Description

I believe Strayer Education Inc. (STRA), a for-profit education company, is a compelling short at current price levels with upside of over 50% and a reward/risk of around 3/1.  

• Reward (price target): STRA's cash EPS (OCF-D&A-stock based comp.) for 2008 was $4.72 and grew 9.9% over 2007 cash EPS. Due to organic enrollment growth slowing, tuition receivable charge-offs likely increasing and current discounting, cash EPS is not likely to grow much faster than 10-15%. Based on my 2009E cash EPS of $5.30, I apply a 15x P/E multiple and arrive at an ~$80 stock price.
• Risk: If STRA trades at 25x (given EPS growth is expected to be 23% per year for the next 2 years) the average sell-side 2010E EPS of $8.62 then STRA could trade back to $215. This would be downside of 15%.
• Consensus View: STRA is a countercyclical, recession resistant growth story since unemployed/underemployed people tend to go back to school during tough economic times. At the same time, the 4% annual increase (based on 2009-10 vs. 2008-09 academic year) in Title IV funding through greater Pell Grants will help affordability. Title IV annual loan limits were raised by $2,000 or a little over 20% for undergraduate students on 7/1/08.
• My View/Edge: Revenues and EPS growth rates are likely to slow due to its business model issues. At the same time, revenues and EPS may be overstated due to its balance sheet issues. Sell-side analysts are not focused on either of these. As a result, 11 of 14 have a buy rating and 3 have hold recommendations. The average/median sell-side price target is $225-$230.

Short Thesis

• Expensive Valuation: 5.1x 2009E Revenues, 15.8x 2009E EBIT, 26.7x 2009E EPS
• Tuition Receivable Growing Faster than Revenues:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  Revenues		396.3	318.0	263.6	220.5	183.2	147.0	116.7	92.9	78.2
  	% change YoY	24.6%	20.6%	19.6%	20.4%	24.6%	26.0%	25.7%	18.7%	12.1%
  Tuition receivable, net		131.5	100.7	80.8	55.9	41.7	36.0	25.8	19.0	15.3
  	% change YoY	30.6%	24.6%	44.4%	34.2%	15.8%	39.7%	35.5%	24.6%	1.8%
  	as a % of revenues	33.2%	31.7%	30.6%	25.4%	22.7%	24.5%	22.1%	20.5%	19.5%

• Tuition Receivable Growing Faster than Unearned Tuition:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  Tuition receivable, net		131.5	100.7	80.8	55.9	41.7	36.0	25.8	19.0	15.3
  Unearned Tuition		114.9	91.5	73.9	55.8	42.1	39.1	29.9	23.2	18.0
  	Tutition Rec, net/Unearned Tuition	1.1	1.1	1.1	1.0	1.0	0.9	0.9	0.8	0.8

• Cash EPS (OCF-D&A-stock based comp.) Diverged from EPS starting in 2006:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  EPS		$ 5.67	$ 4.47	$ 3.61	$  3.26	$  2.74	$  2.15	$  1.81	$  1.55	$  1.41
  Adjusted (Cash) EPS		$ 4.72	$ 4.30	$ 3.26	$  3.29	$  3.50	$  3.02	$  2.02	$  1.71	$  1.61
  	Adj. (Cash) EPS/EPS	83.2%	96.1%	90.4%	100.9%	127.9%	140.8%	111.7%	110.7%	114.9%

• Allowance for Doubtful Accounts and Addition to Allowance Increasing:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  Allowances for doubtful accounts		4.8	3.2	3.0	1.9	1.3	0.8	0.6	0.5	0.5
  	as a % of tuition receivable gross	3.5%	3.1%	3.6%	3.3%	3.0%	2.1%	2.4%	2.3%	3.1%
  Addition to allowance charged to expenses		12.7	10.5	7.8	5.5	4.2	2.7	1.8	1.6	2.1
  	as a % of revenues	3.2%	3.3%	2.9%	2.5%	2.3%	1.8%	1.5%	1.7%	2.7%

• Tuition Price Increases Hurts Affordability, Leading to More Debt Per Student:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  Cost/course (undergrad part-time)		$ 1,510	$ 1,430	$ 1,355	$ 1,285	$ 1,215	$ 1,150	$ 1,094	$ 1,040	$    990
  	% change YoY	5.6%	5.5%	5.4%	5.8%	5.7%	5.1%	5.2%	5.0%	4.8%
  Title IV Funds as a % of Revenue		72%	72%	71%	72%	71%	67%	63%	58%	51%
  Debt Incurred by Avg. Enrollee		$ 6,016	$ 5,799	$ 5,410	$ 5,224	$ 4,929	$ 4,408	$ 3,964	$ 3,479	$ 2,874
  	% change YoY	3.7%	7.2%	3.6%	6.0%	11.8%	11.2%	13.9%	21.1%	14.4%

• Poor Affordability Leading to More Part-time Students Taking Fewer Classes:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000	1999	1998	1997
  Part-time (<3 courses per quarter)		82%	79%	78%	77%	76%	75%	76%	74%	73%	72%	71%	65%
  Avg. Quarter Course Credits per Student		8.2	8.2	8.3	8.1	8.6	8.7	8.6	8.8	8.8	8.9	9.0	9.0

• Major Business Model Change-More Students Solely Taking Classes Online:

  		2008	2007	2006	2005	2004	2003	2002	2001	2000
  Pure online student participation		27,300	21,400	18,000	15,000	11,669	8,550	5,401	3,222	495
  	as a % of enrollment	61.3%	59.3%	57.4%	54.9%	49.6%	42.5%	32.7%	23.0%	4.1%
  Avg. On Campus Student Enrollment		288	288	318	367	416	464	557	696	859

• 2008 Tuition Priced High vs. Traditional Non-Profit Online Schools:

  Total Tuition (full-time student)			Avg. Non-profit
  		Strayer	Online School	Difference
  Bachelor's Degree (54% of students)		$ 60,200	$                 40,200	$    20,000
  Master's Degree (27% of students)		$ 24,480	$                 15,480	$      9,000
  Associate's Degree (11% of students)		$ 30,100	$                 18,750	$    11,350

   
• Comparatively Higher Priced Degrees & More Campuses = Less Students/Campus:

  		2008	2007	2006	2005	2004	2003	2002	2001
  Bachelor's Degree (% of students)		54%	55%	55%	56%	58%	61%	62%	62%
  # of Bachelor's Degree Students		24,273	19,909	17,172	15,423	13,684	12,203	10,174	8,686
  	% change YoY	21.9%	15.9%	11.3%	12.7%	12.1%	19.9%	17.1%	-
  	Per Campus	405	390	409	460	480	488	509	560
  Master's Degree (% of students)		27%	28%	26%	25%	23%	20%	18%	16%
  # of Master's Degree Students		12,169	10,101	8,310	6,833	5,386	4,107	3,034	2,241
  	% change YoY	20.5%	21.6%	21.6%	26.9%	31.1%	35.4%	35.4%	-
  	Per Campus	203	198	198	204	189	164	152	145
  Associate Degree (% of students)		11%	11%	11%	12%	12%	13%	12%	11%
  # of Associate's Degree Students		4,726	3,868	3,593	3,187	2,817	2,541	2,064	1,541
  	% change YoY	22.2%	7.7%	12.7%	13.1%	10.9%	23.1%	33.9%	-
  	Per Campus	79	76	86	95	99	102	103	99
  Non-degree Programs (% of students)		8%	6%	7%	7%	7%	6%	8%	11%
  # of Non-Degree Students		3,396	2,204	2,297	1,862	1,652	1,287	1,260	1,541
  	% change YoY	54.1%	-4.0%	23.4%	12.7%	28.4%	2.1%	-18.2%	-
  	Per Campus	57	43	55	56	58	51	63	99

   

• Comparative Business Analysis (2008 vs. 1997) Highlights How STRA Has Grown:

  		2008	1997	Growth
  Campuses (at year end)		65	9	622%
  Students enrolled (by fall term)		44,564	9,419	373%
  Faculty members (total)		2,407	554	334%
  Instruction & education support		130.8	19.7	563%
  Selling & promotion		76.2	5.5	1291%
  Pricing (part-time bachelor's degree)		$ 1,585	$    855	85%
  Tuition receivable, net		131.5	10.1	1206%
  Unearned tuition		114.9	11.8	875%
  Allowances for doubtful accounts		4.8	0.2	1977%
  Add. to allowance charged to expenses		12.7	1.4	821%
  # of credits taken by avg. student		8.2	9.0	-9%
  Title IV Funds as a % of Revenue		72%	50%	44%
  Part-time as a % of student body		82%	65%	26%
  Revenues		396.3	53.1	646%
  Operating margin		32.0%	38.9%	-18%
  EPS		$   5.67	$   0.93	509%

• Tuition Reimbursement by Companies at Risk: Approximately 20-25% of STRA's revenues are tied to tuition reimbursement by students' employers. Recent surveys suggest this is likely to be cut 11-18% in 2009.

• Unusual Promotions/Discounting: For the first time STRA is giving students a $300 books vouchers and waiving the $50 application fee if students enrolled by April 13. Per the average student taking 8.2 credit hours per quarter, this would equate to about a 10% discount for that quarter.

• Scare Tactics to Induce Enrollees and Possibly Pulling Future Revenues Forward: Per a Strayer recruitment email it reads, "Please note that current levels of Financial Aid available to new and continuing students have never been higher. This is allowing nearly all of our students to attend Strayer University with no up-front 'out of pocket' expenses whatsoever. But, in view of the worsening economy, there is a great deal of concern as to how long these levels of Federal Funding support will continue. As a result, we are advising all individuals considering using Financial Aid to help them go to school do so sooner rather than later if at all possible."
• Student Demographic Trends: The % of the student population made up of minorities has increased from 52% in 2001 to 71% in 2008; % made up of women has increased from 56% in 2001 to 67% in 2008. These groups tend to get a lower return on an educational investment, which could hurt STRA's cohort default rates and draw attention to its business practices.
• Major Insider Selling: On December 1, 2008, the CEO sold 95.4% of his shares, cashing out over $30mm of stock at an average price of $228.40. This was the first day these shares became 100% vested. On 2/25/09, senior VP and General Counsel for Strayer sold over 40% of his shares at an average price of $181.31 per share, cashing out about $550k.  

Supporting Details to Short Thesis

• Tuition Receivables Growing Faster than Revenues and Unearned Tuition: Since STRA does not finance any of its students the likely reasons are: 1) Strayer now allows students to start school (up to one quarter) before getting approved for Title IV loans and if the student subsequently drops out then Strayer has no recourse; 2) Companies are cutting back and/or delaying their tuition reimbursement and thus tuition receivable is building; 3) Strayer overbooked revenues tied to students that drop out part-way through a quarter and/or don't renew the following quarter and thus leads to difficulty in collecting payment from the government and/or companies for tuition reimbursement.
• Allowance for Doubtful Accounts Increasing: Given the growth in tuition receivable, net it appears that there is a high likelihood that both the allowance and addition to allowance charged to expenses will increase in the future thereby putting pressure on margins and thus EPS. Over the past 12 years, allowances for doubtful accounts are up 20.8x, but additions to allowances charged to expenses are up just 9.2x. 
• Major Business Model Change: Originally, a major appeal of going to Strayer University was that a working adult could keep his/her job and continue his/her education by attending a local campus. However, if 61.3% of students just take classes online it begs the question if one might increasingly look at traditional (non-profit) schools that have online programs without a physical campus in his/her city, but cost less and have a better reputation.

Share Statistics

• Cost to Borrow: Zero.
• Short Interest: As of 3/31/09, the short interest as a % of the float was 26.9%.
• Liquidity: The average daily trading volume is over 511k shares, which equates to $95mm at the current stock price.

Catalyst

Revenue and EPS growth slows due to the aforementioned issues and thus misses EPS estimates over the next 1-2 years.