Description

American Public Education, Inc. operates American Military University and American Public University, online universities offering both bachelor’s and master’s degrees. As of 12/31/13, they served 112,400 students, which break down roughly by payment type: Department of Defense Tuition Assistance (35%); Department of Education Student Loans (37%); Cash (12%); and Veteran's Administration (16%). APEI has not raised tuition in 12 years, and as such, is a low-cost provider in the online education space. They are able to do this largely through very strong word of mouth and an excellent reputation within the military community, which is now spreading to the civilian world. The company was founded in 1991 and is based in Charles Town, WV.

For perspective, here are some facts about APEI: Average age for military students is 30; for civilian students, it’s 35. Class sizes are capped at 25 students and 20 for math classes. Average class size is 14. APEI has a retired major general and a relatively recent combat veteran/Rhodes Scholar on its board of directors and has four astronauts who teach space studies. 90% of their students are working adults who hold full-time positions, and 85% of students enter with transfer credits. About 50% of their programs are “commodities” (English, business, criminal justice), while 50% are oriented towards their target student population (working adults who are more likely to recognize the name through some affiliation with the military). These include degrees like “Emergency and Disaster Management”, “Homeland Security”, “Middle Eastern Studies”, “Military History”, “Security Management”, “Fire Science Management”, “Transportation and Logistics Management”.

Investment Summary: While multiples for other “investable” for-profit education companies have rebounded to an average of 8.5x EBITDA, APEI still unfairly trails at ~6.5x. APEI should be able to drive organic growth and profitability and the discount should disappear over the next couple of years.

Why does this opportunity exist?

• There is a continued overhang associated with being in the for-profit university sector.
• APEI is most affected by rumors and changes to military funding (Tuition Assistance or “TA”) and 90/10 changes (see detail in the “Risks” section below). The size of the armed forces will be declining over the next five years, and there have been recent changes to how the armed forces handle the Tuition Assistance program.
• APEI has struggled transferring its success among the military into the civilian world. Over the past couple of years, the company has had its own operational missteps.
• Among investors, APEI is still relatively small and not very well known. Generalists probably won’t look at the for-profit sector at all. People who know the sector admire it, but still may shy away because of the military side.

MOST IMPORTANT QUESTION: In a world filled with certain uninvestable for-profit education stocks, is APEI investable?

Let’s get a more detailed answer straight from one of the sector’s most ardent enemies, Senator Harkin. In a July 2012 report on many for-profit education companies, here’s the conclusion:

“Students attending APEI have significantly better rates of retention than the companies of comparable size, particularly when compared to other publicly traded companies. The students that APEI enrolls appear to be faring much better than at many companies the committee examined: just 35 percent of Bachelor’s students and 46 percent of Associate students withdrew from the school during the 1-year analyzed. Moreover, the company appears to be having success in expanding its long-time model of low-cost online programs for military students to a general student population. The company is unique in that it offers tuition prices that are competitive with public colleges and universities. Even with revenues received from military students and veterans factored in, the company has well diversified sources of revenue and does not appear to face regulatory compliance challenges. This is due in part to employer partnerships, particularly with Wal-Mart that helps to pay student tuition.

“However, APEI has also experienced rapid enrollment growth in recent years, growing from 15,500 students to 77,700 in the 3 years between 2006 and 2010. Moreover, the company is quite new to the Federal financial aid program. Thus it will be interesting to see if APEI is able to maintain its record of student success and low-cost programs with this rapid expansion.”

Furthermore, APEI’s graduates fare better in standardized proficiency tests than national averages, and according to alumni surveys, 94% would recommend the university to family, friends or co-workers. 99% of employers of APEI graduates would hire another graduate from APEI.

APEI’s affordability and results have resulted in it standing out in articles like this:

http://thehill.com/blogs/congress-blog/education/222214-good-for-profit-colleges-can-help-veterans-succeed

With question #1 out of the way, onto the Investment Thesis:

• Best-positioned online-only education company: Because APEI started as a distance learning institution in 1991 (founded by an ex-Marine), it has low facilities costs and passes those cost savings onto its students. Since the 1990s, all of APEI’s courses have been offered over the Internet.
  • Their long-standing status as the #1 school for TA students is a sign of both quality and value. See the market shares below (note that with the exception of the Marines, the #2 competitor in each branch in FY11 was a public, not-for-profit online institution – University of Maryland University College).

Note: Since FY11 (the government’s fiscal year), the branch-level data has gotten harder to get. The latest aggregate data I’ve seen shows APEI’s relative market share at 2.1x. APUS stands for American Public University System.

• The efficiencies APEI developed for an online-only platform translate well to the civilian market and grant APEI a low-cost platform. At $250/credit hour for undergraduate programs, APEI is priced significantly lower than most of their for-profit and not-for-profit competitors in the civilian market. Costs for tuitions, fees, and books are currently ~20% below the average in-state costs at public four-year universities based on analysis by the College Board. (Note that most colleges offer active military students a tuition rate of $250/credit hour, which is currently the limit for TA.)
• Students are naturally seeking out institutions with APEI’s value proposition – and there aren’t many of those institutions. Community colleges and state schools are reducing capacity due to funding issues and it’s becoming more difficult for students to get the classes they want to graduate. Many for-profit education companies are in financial distress or decline (and are still charging much more expensive tuition) and some of these students may find their way to APEI’s more affordable value proposition. Even not-for-profits competing for these students are more expensive. Southern New Hampshire University charges $320 per credit hour (for undergraduates) and charges for books. Arizona State has gotten some attention recently with a Starbucks partnership, but their tuition is $513/credit hour. For reference, an undergraduate degree at the University of Phoenix would cost $525/credit hour.

• Innovative marketing approach leads to word of mouth referrals and lower sales expenses. APEI works with key influencers in different organizations to develop courses and degree programs that would be most effective for their members. As a result, APEI is seen more as a partner of those organizations with credibility, as opposed to just a “for-profit school.” This is exactly how they developed their penetration in the military (where they have great relationships with the education coordinators on military bases) – word of mouth referrals for TA students is near 70%.
  • For example, they partnered with the National Association for Environmental Professionals and formed an Industry Advisory Council comprised of leaders, educators, regulators from the EPA and Fish & Wildlife. The council came together to review a curriculum and critique the program.
  • Many of APEI’s partners at this point have a high proportion of veterans in their organizations, like the International Association of Emergency Managers, the Institute of Supply Management and fire/police organizations.
  • Other strategic partnerships include 330 community colleges.
  • APEI has a partnership with Walmart, whereby every Walmart associate can get a 15% discount on APEI tuition. Over 3,000 students have entered this program.
• High quality is shown through credibility with the military, outside accolades, and student behavior:
  • APEI was the first for-profit company to win the Sloan Consortium’s top honor for best practices in online education. It is one of six participants in the Open Academic Analytics Initiative which is designed and funded by the Gates and Hewlett Foundations to focus on identifying and scaling technology-enabled approaches to improve college readiness and completion, especially for low-income young adults in the US.
  • In an industry where enrollment advisor turnover is rampant, APEI has had very little turnover.
  • 50% of the 2009 graduating class returned for a second degree.
  • Regulatory metrics are in great shape.
• Expansion into nursing makes sense. In 2013, APEI acquired a for-profit nursing school in Ohio called Hondros College of Nursing. This was a family-run organization that was undermanaged and underutilized compared to the demand for nursing education today. It is now being led by APEI’s former CFO, who was the COO of Strayer University during its period of significant campus growth in the late 1990s/early 2000s.
• Strong management team with decent alignment.
  
  • Management and board own collectively ~4% of shares. The CEO owns 2.2%.
  • 25-30% of management’s annual bonus is related to APEI’s “Student Satisfaction Quotient”, which incorporates 26 student-related metrics. (The rest is based on qualitative management objectives, earnings, and free cash flow metrics.)

SECOND MOST IMPORTANT QUESTION: So if the education is such a compelling value proposition, why has their performance been inconsistent?

#1: Uncertainty in Tuition Assistance. The uncertainty in TA is not new, and actually, there is now greater certainty about the budgetary stability of the program for next year than in the past couple of years. But TA enrollments have been choppy over the past four quarters due to sequestration, the government shutdown in October 2013, and a new DOD Memorandum of Understanding that will require APEI (and others) to go through more hoops in enrolling service members with their TA benefits. The good news is that next year’s performance should be better.

How important is TA to service members? When sequestration kicked in in early 2013, cutting major DOD programs, TA was suspended as well. Within a few weeks, Congress had passed a law that restored TA funding. Standalone bills within both chambers of Congress were advanced with many cosponsors from both parties.

It is true that active military personnel will decline, but it’s only expected to decline about 2-3% over the next three to four years. Overall, TA represented about 0.1% of the Defense Budget in FY2013.

#2: Is it really so hard to get good civilian students? Due to their low tuition (and limited marketing dollars compared to other institutions), APEI takes a grass-roots approach to marketing: they forge relationships with organizations such as police and firefighter associations that have interests in programs that APEI offers. Cognizant of negative repercussions later on from students who don’t graduate, APEI wants to make sure that its incoming students will complete an online program. Perhaps they are being overly conservative, but they continuously experiment with advertising approaches to find the right people, and they have not found the magic formula. Unfortunately, the grass-roots approach moves at the pace of grass growing.

How can a high quality online university with all sorts of accolades and a great value proposition, not be able to attract qualified new students? Why can’t they translate the success among the military and veterans into the civilian market? How have some (not all) other for-profits returned to new student enrollment growth?

It’s complicated: APEI’s low price sometimes conveys the impression of low quality, so APEI doesn’t make it into the consideration set. Once someone learns about the quality of APEI, then they appreciate the value. APEI is starting the process of evaluating tuition price increases for its most differentiated offerings, which may ironically attract more students.

#3: “Dog ate my homework” items. APEI has dealt with a lot of uncertainty outside its control over the past two years to cause volatility in its performance (TA temporarily shut down in early 2013, government shut down in late 2013, changes to enrollment requirements for TA in 2014), but it has also had its own screw-ups that have been annoying:

• In 2012, an advertising push resulted in “coursetakers” who were just interested in getting financial aid (perversely, low-cost universities can fall victim to this because “students” can borrow more than tuition costs. Lower tuition means more dollars in the pocket of the “student” who has no intention of completing a program.)
• In 2013, they had problems ramping up federal student aid because a new internal system caused disruptions in enrollments
• A minority investment into New Horizons in 2013 (international franchise business for professional certifications) did not do well out of the gates and they needed to hire a different leader (It seems to have turned around now.)
• They still have not gotten approval from the Dept of Education for their acquisition of Hondros, (they are operating legally under a “provisional” approval), but they cannot open new locations outside Ohio until that happens.

THIRD MOST IMPORTANT QUESTION: Given all that, why will things improve now?

#1: Persistence is improving. With tighter controls over who is admitted, APEI is doing a better job at keeping the students they have. In addition, they have recently implemented programs (both computer-based and with human intervention – an “all hands on deck initiative,” according to the CEO) that have improved student persistence even further. We can see the progress there by comparing the Net Course Registration growth in the last quarter (-5%) to the average Net Course Registration growth over the past 4 quarters (-9%).

#2: APEI has multiple levers:

• Their reputation in the military market is translating into growth in the veterans market (with GI Bill benefits). This should continue as troops continue to be drawn down. Year-to-date, VA students have growth 9% and Q314 new VA student enrollment increased 17%.
• As mentioned above, they will be able to experiment with price increases in a way that other schools cannot. Sometime in 2015, they will likely start charging more for their differentiated graduate-level programs, and they will either expand their margins or invest in finding more appropriate undergraduate students.
• Hondros College of Nursing is starting to grow nicely, and they have easily expanded capacity (the school formerly only ran daytime classes). Q314 enrollment increased 8%, and they are expecting 16% new student enrollment in Q414.

#3: More for-profits are bleeding students: There is not a perfect overlap for some of the students who were at COCO, EDMC, CECO, and ESI, but some of those students might look elsewhere for more economic options such as APEI.

#4: Strategic initiatives/hidden assets are very interesting:

Fidelis: Last year they made a minority investment in Fidelis, a start-up that focuses on improving student persistence via a social media platform. Through the investment, APEI became its first customer and has seen a near-40% improvement in persistence from students who are using Fidelis vs. non-users, and they are now expanding its availability to all new students. Given the profitability of continuing students vs. trying to find another one, this should have huge value it is scalable. Fidelis currently has a couple of other clients.

 School as a Service: APEI is providing its online education platform to a small campus-based university in West Virginia. There are some regulatory issues for them to provide it on a larger scale, but they might be able to fix that issue with the right acquisition. Based on my last conversation with the company, they are actively looking at this. For reference, another cloud-based “school-as-a-service” system (2U or ticker TWOU) recently went public and now trades at >5x EV/Run-rate revenues (~$110m revenues).

#5: Valuation and risk/reward is compelling: Even after the recent jump in the stock price (sorry – I couldn’t get this done fast enough and my VIC deadline is looming), APEI is trading at ~6.5x EBITDA (both LTM and next year), not far off historic lows, with 18% of the market cap in cash. When APEI is in growth mode, it should easily trade at 8-10x EBITDA due to a sustainable competitive advantage and a negative working capital business model. The four remaining “regulatorily clean” (my opinion) publicly-traded companies are currently trading at an average EV/EBITDA multiple of 8.5x. From a risk-reward perspective, a Base Case should result in a $46-48 stock price while a Downside Case would result in a $30-32 stock price due to the cash flows that the business will continue to generate. In an Upside Case of faster student enrollment for their high fixed-cost business model, the stock should be worth $54-63.

Risks:

• The TA disruption or TA enrollment declines faster than expected. While it’s a drop in the bucket for the military and is a huge benefit for service members, TA could be cut in the future. As we have seen, however, there is strong Congressional and public support for this program.
• 90/10 is converted into 85/15 with military additions: “90/10” is a federal rule that requires for-profit institutions receiving money from federal student loans to receive at least 10% of their funds from non-federal sources. TA and VA funds are actually not currently considered federal sources.
  • In the past few years, Senators Harkin and Durbin have proposed changing the 90/10 rule so that (a) military benefits (TA and VA) are included in the 90% side (revenue from federal sources) and (b) the 90% threshold is reduced to 85%. This would be bad for APEI, but the Republicans taking over the Senate greatly reduces the chance of this occurring. It used to get so much attention because Senator Harkin is the (outgoing) chairman of the Senate committee overseeing education.
  • If this went through, almost the entire for-profit sector would be out of compliance, and if the DOE didn’t shut down the industry with its gainful employment regulations, it’s unlikely that Congress will. Note also that the chairman of the education subcommittee in the House is from CPLA’s district.
  • APEI’s VP of Governmental Relations has testified before Congress on the issue of 90/10. In addition to highlighting the quality aspects of APEI (to establish credibility), he went on to demonstrate the ludicrousness of 90/10, which was intended as a proxy for educational quality:

 “By way of a more detailed explanation, for an institution like [APEI], the cost of full-time study is $6,000/year, but a high-need student who qualifies for the maximum amount of aid is entitled to receive a total of $15,050. The institution’s ability to comply with the 90-10 rule then becomes mathematically impossible unless it chooses to raise its tuition dramatically, thus creating the necessary 10% gap that federal financial aid does not cover. Of course, doing that makes tuition less affordable and increases the debt burden on students and their families, which we believe likely increases the risk of default.”

• Headlines, headlines, headlines: The supposed “abuses” of the for-profit sector, especially those targeting service members, are fodder for the media, and the CFPB is making sure that disclosures are responsibly made. General Petraeus’ wife, Holly, is leading this effort.

Catalyst

Rebound in Tuition Assistance enrollments.

Improvements in total enrollments lead to revenue growth.

Expansion of nursing campuses.

Acquisitions that improve APEI’s flexibility for cloud-based system services.