We've seen this before: an industry temporarily perceived as broken with investors fleeing the stocks en masse because of fear of regulatory changes. Remember Macondo? In 2010, there were days where there was literally no bid side in high quality driller names like Seadrill (SDRL), which subsequently rose well over 100%. I believe the same sort of buying opportunity is present in quality for-profit education stocks today.
The regulatory bear case for non-profits was accurate, but has played out to a large extent. More recently the bear case seems to have shifted to a perception of increasing competition. I think the impact from non-profits and MOOCS will probably not be as substantial as many fear. Consensus opinion seems to be that competitive pressures and regulation has led to irreversible enrollment declines in the for-profit industry, but the evidence suggests a (natural) cyclical downturn after a boom period and elevated long term unemployment is to blame. That is a much less dire situation, since long term demand for higher education in the US looks healthy.
STRA is an underestimated and deeply out of favor company with short interest currently > 30% of float. Expectations really are incredibly low: A reverse DCF with a 10% discount rate, 0% forecast period growth over the next ten years and 0% terminal growth for another 10 years yields 46 USD. Comparing that with today's price of 43 USD, we can safely say that Mr Market is not optimistic when it comes to Strayer's future.
STRA is dirt cheap based on normalized earnings power and cash flow metrics. My estimated fair value of STRA is 72% higher than today's price of 43 at 74 USD. I base this on the average of a DCF valuation, an EPV (Earnings Power Value aka "no growth" valuation) and the likely value of STRA in a buyout scenario.
Strayer has best-in-class management and its new graduation fund program will improve its value proposition while at the same time strengthening its competitive position. Increased regulation and oversight will benefit the more serious players like Strayer longer term by creating increased barriers to entry, and put the diploma mills out of business. I think Strayer is the best for-profit play going forward because it has both cost advantages from scale, several recruitment channels that do not depend on aggressive marketing, a high percentage of degree students which bring more recurring revenue streams and a reputation for quality (as far as for-profits go) - a potent combination.
STRA simply looks like a good investment even if the boom years will never return and the industry is facing a new normal. STRA will see much lower margins and lower enrollment growth than what's been the case historically in the short term, but the stock is very cheap. STRA is trading at:
• 6.1 x 10 year average free cash flow
• 4.3 x EV/TTM EBITDA
• a 45% discount to its earnings power value (EPV)
• < 7.5 x TTM depressed EPS
=That's too cheap for a high quality business!
I believe management is responding correctly to the challenges that a more competitive climate presents. As a result of recent initiatives that will be detailed elsewhere in this write-up, STRA will offer bachelor degrees at an extremely competitive price among comparable for-profit universities (even cheaper than many public options). This will obviously create some margin pressure, but it will also help STRA capture market share from other players through this downturn. The impact of these initiatives are likely to increase over the next few quarters, further suggesting that now, rather than later, is the right time to buy.