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Making the Grade

Author: Bill Meagher
May, 2012 Issue

Considering a degree from a for-profit university? Do your homework.


"Are you a Phoenix? Rise." That’s from the ubiquitous TV commercial hyping the benefits of attending the largest college in the country, the University of Phoenix.

The school boasts more than half a million students on its rolls including its online numbers and, like other for-profit institutions, it’s been hailed by Wall Street as a sound investment and a moneymaker. But some of its former students are less than pleased with the results of their academic experience. And this is to say nothing of the failing grades some states—and the federal government—give the college founded by maverick billionaire John Sperling.

To be sure, Phoenix is not alone in coming under the sharp gaze of various attorneys general. Corinthian Colleges, Kaplan and Education Management Corp. are all being probed by either states or the feds for everything from student recruitment violations to saddling students with too much debt to lying about graduation rates and career advancement opportunities.

It’s just that the University of Phoenix and its larger-than-life founder Sperling cut a significant figure in the for-profit world, a world that Phoenix dominated for a long time.

But times change.


Education as big business

The for-profit college industry is now worth $33 billion, and there are 13 different colleges that make up Bloomberg’s for-profit college index. Those schools are all public companies offering everything from graduate degrees to teaching people how to drive trucks. Bloomberg’s index is a measurement of how well the schools’ stocks are performing. As February pushes into March, that index was down 8.6 percent, the sharpest drop in 13 months, led by Phoenix’s parent company Apollo Group’s 16 percent plunge.

A quick check of the latest financials from some of the Bloomberg index schools reveals a mixed bag. At Santa Ana, Calif.-based Corinthian Colleges, net revenues for the last quarter were off almost 14 percent at $415.5 million, and student population was down almost 10 percent. Net revenue at Phoenix’s parent Apollo declined about 11 percent to $1.7 billion. Its enrollment took a hit as well, with 373,100 on the books, a plunge of about 15 percent. But Bridgepoint Education, another California-based for-profit education company, was up, with revenues growing (by $52 million) to $243 million. And it added 23,000 students.

As you can see, for these colleges, there’s a direct relationship between revenue and enrollment.

There’s no shortage of high-profile investors that have put millions into the colleges without football teams. The Washington Post owns Kaplan; investment bank Goldman Sachs holds 39 percent of Education Management Corporation’s stock.  Tiger Global Management, Lone Pine Capital and Blum Capital Partners all have holdings in the for-profit college sector. Even Warren Buffett is in, as he owns 24 percent of the Washington Post Company.

And why wouldn’t the colleges be catnip for investors? From 2000 to 2010, the sector’s student enrollment was up 235 percent and market share for the for-profit schools jumped from 3 percent to a little more than 9 percent, according to a white paper from John Aubrey Douglass, a senior research fellow at UC Berkeley’s Center for Studies in Higher Education. The paper, titled “Money, Politics and the Rise of For Profit Higher Education in the U.S.: A Story of Supply, Demand and the Brazilian Effect” makes a compelling case for why the University of Phoenix and all of its for-profit cousins will continue to make the cash register ring.

A close read of Douglass’ work reveals the Brazilian Effect has nothing at all to do with hot wax.

Rather, Douglass states his case this way: For-profit colleges have gained a foothold because the total demand for higher education is being left unsatisfied by traditional public and private schools. In the long term, he believes the for-profit sector will grow—not because its product is high-quality or meets a societal demand—but because traditional schools will fail to capture enough public subsidy to grow sufficiently to keep the for-profits at bay. Then they’ll rush in to pick up market the way for-profit colleges have in such faraway places as Korea, Poland and, yes, Brazil. 

With analysts, investors and the smartest guys in the room measuring the bottom-line merits of the for-profit set, somebody needs to be on the other side of those trades.  And a pair of hedge funds has openly bet against the colleges succeeding by going “short.” Both FrontPoint Partners and Kynikos Associates have shorted those stocks. (Selling short occurs when an investor borrows stock and sells it at a price, betting the value of the stock will decrease. If he’s successful, the stock price drops and he buys the shares back at the lower price, replacing the borrowed shares and pocketing the difference as profit.) We’ll come back to the hedge funds later, but first a short course on for-profit colleges in the United States.


Student demographics

While the rise of for-profits is a relatively new phenomenon, some for-profit schools have been around for more than a century. According to a study of for-profits by Harvard University released in February, Strayer University has been around since 1892 and Blair University, founded in 1897, morphed into Everest College, which is still in business today.

According to the U.S. Department of Education, for-profits enroll 12 percent of the nation’s undergrads, and those students use 24 percent of the PELL grants in the country. Nationally, there are about 3,000 for-profit colleges; 165 of those schools are located in California. But those numbers are a little soft, since so many schools have active online divisions giving students the ability to attend class from anywhere.

In the old days, before reality TV, this was known as distance learning. And much like reality TV, the prospect has been more promising than the delivered product.

While there are a wide variety of schools offering a range of education options, from Le Cordon Bleu cooking schools to post graduate degrees, the schools mostly have a trio of fundamental things in common. By and large, the for-profits’ student populations tend to be older, dominated by women, minorities and lower-income students. The vast majority of revenues generated by for-profit colleges come from tuition. And the vast majority of tuition paid by students comes in the form of financial aid from Uncle Sam. At the University of Phoenix, more than 80 percent of all its revenues come from students’ federally funded grants or loans, according to the school’s own data. Roughly 95 percent of the students attending for-profit colleges are eligible for student aid, according to the U.S. Department of Education. (To put that number into a little perspective, at public colleges, revenue from tuition shrinks to 13 percent. At private, nonprofit colleges, it’s 29 percent.)

The Association of Private Sector Colleges and Universities, an advocacy group backing for-profits, say about 13 percent of minority students nationwide are enrolled at profit-making universities. Those same schools serve between 150,000 and 200,000 military veterans attending schools on the post 9/11 GI Bill.

Indeed, one of the most powerful arguments to be made in favor of for-profit schools is that they serve a student population that isn’t being served in the same numbers at traditional institutions of higher learning.


Investment and employment

No less a high-profile figure than Republican presidential candidate Mitt Romney has sung the praises of for-profit colleges regarding keeping the costs of college down. He also said he likes the way that for-profits compete for the business, citing Full Sail University in Florida as an example. He told the New York Times, “You’re going to find students saying: You know what? That’s not a bad deal. I’m not willing to come out of college with $100,000 in debt’ The alternative is to say the government is going to pay for that.”

As it turns out, Romney had actually visited the Florida campus that focuses on instruction in the production of film, music and video games as well as other fields. The school is owned by TA Associates, a Boston-based private equity shop with Chairman Kevin Landry at the helm. Landry is also the campaign chairman for Romney in Florida.

Romney may have his wires crossed a little when it comes to the debt. The median level of debt that Full Sail students carry as they voyage out into the world is $59,000, according to the school.

The purpose of the Romney Full Sail story wasn’t to put the hammer to the Mittster, which hardly seems sporting. Rather, the episode demonstrates that for-profit schools are mainstream now and popping up everywhere, from malls to presidential campaigns.

While Romney likes what he sees in for-profits, the schools have their share of critics to be sure. One would be Senator Tom Harkin, a Democrat from Iowa. In 2010, Harkin held a half-dozen public hearings regarding just where for-profit schools fit in and how they performed. At one point, Harkin told the audience in a senate hearing room that, “Facing the budget problems we have in the next 10 years, we just can’t permit more and more of the taxpayers’ dollars that are supposed to go for education and quality education, to be going to pay shareholders and private investors.”

Harkins was waving a Government Accountability Office report in the air at the time. The report showed that 15 different for-profit schools had been found to be violating federal law regarding predatory recruitment of students. The report in particular pointed at Phoenix and Kaplan for paying bonuses to their recruiters for signing students up who need large amounts of federal aid. And other schools were cited for targeting veterans under a post 9/11 GI Bill, pushing the former active duty men and women into high-priced programs that offered them little in the way of genuine career upsides.

The Department of Justice and four states filed a multi-billion dollar lawsuit alleging fraud against Pittsburgh, Pa.-based Education Management Corporation, the second largest for-profit college. The lawsuit essentially says that the company wasn’t eligible for the $11 billion in federal and state aid it pulled in between 2003 and last year. Some of EMC’s brand schools are Argosy University, South University, Brown Mackie College and Art Institute.

The company has denied it did anything wrong and vows to prove that in court. The states that joined the feds are Illinois, Indiana, Florida and California. The 122-page suit said that recruiters used “boiler room” tactics to convince students to enroll, pressuring them and promising lofty career placements.

Kentucky, New York and Massachusetts have also brought their own actions against EMC. In all, according to California Watch, a program founded by the Center for Investigative Reporting in Oakland, 11 different states have filed lawsuits against for-profit schools across the country.

Part of the problem is that for-profit schools have not demonstrated that their students get much bang for the buck. According to the Education Trust, public colleges in the United States averaged almost $3,000 in tuition in 2010, private schools $10,226 and for-profit schools $14,280. In terms of debt, students earning bachelor degrees left for-profits with a little more than $31,000 in debt, but public school students clocked just $8,000 and private schools came in at $17,000.

More than 90 percent of for-profit students end up taking out loans to pay for their education compared to just 14 percent of public students. And when it comes time to pay the loans back, public students defaulted at an 11 percent clip in 2008, compared to 25 percent of for-profit students who failed to pay their loans back. 

Numbers from 2010 showed that 43 percent of the federal student aid defaults were for those enrolled in for-profit schools, even though they represented just 26 percent of students receiving federal aid and just 11 percent of college students.

All that being said, on the last day of February, the Republican-led House of Representatives voted to ease federal student aid regulations beginning in 2014.


Graduation day?

Graduation numbers don’t shine at for-profits. A 2010 report from the College Board shows that the graduation rate for full-time students at public colleges is 55 percent, and private schools push them out the door at a 65 percent rate. But for-profits post a 22 percent graduation rate. And according to the Harvard study in February, six years after for-profit grads have left their alma mater, they’re employed at lower rates than traditional students including those who attended junior colleges. And for-profit grads earn less than their peers as well.

Part of the problem for-profit schools have is one of image. CEOs at large, for-profit schools are paid like CEOs on Wall Street. Robert Silberman from Strayer pulled down $41.9 million in 2009, or about 26 times more than the average college president. Harvard’s Drew Faust had to make ends meet on $800,000.

And this isn’t even touching stock awards or sales. Sperling sold off $263 million in Apollo shares, according to the SEC. Former CEO Robert Knutson from ECM made $132 million by selling shares.

These numbers come rolling out like those generated by investment bankers or hedge funds, not academic executives. So when federal or state education officials look at defaults or graduation rates, it’s understandable when they question the balance of pay scale and performance. Especially when more than 85 percent of the financial aid putting students in the for-profit classes are coming from the feds.

And it certainly doesn’t help when the Association of Private Sector Colleges and Universities holds its annual gathering at the Ritz Carlton at Lake Tahoe, as it did this year. Next year, it’s the Four Seasons at Jackson Hole, Wyoming. The group has tried to stay abreast of new state and federal regulations, spending almost $4 million over the last decade on lobbying and bringing on former majority leader Trent Lott from Mississippi to move its agenda forward this year.

While Lott makes his case for the private sector schools, investors are still bullish on the for-profit sector. But there are some who've taken the other side of those bets. Steve Eisman and his fund FrontPoint Partners became famous in investment circles when he appeared in Michael Lewis’ book The Big Short, recounting how Eisman made large coin betting against subprime mortgage bonds. Speaking at an investment conference almost two years ago, Eisman said, “I thought there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime mortgage industry. I was wrong. The for-profit education industry has proven equal to the task.”

FrontPoint has actively shorted the for-profit sector and, as the share prices of the public stocks have gone down, the hedge fund has likely made some money.

But Apollo and the rest of the public companies in the for-profit college sector aren’t going anywhere. And if the last decade is any indicator, their stocks may steal a line from the University of Phoenix TV commercials.





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