DeVry has two categories of business: the ones profoundly challenged by the current reduction in enrollments across the entire for-profit education sector and the ones that do not face these problems. The company has, piecemeal, provided investors with the data needed to value the healthy businesses independent of the troubled businesses. But it has not made it easy.

On the surface, the DeVry trades at 7x consolidated FY 2013 EBIT (Jun FYE), not a particularly attractive multiple for a conventional for-profit education company. However, this EBIT is depressed by two businesses that are currently losing money. Exclude those losses from results and assign a punitively low valuation to the conventional for-profit undergraduate business. Now you can buy the remaining businesses for 6.3x EBIT. These businesses are high-return, growing robustly and well-insulated from adverse trends in regulation emanating from the Department of Education.

DeVry groups its businesses into three segments. Let’s take them one at a time.

Business & Technology (“Business, Technology & Management”)

This segment consists of the traditional undergraduate university (estimated 85% of segment revenues) as well as the graduate business school (Keller, estimated 15% of segment revenues). Both possess reasonably well-respected brands of long standing and remain untainted by any charge of wrongdoing. The Chairman of DeVry’s board is Harold Shapiro, the well-respected former President of Princeton.

The segment reported $1.5 billion in revenues in FY 2011 with 25% EBIT margins. Undergraduate new student enrollments have fallen 35% since the peak and may continue to decline further. However, Strayer recently reached a bottom in enrollments and the rate of decline at DeVry has decelerated over the last year. Total enrollment will eventually follow new enrollment down. Assume undergraduate revenues decline peak-trough by 40%. Enrollment in Keller has declined less than 10% so far. Assume revenue from this piece falls by about 10% before stabilizing.

These assumptions imply a total 36% decline from peak to new normal in revenues for the overall segment. Margins for this segment across the last decade averaged 13%, with the lowest year being 5%. The segment reported 16% margins in FY 2012; Q1 ’13 reported a 900 basis point yr/yr decline in margins to 9%. As the business slowed in the last few years, the company has been slow to take out costs. Assume management eventually normalizes margins at 7%. That implies revenue of $930mm and $65mm of EBIT. The company would regard these as absurdly conservative estimates of normalized results, and they probably are. But let’s take a further measure of safety by assigning a 4.0x EBIT multiple.

This values the segment at $260mm – for a segment that reported $359mm in EBIT in FY 2011.

There is obviously a good chance that the segment eventually returns margins to historical average levels of 13%. But to justify an attractive return on the stock’s current valuation, we need to assume no more than that revenues bottom in 2014 with sub-average profitability of 7%.

Medical (“Medical & Healthcare”)

This segment consists of a nursing school (Chamberlain), two medical schools (Ross and American University of Caribbean) and Carrington.

Chamberlain and the medical schools together reported about $460mm of revenue in FY 2012 and EBIT margins of about 26%. A student’s return on capital from a nursing or an M.D. degree is demonstrably good. As a result, these businesses are essentially unaffected by the DOE regulations and the economic cyclicality that have crushed enrollment levels at most for-profit education companies. They both continue to grow new enrollments robustly. Moreover, the clinical/lab aspect to their curricula make it unlikely that low-cost online alternatives can displace them. A 6.3x EBIT multiple would be a steal for these businesses if available on a stand-alone basis.

Carrington has been a train wreck. It trains healthcare technicians, for which workplace demand is traditionally highly cyclical. This segment lost $33mm in FY 2012. It continued to lose money in the most recent quarter, though less than it did a year ago; also, new enrollments in the most recent quarter increased vs a year ago. Eventually, DeVry’s management will have to restore this business to profitability or eliminate it. I would expect the former, but assign no value to the business, positive or negative.

Overall, the Medical segment reported 16% revenue growth in the most recent quarter. Assuming 10% growth in profits FY 2013 vs FY 2012, Medical will deliver $130mm in EBIT, excluding Carrington losses. At a 6.3x EBIT multiple, Medical is worth $820mm.

Miscellaneous (“International, K-12, Professional”)

This segment should report about $195mm of revenues FY 2013. It consists of (1) several Brazilian undergraduate institutions ($85mm revs FY 2013), (2) Becker Professional Education (exam preparation for CPAs) and (3) Advanced Academics (online education for K-12 students).

Advanced Academics lost $8mm in FY 2011 and $14mm in FY 2012. Its losses continued in Q1 ’13, though they were smaller than in Q1 ’12. As with Carrington, let’s assume management eventually either fixes or eliminates the business.

Excluding losses from Advanced Academics, this segment delivered $41mm and $37mm in FY 2011 & 2012 EBIT. DeVry Brazil grew enrollments organically about 10% year/year in the most recent quarter (Note: this number was not reported but can be calculated by backing 10,800 acquired student out of FY 2011 end of year student count). Becker’s results in the last quarter were roughly flat, weakened by the soft economy. It has, however, a strong franchise and durable demand for its product. Becker and DeVry Brazil together have more than 25% EBIT margins, are unaffected by DOE regulation trends and would deliver a good return if bought at 6.3x EBIT.

Summary

The chief risk to this thesis, as with most companies owning a mix of troubled and healthy businesses, is the possibility that management misallocates capital. Management has so far been slow to cut losses in the obvious places. Also, it delivered mediocre returns on the $900mm spent for acquisitions over the last decade. The CEO owns 684,000 options and pays himself about $6mm annually, in good years and bad, mostly in stock and options. The stock’s decline from its 2011 peak has cost him significantly. He seems now to be focused on doing what is necessary to staunch the bleeding. In the most recent quarter, the company announced more cost take-outs in the struggling businesses than it had initially indicated.

The other risk to the above analysis  is that management overstated the losses associated with Carrington and Advanced Academics. These were reported verbally on the Q4 ‘12 conference call, not written more credibly into an SEC-filed document. There is some probability that the ‘savings’ from eventually eliminating the losses will magically disappear into remaining businesses in the form of ‘growth’ investments.

Overall, however, the risk versus reward is excellent from a stock price of$24/share - enterprise value $1.387 billion. Excluding losses associated with Carrington and Advanced Academic, you are buying DeVry’s outstanding and rapidly growing educational franchises for 6.3x EBIT, while paying 4x an extremely conservative EBIT estimate for the troubled Business & Technology segment. Alternatively, assuming the Business & Technology segment, which reported $1.3 billion in FY 2012 revenues is worthless, you are paying 7.8x EBIT for the healthy businesses.

Upside to this scenario  includes: return of the undergraduate segment to double digit margins; return of Carrington and Advanced Academics to meaningful profitability.