Description

This may well be a controversial idea as it is not traditional hardcore Graham & Dodd value idea, and it certainly is a risky and uncertain one, but I believe the risk/return proposition is quite interesting for COCO at current levels, which represent good relative value. Because this is a timely and volatile situation (the stock has recovered modestly this morning), I will keep the write-up brief as there is ample factual material in the public domain. COCO is a for-profit post-secondary education business that operates 88 colleges in 22 states and 35 colleges and 15 corporate training centers in Canada. A detailed description of COCO can be found on its website (www.cci.edu) and in its SEC filings, and there is ample sell-side coverage of COCO and the sector.

The for-profit education sector has been an incredible winner for the past five years, but has flamed out considerably in the past several months based on an overhang of legal and regulatory investigations/lawsuits and concerns about slowing growth rates. This has been a very richly valued, hot money type sector, though in fairness, these businesses have grown tremendously and generated significant increases in earnings and cash flow. In the case of COCO, the Company’s rapid growth also was fueled by acquisitions, and it is quite clear from the timing and magnitude of the recently announced earnings miss, that management does not fully have their arms around the business. The next year should be one of catching their breath and getting better control of current operations. Having said that, these appear to be reasonably good assets in a secular growth market, and the current cost and marketing issues appear eminently addressable through increased focus on execution, which we should expect to see from management in coming quarters.

Even assuming no growth in operating income or EBITDA in the next year (a very conservative assumption in light of the most recent 12% same-school enrollment figures), COCO is trading at less than 13x EPS and less than 6x EBITDA with no debt, less than market multiples in a sector that, notwithstanding that growth has undeniably slowed (in part probably due to the robust economy), still enjoys secular growth rates at multiples of GDP and very high ROIC. Even at only mid--to-high single digit growth rates, and no return to the lofty multiples of previous years, COCO has at least 50% upside in the next 12 months, and more if management can execute and restore the multiple to something closer to the sector average, which itself is (and should be) down significantly.

The situation clearly has hair (hence the opportunity), but regulated businesses (including this industry in the late 1990’s) periodically go through bouts of regulatory focus that result in some dislocation. That is not to minimize these issues, but at this juncture they appear to be somewhat routine/lower level in nature and not necessarily indicative of systemic problems. These issues are like many of the healthcare companies that periodically deal with Medicare/Medicaid investigations, most of which never rise to a dire level but typically relate to substandard documentation and administration. To date, there are no really serious allegations of fraud or the like at COCO or anything to suggest senior management is corrupt, though further disclosures on this front are a risk and bear close scrutiny.

The Company's strong financial profile provides flexibility around share repurchases to buttress the shares, and COCO's relatively low valuation, if it persists, could prompt a takeover run as many of the comps continue to trade at significant premiums to COCO.

Catalyst

A few quarters of solid execution and restoring credibility
Increased visibility on fiscal 2005 earnings and cash flow
Share repurchases
Takeover