Description

Description:

EVCI runs Interboro in NYC. You folks who live in this area are no doubt more familiar with it than me, but EVCI purchased Interboro in Jan 00 and offers two year college associate degrees.

The school has a novel strategy - the students are high school dropouts who, if they pass a test, can get funding from NY by Pell and TAP grants, all of which pays the tuition at EVCI. I don't pretend to know the area but have talked to several people who do, and the drop-out rate in NY schools doesn't automatically quality one as incapable of higher education (though the graduation rate here is apparently around 20% despite EVCI's best efforts to keep the students on course).

There certainly appears to be a demand as enrollment has grown steadily:

Enrollment
2000 2001 2002 2003 2004 2005
Spring 725 890 1410 1800 2800 3700
Summer 510 600 950 1100 1975 2650
Fall 780 1000 1750 2300 3900

The company has also purchased local area school TCI for 16m w/an 8% floating rate loan (for the year ending Sep 04, TCI had sales of 34.8m with net income of 890k; for Sep 05, sales of 34.3m and 1.2m NI & 650k d/a) and acquired a school in Penn (not profitable) earlier this year.

Why I'm Interested in the Company.

Well, if the trailing numbers were accurate this would be an interesting investment. Based on my numbers, I find EVCI trading at 3.8x earnings and 1.1x book. The balance sheet before the TCI acquisition (closed Sep 05) was liquid enough, with 4.6m in cash, 8.9m TL, with a big AR balance but per the company they had already collected most of it (15m by Oct).

Unfortunately, these numbers are no longer to be trusted. On Oct 19, EVCI announced that compliance review by NY state resulted in " ...assertions of irregularities in Interboro's admissions practices" and "recommendations includ(ing) increasing the number and percent of full-time faculty, having contracts with full-time faculty, improving Interboro's libraries, improving other facilities and equipment resources and assessing and improving the quality of student learning." which the company said they planned to implement, albeit at a price to margins. EVCI recently reported non-descript Q3 results but delayed its filing pending a company audit of these findings.

Frankly, I am ignorant in the gory ways of education companies, but problems like these seem to be part of business procedure, and it doesn't always mean the end of life as we know it (my only information on the audit is based on what they company said in the press release).

After all, if states and the Fed govt pay your bills, they aren't going to make life easy on you. EVCI has been the subject of other audits in the past (as an example, a March 05 TAP audit had a disallowance of 903k and apparently EVCI lived to fight another day) and I have no idea if this one is far more serious than the others. Plus, the company's comment about margin issues doesn't sound reassuring.

Still, it trades for 3-4x earnings. Maybe these things are routine things that pressure margins but can be overcome. Maybe there isn't any real fraud. Maybe this stuff can be fixed. Before the TCI acquisition, EVCI had about 11m in cash above and beyond liabilities (on a 22m company, though that number is a moving target with the options and restricted stock and other goodies, but you get the point), and in theory the problems with EVCI have no bearing on TCI’s performance so paying 22m for a company EVCI just paid 16m for doesn't seem to value the Interboro as worth much of anything.

What Has to Happen for Them to Succeed. Before, it seemed obvious. Keep enrollment up at Interboro, make TCI more profitable, and start to make money in the new Penn. school (which was a drag on profits in the latest quarter). Now, it doesn't seem straight-forward - hope that management isn't a bunch of scumbags (I don't know how else to say this) and that margins won't get hit too hard if they do have to increase expenses, and assume the TCI acquisition turns out to be a good one.

Pitfalls. Besides the ones listed above, EVCI had its ugly side before this latest issue. Management pays itself handsomely with restricted stock grants and options and everything else under the sun. I won't get into the gory details (you can see it all in the filings, and nobody who owned this stock ever pretended that management didn't feel entitled) but chalk this as a huge negative. Past audits have also revealed issues and there is no guarantee this won't occur again. Management has also articulated a growth strategy by acquisition - this all becomes questionable in light of problems at the main school. Plus, a lot of the previous buying arguments in this stock (near $12 not that long ago) revolved around the idea that margins could expand, but now that seems questionable too.

In the end, I think this is worth a speculative investment, but I've kept it very small. Plus, I’ll admit to posting this idea mostly because I’d like some feedback on it from you people who are a whole lot smarter on these things than me. EVCI has been owned by other folks in the hedge fund world and I’d be curious if they are bailing or buying right now and more importantly - why or why not?

Catalyst

Audit findings turn out to be routine drubbing by state rather than outright fraud that threatens the company