Analysis: Testing times for schools as government tightens grip

By Bijoy Koyitty and Megha Mandavia

BANGALORE (BestGrowthStock) – U.S. for-profit education firms are scrambling, largely in the dark, to adapt to upcoming reforms triggered by students facing big debt repayments but with little promise of a job.

The Obama administration has urged a broad overhaul of an education sector criticized for turning out poorly prepared and debt-heavy students. Bad debt is equal to around 5 percent of total revenue in the for-profit education sector.

With tougher regulations looming — a final draft is expected by November 1 — for-profit schools will look to cut programs, accept fewer students and trim tuition fees.

All of which will dent near-term earnings for a sector that has seen blistering growth — even when the rest of the economy plunged into recession.

“It’s not business as usual,” said Signal Hill analyst Trace Urdan. “Companies are adapting their practices in real time to what they think will be the nature of the rules in place.”

“We’re very much in the dark. The schools don’t know how to analyze the proposed rules,” Hill added.

The axe is likely to fall hardest on short-term courses — associate or certificate degree courses in less academic subjects — where students struggle to find jobs, have high drop-out rates and, consequently, higher debt expenses.

Companies such as ITT Educational Services (ESI.N: ), Lincoln Educational Services (LINC.O: ), Corinthian Colleges (COCO.O: ) and Career Education Corp (CECO.O: ) specialize in such courses.

Lincoln Education last week cut its full-year outlook as it moved to reduce the percentage of higher-risk students. “(The risk) is more related to how the program is priced relative to what students can expect to make when they leave,” said Amy Junker, analyst at Robert W. Baird. “There needs to be a correlation between the two.”

For-profit firms such as Apollo Group (APOL.O: ), Corinthian and ITT accounted for almost a quarter of the $85 billion U.S. Title IV loans for higher education in the 2007-08 school year.

Federal aid makes up three-quarters of revenue, or more, at many for-profits. Default rates at these schools can be as high as a quarter of loans.

The average debt per graduating senior at private for-profit universities in 2008 was more than $33,000, more than a fifth higher than in 2004, according to the National Post-Secondary Student Aid Study conducted by the DoE.

DEBT TRAP

According to the Department of Education’s latest draft, programs would lose their eligibility if over 65 percent of ex-students failed to pay the principal on federal loans, and if graduates’ debt was more than 12 percent of total income.

“Many operators are going to crack down on their entrance requirements … it could potentially reduce their risk profile, but may hit near-term earnings growth,” Morningstar’s Todd Young said.

Other rivals such as Strayer Education (STRA.O: ) and Capella Education (CPLA.O: ) will be less affected as they focus more on bachelor and masters degrees mostly attended by a working population comfortable with paying back loans.

They and others like American Public Education Inc (APEI.O: ), DeVry Inc (DV.N: ) and Bridgepoint Education Inc (BPI.N: ) look attractive assets in the current environment, says Urdan.

Apollo, the largest for-profit education provider, was hit by bad debt costs due to betting big on short-term courses in 2009, but the backfire has pushed it to move ahead of the reforms.

The parent of the University of Phoenix is now looking closer at the type of students it enrolls and is shifting its admissions mix to bachelor and graduate students.

A spokesperson said Apollo is evaluating its enrolment practices, policies and procedures, but declined to comment when asked if the company may take additional measures such as reviewing tuition fees.

“The legislation doesn’t actually take effect until 2011,” noted Young at Morningstar. “The next couple of quarters are going to see drastic changes as far as these companies’ financial performance is concerned.”

SCHOOLS OUT?

In a latest test, a U.S. Senate committee last week sought more information from at least 9 publicly traded for-profit companies over their recruitment practices and use of financial aid for students.

The S&P 1500 education services sub-index has tumbled 35 percent since late-April to 22-month lows — but it had soared 68 percent in the early months of the financial crisis as a wave of job seekers headed back to school to boost their employment prospects.

With the broad economy showing signs of recovery, the sector had predicted comparatively slower growth, but the government’s renewed vigor to cut loan default rates may mean schools will depend more on their students’ ability to find well-paid jobs.

ITT said 73 percent of its 2009 graduates had found work by end-April 2010, versus 77 percent the previous year.

“Regulatory scrutiny has shifted the focus from the demand side to the employment side, so the companies have to be very concerned about whether their graduates find employment,” Urdan said.

(Editing by Ian Geoghegan)

Analysis: Testing times for schools as government tightens grip