Description

Concorde Career Colleges (CCDC) is a micro-cap for-profit provider of post-secondary vocational education, offering career training primarily in the allied health field, which includes LVNs (Licensed Vocational Nurse), Medical Assistants, Dental Assistants, Radiographers (X-Ray technicians), Surgical Assistants, and Respiratory Therapists. The company has 12 campuses in seven states with a recent student population of 7,688. Concorde trains people (mostly women) with little education (high school) and poor employment prospects (WalMart, McDonalds) for entry level jobs in the field of health care.

Concorde reached $28/share earlier this year, before receiving a vigorous drubbing that left it significantly undervalued. Concorde is cheap based on a conservative forecast of revenues and earnings, it has a Fort Knox balance sheet and continues to drown in cash, it is completing a major expansion and will enjoy reduced cap-ex, increased free cash flow (It is currently free cash flow positive), increasing revenues and improving margins over the next several quarters, it is positioned in healthcare, which is a growth niche within the education industry, it is free of legal/regulatory issues, and it is bite-sized, with a shareholder structure that points toward an ultimate sale of the company in an M&A intensive industry.

Concorde’s shares were pummeled for two reasons: First, this year’s earnings fell short of expectations due to poor enrollment growth and margin pressure. Second, the for-profit education industry is going through a horrendous period as three major players (ITT Educational Services, Career Education, and Corinthian Colleges) are involved in various government investigations and lawsuits, placing the whole industry out of favor. Also, some competitors have been hit with a decline in enrollment growth and/or margin pressure, calling into question the torrid growth that the industry has experienced in recent years. These factors have caused education stocks to be re-rated from Alice-in-Wonderland valuations to more reasonable levels, although companies that continue to perform and are free of regulatory issues still carry aggressive valuations in my opinion.

Enrollment and Margins: Margins deteriorated for several reasons. The small factors were things like increased advertising expense and Sarbanes Oxley. The big factors were 1) increased cost of education, specifically, teachers’ salaries, which is due to the acute shortage of qualified, credentialed health care workers (more on this below), and 2) increased expense associated with adding 65 new classrooms to the company’s footprint in the past 18 months, an increase of almost 40%, as well as new personnel for programs that were transplanted among existing campuses and will be accepting students in the next few quarters. It is important to note that Concorde expensed the majority of these outlays rather than capitalizing them. Enrollments were challenged because of delays in adding programs as well as lower than expected enrollments in existing programs. Also, the LVN program at one campus was placed on probation due to a high failure rate and was not allowed to accept new students until performance improves, costing the company 48 students. These factors resulted in slightly negative overall enrollment growth this year and a deterioration in operating margins from close to 15% to 8.7% as of last quarter.

Concorde will have to learn to live with Sarbanes Oxley and higher teachers’ salaries. Advertising expense may taper off after the political season and Olympics, although some of the increase in advertising expense was blamed on heightened competition. The major cost factor of adding classrooms and transplanting programs, however, will go away altogether. On balance, with new students showing up for recently added programs, I estimate that operating margins will revert upward off a higher revenue base to perhaps 12%, which is conservative considering historic margins and competitors’ margins which are in the mid to high teens industry-wide.

A quick look at Concorde’s balance sheet history highlights the attractiveness of the company’s business model. Concorde suffers an embarrassment of riches, with approximately $22.5mm or $3.40/share in cash and no debt. $2mm to $3mm was raised in a private placement from a VC firm a few years ago, and the rest of the cash has been generated internally. In the most recent quarter, cash went from $19.3 mm to $22.5mm, and this was while the company suffered miserable enrollments, increased operating costs and was incurring above average capital expenditures while adding classrooms and programs, demonstrating the company’s free cash flow generation.

The for-profit education business model is roughly akin to retail. Existing campus enrollments (same store sales) and new campuses are inputs for total enrollment growth, tuition hikes and enrollment growth are inputs for revenue, and operating margins, taxes and shares outstanding are inputs for per share earnings. The major difference is that Education is highly regulated in the U.S., and both federal and state governments are very active in preventing poor quality operators from becoming established. While I don’t have a strong opinion about how the investigations will play out at CECO and ESI, I am confident that the for-profit education industry will survive and that the upstanding providers will fare well in the years to come, due to the high value placed on education in our society, the trend toward degree inflation, professional licensure and credentialing, and the low level of competition from non-profit and state providers such as community colleges. A major difference from retail is that students pay tuition up front, making the working capital cycle extremely attractive for schools.

Valuation: Concorde will do $80m to $82m in revenue this year. If you conservatively assume that the almost 40% increase in classrooms brings a 30% increase in revenue from new enrollments, and that tuition hikes over the next two years add an additional 6% in revenue growth (Tuition hikes are historically higher – in the range of 4% or 5%/year or 10%/2 years), Concorde should achieve approximately $110m in revenue in 2 to 2.5 years. If operating margin reverts to 12%, Concorde will achieve $13.2m in EBIT. I think a 10x EBIT multiple is fair for Concorde, given its cash generation, long-term growth prospects and its value to an acquirer (An acquirer such as Corinthian or the Post could reduce G&A substantially). Adding $22.5m in cash plus another $5m that will likely be generated in the next couple of years (which is way low), you get approximately $160m in enterprise value divided by 6.27mm shares, or $25.4/share. Industry comps that are unfettered by regulatory or legal issues trade much higher than 10x EBIT (Strayer, EDMC, UTI), but since Concorde has disappointed it is trading well below these peers. The next couple of year’s results will correct this discrepancy, which may result in Concorde achieving a valuation in excess of 10x operating income.

Also, my estimates for revenue growth and cash generation are probably on the low side because Concorde’s niche – allied health – should enjoy strong growth, and margins will improve as G&A shrinks as a percent of sales. There is currently a terrible shortage of skilled healthcare workers in the U.S.: The Bureau of Labor Statistics estimates that job growth in the healthcare sector will outstrip growth in overall U.S. employment by a factor of almost 2:1 over the next ten years. The average age of nurses is ridiculously high, and pressure to cut costs causes hospitals to hire more assistant nurses (LVNs) and other low level health care workers to ease the workload for RNs and MDs. Also, the aging population means that more and more people require the services of healthcare workers. Finally, there is a trend in the healthcare field toward credentialing which will increase the necessity for healthcare education. Concorde is positioned as a gateway between a job at WalMart and a stable, high paying career in healthcare.

The challenge is one of execution. Concorde’s management has admittedly failed to deliver the growth that analysts were looking for this year, or that could be reasonably expected given the company’s position in the allied health field. The margin of safety lies in the Concorde’s ownership structure and the merger intensive nature of the for-profit education industry. Argosy Education, CDI, Whitman, California Culinary Academy and Qwest were all small/micro caps that were acquired by larger competitors (EDMC, COCO, CECO, and The Washington Post). In my humble experience I have not seen a small or micro cap for-profit post secondary education company avoid being acquired. The larger companies are under pressure to grow due to the law of large numbers, and if EDMC or COCO must find 15,000 new students in any given year to meet their growth targets, it is logical for them to buy 7,688 of the 15,000 via acquiring a company like Concorde (Or Argosy or CDI or Whitman, as they have done in the past). The recent unsolicited approach to DeVry is of course another indication of the M&A activity in the industry.

Concorde’s ownership structure also leads me to believe the company will be sold within the next 3 to 5 years. The founder’s son and current chairman, Jack Brozman, owns 25% of the company and a Maryland based VC firm owns another 25%. Brozman is in his mid 50s and wants to play more golf, but realizes that he must maximize the value of his sizeable investment in Concorde first. He managed and sold a pre-school company several years ago. The VC firm must also have a finite investment horizon for their stake in Concorde. Given the large ownership of these two parties and their ultimate desire to maximize/monetize their respective investments, a sale of the company is by far the best solution. There was even a rumor in a Wall Street research report, which I have not been able to confirm, that Concorde was in talks a couple of years ago.

Concorde’s market capitalization is bite sized for CECO, COCO, WPO or EDMC which are all valued in the billions. Also, there are at least three private equity firms active in the for-profit education sector (Leeds, Weld in NYC, Warburg Pincus, and the one that did the Strayer deal) and certainly many more that I don’t know about. In sum, while admitting that COCO and CECO are not likely to be venturesome acquirers in the near future, Concorde is an attractive property in an attractive industry with a number of potential buyers. At the very least, Concorde’s attractiveness as an acquisition target provides downside protection.

Catalyst

Catalysts: 1) Resolution of the legal/regulatory issues surrounding CECO and ESI. These investigations can not go on forever. Even the most negative outcome – both companies are put out of business – would be a positive for the industry’s investment climate going forward, including Concorde. 2) Enrollment growth, improving margins and free cash flow generation from recently added capacity and programs. 3) Ultimate sale of the company.