This Industry Has a Failing Report Card

The for-profit education industry has attracted some serious public relations problems these days -- not to mention regulatory scrutiny. However, this industry's report card fails on many levels, making it a segment I can't recommend investing in.

News headlines about for-profit educators have probably made you at least remotely aware of the serious social ramifications that are involved -- ramifications that we all end up paying for, one way or another. If that's not enough danger, real bottom-line financial risks loom for these companies, too.

Supposedly "cheap" valuations and negative sentiment surrounding the industry may tempt some investors to buy the stocks. Don't grade these companies on a curve; that could result in a hard lesson in failed investments.

For-profit education and American debt
GMI, which provides global corporate governance and environmental, social, and governance research -- or ESG -- has released a report on the for-profit education industry's high-risk position in the marketplace.

Right off the bat, the report reveals some troubling facts concerning the industry. The group overall tends to produce low graduation rates. Add in this sobering element of our overly indebted nation: Student loans currently represent a greater amount than American consumer credit card borrowing, and nearly half of all student loan defaults emanate from for-profit education's borrowers.

Although some laud the for-profit education industry as a free-market approach to education, here's a factor that contradicts free market arguments: some of these companies rely quite heavily on government programs and funds. GMI pointed out that for some, Federal Title IV student aid funding represents as much as 89% of their revenue source.

Three major failures
Three of the four companies GMI covered are considered to have a high degree of fiduciary risk, receiving the lowest ESG rating GMI doles out. The list included Apollo Group (NAS: APOL) , the company behind a far more recognizable moniker: University of Phoenix. Education Management Corp. (NAS: EDMC) and Corinthian College (NAS: COCO) also earned GMI's worst rating.

Corporate governance-related red flags shared by all three include concerns about directors' industry expertise, the ratio of CEO equity to CEO base salary, and incentive pay that's poorly linked to outperforming peers. The report highlights other corporate governance-related red flags, too, such as Apollo's and Education Management's related party transactions involving management or the chairman, as well as their restrictions on shareholder voting rights.

Washington Post (NYS: WPO) was reported as the least risky company of the four examined. Although its Kaplan subsidiary contributes more sales to the company than its better-known newspaper business, GMI found that its relative absence of corporate governance or accounting concerns and its more diversified revenue alleviates its riskiness.

Like school in summer -- no class
If the previous arguments aren't convincing enough, let's talk about the elements that are poised to hit the for-profit education segment straight in the pocketbook.

Federal and state probes of these companies' use of public funding and high student loan default rates have gotten plenty of attention. The specific issues involved should chill investors.

For example, the Department of Justice filed a fraud suit against Education Management earlier this year. Education Management has been accused of not being eligible for any of the state and federal financial aid it received from mid-2003 to June of this year, or more than $11 billion, which is only slightly less than the company's total revenue over the eight-year period. Under the False Claims Act, it could be subject to triple damages, or $33 billion.

GMI points out that even though "negative externalities" -- costs that society pays for, as opposed to the corporate behavior that caused the costs -- are usually associated with industries like the tobacco industry, or big corporate polluters.

However, similar concepts are at work with these companies, which seem to be churning out more bad debt than highly skilled workers. And these days, more people are aware that responsible corporations must foot the bill for big costs to society.

Risk Avoidance 101
Although GMI's research focused on just the four companies mentioned above, I wouldn't touch shares of Strayer (NAS: STRA) , DeVry (NYS: DV) , Bridgepoint Education (NYS: BPI) or any of the other for-profit education companies right now, either. (Note that several of my Foolish colleagues involved in Rising Stars and in several of our premium services have bought or recommended Bridgepoint. While I respect their opinions on that stock, we're a motley bunch here at The Motley Fool, and I simply can't consider industries or companies that are teeming with this kind of risk.)

The reputational risk facing the for-profit education industry boils down to an extremely unpleasant factor. It too often capitalizes off of the poor economy and many Americans' desperate attempts to improve their lot in an extremely challenging job market. I'm all for trying to improve one's financial standing in the world and expand skills, but too many folks are taking on huge piles of untenable debt that they can't afford, for an end result that likely won't result in well-paying jobs (or even the ability to pay off the obligations).

The for-profit education industry profits off that desperation, and doesn't appear to be doing much to help the marketplace or the American economy at large. That's a lesson in trouble for all of us.

Check back atFool.comevery Wednesday and Friday for Alyce Lomax's columns on environmental, social, and governance issues.

At the time thisarticle was published Alyce Lomax does not own shares of any of the companies mentioned. The Motley Fool owns shares of Bridgepoint Education. Motley Fool newsletter services have recommended writing puts on Bridgepoint Education. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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