Selling Education Short: For-Profit School Stocks May Be Ripe for a Fall
In a May 26 speech to the Ira Sohn Conference in Manhattan, a charitable organization where guests pay to listen to hedge funds pitch investment ideas, Eisman likened for-profit education loans to subprime mortgages. That's because the banks use government money, received through a program called Title IV, to lend money to people who may not be able to repay it, so they can attend online education programs that most of them don't complete.
For-profit education was limping along with limited access to this federal money until George W. Bush took office. According to Eisman, from 1987 to 2000, the industry got between $2 billion and $4 billion in government funds annually.
But when Bush took over, the Department of Education "gutted many of the rules that governed the conduct of this industry," said Eisman. "Once the floodgates were opened, the industry embarked on 10 years of unrestricted massive growth. Federal dollars flowing to the industry exploded to over $21 billion, a 450% increase."
A Fast-Growing Profit Machine That Exploits Its Customers
This flow of government money accounts for "100% of the growth in the for-profit education industry," according to Eisman. And that growth has been very high -- industry sales have expanded at a five-year average annual rate of 26.4%, over three times the S&P 500 industry average. That growth has been very profitable, too: The five-year average return on equity for the industry is 33.5%, twice the S&P 500 industry average.
Unfortunately, that profitable growth comes at a cost to the industry's customers -- students. Dropout rates at for-profit institutions are exceptionally high, and leaving school without a degree also leaves students with huge loans on which they often default. Business Insider reports that while 55% of U.S. college students get degrees within six years of starting their programs, at the University of Phoenix -- which, with 400,000 students is the nation's largest for-profit university -- only 18% get their degrees in six years. That number drops to 6% at some campuses, and a scant 4% for online students. And the dropouts default on loans "as big as $100,000 for incomplete bachelor's degrees and up to $200,000 for advanced degrees," according to Business Insider.
Recruiting the Homeless
Along with high quit rates comes tremendous sales turnover. Lofty sales goals and incentives for enrollment specialists at these for-profit education companies lead them to harass potential customers -- calling them as often as 20 times a day. If the salespeople can't meet their quotas, they get fired quickly. But if they do, they can make six-figure salaries. Most for-profit education salespeople bail out after six months.
According to a memo written by a former employee of one for-profit education company, Bridgepoint Education (BPI), "The level of deception is disgusting -- and wrong. When someone who can barely afford to live and feed kids as it is, and doesn't even have the time or education to be able to email [enrolls], they drop out. Then what? Add $20,000 of debt to their problems -- what are they gonna do now. They are officially screwed. We know most of these people will drop out, but again, we have quotas and we have no choice."
A surprising number of the people enrolled by these companies are homeless. According to Bloomberg, homeless people account for almost 5% of the students in the Newark, N.J., branch of Drake College of Business, a trainer of medical and dental assistants. In late 2008, Drake started offering $350 every two weeks to students who showed up for 80% of classes and held onto a C average. Carmella Hutson, a case manager at the Goodwill Rescue Mission in Newark told Bloomberg, "It's basically known in the community: If you're homeless, and you need some money, go to Drake."
An Industry in Need of Reregulation
This state of affairs is similar the industry's condition back in 1990. Back then, for-profit education consisted of what Bloomberg referred to as "fly-by-night trade schools [that] siphoned off students from welfare and unemployment lines, ostensibly to train them as truck drivers or hairdressers."
Those institutions provided little real schooling, but obtained federal student aid. Their default rates on student loans rose to 22% before Congress toughened regulations in 1992. Specifically, Congress set limits on default rates for individual colleges and put a lid on how much of their revenue they could get from the government. They also were forced to ban the practice of paying recruiters based on the number of students they enrolled. But in 2000, Bush "relaxed the ban on incentive compensation for recruiters, opening the door for the aggressive wooing of the homeless," according to Bloomberg.
Now, the U.S. wants to impose more discipline on the for-profit education industry. "Targeting vulnerable populations who are not likely to benefit is one example of overzealous recruiting that can be driven by paying based on enrollment numbers," Robert Shireman, deputy undersecretary of the Education Department, told Bloomberg.
Why Shorting Is a Risky Play
Eisman, who noted that Shireman is leaving his post, believes that if regulations against such exploitation are put back in place, revenue and earnings growth at these for-profit education firms could shift into reverse.
He cites a proposed "gainful employment" rule that would limit student debt -- specifically, to a debt-service-to-income ratio no greater than 8%. This change would stunt growth in the industry and probably force a drop in tuition levels.
Using different scenarios, Eisman estimates that 2010 earnings at for-profit education companies such as Apollo (APOL) and Corinthian Colleges (COCO) could drop between 40% and 60%.
But the decision to short these stocks is no sure thing. Until tighter regulations are actually implemented, the lobbyists who get paid to preserve the for-profit education industry's lax regulatory deal will be fighting hard to do just that. And those lobbyists have far greater financial resources to bring to bear on preserving the status quo than do the people who are looking out for students' interests.