 

Investment Risks

Cheaper Alternatives and Non-profits Could Potentially Take Share from BPI:  We think Bridgepoint’s price point is being increasingly challenged by American Public Education (now at 45,000 civilian students) and nonprofits that continue to add online courses and improve their search engine marketing and increase their purchase of leads. While Bridgepoint is one of the lowest cost for profits, there are a number of nonprofits that are less expensive than BPI.  Ashford’s cost per credit (including all mandatory fees and assuming a 120 credit hour bachelor’s degree) is ~$402, Western Governor’s University (WGU) is $193 per credit, Troy University is $260, Southern New Hampshire is $311, Liberty is $354, and Arizona State is $425. We think the growth of better branded, similar or lower cost nonprofit alternatives could negatively impact Bridgepoint’s growth in the future.  We think bachelor’s completion programs and master’s programs are most at risk from the rise of nonprofit competition; based on conversations with industry executives, the overlap between the nonprofit and the For Profit addressable markets is anywhere from 30% to 40%.  However, we believe the addressable market is large and BPI is well positioned to continue to take share from traditional for profits and non-profits.  We note that recent reviews of Google keyword searches and traffic comparisons on Alexa suggest that BPI is continuing to maintain its momentum.

Legislative and Legal Risk: Senator Tom Harkin’s HELP (Health Education Labor and Pensions) committee hearings on the for-profit higher education companies during the summer of 2010 have increased the risk of legislation that may be unfavorable to for-profit higher education companies. Testimony provided at these hearings, including a GAO report on its undercover testing of the marketing practices of for profit schools, may also increase the risk of law suits against for-profit schools, which could be negative for the stocks of for-profit schools.  We believe the primary sources of regulatory risk faced by the Company relate to Cohort Default Rates, Gainful Employment, the removal of incentive compensation safe harbors for recruitment advisors, compliance with the 90/10 rule, Pell Grant funding, and accreditation (discussed separately as this is a risk unique to BPI).  We believe BPI’s lower cost structuring and lower priced model have better positioned the Company for risks related to changes in the Cohort Default rules and Gainful Employment.  We also believe that the Company has implemented a number of operational changes to manage these risks and the impact is largely internalized in the current financials as 2012 guidance implies a ~7.5% lower EBITDA margins vs. 2010 levels.  For context on operational changes the Company:  1) Raised minimum age requirement for Associate’s degree program from 18 to 22 years (early 2010) 2)  Introduced mandatory full attendance requirement in first course to continue in program (2Q10)  (3)  Launched first phase of an orientation pilot program for students with less than 24 credits (3Q10). (4) Launched second phase of orientation program with a full roll out expected in 2H11 (2Q11).

• Title IV and Cohort Default Rates: As of the year-end December 31, 2011, Ashford University derived 86.8% of its revenues and University of the Rockies derived 85% of its revenues from Title IV funds. Management is confident that it can continue to manage this metric going forward. Ashford University’s two-year cohort default rate (CDR) for 2009 was 15.3%, and the just released draft two-year CDR for 2010 was 10.4%. For the University of the Rockies, the two-year CDR for 2009 was 3.3% and the 2010 draft CDR was 3.9%. Earlier this week, the company received draft three-year CDRs, which were 20.2% for Ashford and 3.3% for the University of the Rockies. Management expects these rates to trend lower in the future as the company continues to invest in attracting and retaining better-performing students.  Regarding Gainful Employment, BPI has 45% repayment rate versus the DoE’s 35% GE threshold.  We would expect these metrics to improve as the Company benefits from the operational changes mentioned above (which we believe went above what the Company needed to do to remain compliant) and an improving economy

• 90/10 rule: Under the 90/10 rule, a postsecondary institution can receive no more than 90% of its revenues from Federal sources, specifically loans or Pell grants under the Title IV program. Currently, federal military tuition assistance and Veterans benefits, do not count toward the "90", but are considered tuition reimbursement similar to standard corporate programs. Recent speculation that the Obama Administration is considering incorporating military funds into the 90/10 calculation and perhaps reducing the cut-off to 85% from 90% has refocused investor attention on this issue. In particular, speculation has focused on whether the President might implement this change via an Executive Order as a way to bypass Congressional (Republican) opposition. We do not believe a change in 90/10 is imminent. Several observations drive this conclusion: 1) This is not a key issue for the President, so it is unclear why he would risk political capital to push through a change. 2) Republicans could spin the incorporation of military benefits into 90/10 as "anti-military" and unfriendly to enlisted personnel, putting Democrats on the defensive in an election year. 3) From a practical standpoint, reducing the cut-off to 85% could theoretically eliminate APEI, APOL, BPI, CECO, COCO, and LOPE from the Title IV program, sharply reducing access to higher education in the US, also a politically unpopular outcome.  However, this is an area of greater risk for Ashford relative to the sector as it generates 87% of its revenue from Title IV sources and potentially an incremental 5% from military sources.

• Pell Exposure High Relative to Other Online Providers: Bridgepoint has significantly more exposure to lower income students than the other predominately online For Profit providers, which makes their students more risky (as shown by past government studies). Oddly, based on Bridgepoint’s data, BPI’s students who receive Pell grants persist at higher rates than non-Pell students. In academic year 2010-2011, 93% of BPI’s average enrollment for the year received a Pell grant. We believe the high Pell Grant exposure may be reflective of a lower quality student base and additionally, exposes the Company to potential cuts funding for Pell Grants.  

WASC Accreditation Process: Bridgepoint’s Ashford University is in the process of applying to change its regional accreditor from the Higher Learning Commission of the North Central Association (HLC) to the Commission for Senior Colleges and Universities of the Western Association of Schools and Colleges (WASC). We expect a decision at WASC’s commission meeting scheduled for June 13, 2012. We believe Ashford will be successful in receiving WASC accreditation, but would not be surprised if there were a couple of “riders” to the approval (related to process, not growth): 

• Ashford’s track record with HLC is fairly solid. We believe HLC (more than any other accreditor) is under immense pressure to scrutinize institutions that run afoul of the rules. Given this pressure we would expect Bridgepoint/Ashford to be one of the most scrutinized institutions accredited by HLC. However, Ashford was given a seven-year accreditation term in 2008, and available disclosures suggest that commission continues to view the institution as a solid member.
• Its also our understanding that Bridgepoint will likely be able to secure WASC accreditation based on its institutional structures, academics (course catalog, outcome tracking, etc.), technologies, and good standing with HLC. Further, we believe the HLC and WASC are not that different in their views on academics, and institutional improvement processes.
• Additionally, BPI has made substantial investments in technology, learning outcomes, marketing, and improving class sizes as areas for investment.  The Company also hired Vicki Schray, a 13-year veteran of the DoE with particularly relevant experience in the Office of Postsecondary Education. We believe these investments should help the company better navigate the risks associated with accreditation.

However, WASC accreditation is not a certainty and while there are a number of options available to BPI in the event of non-accreditation (not discussed in this report), the effect of non-accreditation would be catastrophic for the stock.  In the event of failure to receive accreditation we would value the stock at ~$8 (value of the net cash on the balance sheet; share holders equity is ~$6.3 per share).  We note however that Ashford would still have HLC accreditation through 2015.  Our projections have the Company generating an additional an additional $566M of cash flow during that period, or ~$10 per share (these projections would have to come down as the enrollment base would likely decline if Ashford is going to lose its accreditation).

Warburg Pincus Overhang: Warburg owns 34.6 million shares or about 57% of the fully diluted shares outstanding. We believe they are disciplined long term investors, but we also believe they will likely sell a portion of their holdings at some point. Recently Warburg filed an S-3 requesting that these shares be registered and available for either distribution or sale.  However, the Company’s large cash position does create an opportunity to reduce the private equity overhang via a negotiated repurchase.  In an extreme example BPI could use its cash and marketable securities to purchase 58% of Warburg Pincus’ stake (assume $407 million in cash is used to purchase shares at a 5% discount to 4/18/12 closing price of $21.41).  In this scenario, the Company would $3.87 of EPS vs. the $2.50 midpoint of the Company’s guidance.  This implies a 55% increase over 2012 EPS guidance and 5.5x PE multiple. Note that while we do not expect the Company would use this large a percentage of its cash balance, the example highlights the impact of the Company’s cash position being leveraged to reduce the private equity overhang.

Financial statements: 

Catalyst