Description

We believe Career Education Corporation (CECO) presents a compelling turnaround story in an extremely out-of-favor industry, with key investment risks mitigated by the company’s restructuring expertise, significant cash balance ($3 per share) and excessively low valuation (~1x normalized EBITDA). CECO is an online-centric for-profit education company operating under two core school brands:  1.) Colorado Technical University (CTU) and, 2.) American Intercontinental University (AIU). The Company is in the middle innings of a dramatic change, starting from 12 schools across 79 locations in 2013, to targeting 2 schools (CTU and AIU) across 2 locations by the end of 2017. The core schools that CECO is re-orienting itself around provide value-add degrees, have good student outcomes and are currently profitable. We believe that CECO’s operational restructuring has resulted in complicated financials that obscure otherwise consistent profitability.

CTU will be the company’s most important school going forward. CTU offers undergraduate and graduate degree programs across a variety of subjects with 115 of its 121 programs offered at the Bachelor’s degree program level or above (Master’s and Doctoral). CTU is accredited by the HLC through 2022. Importantly, over 90% of CTU’s students are fully online. We believe this is a critical differentiator for CTU as we believe online-focused programs have the dual benefit of providing students with greater flexibility, as well as allowing the operator to maintain a lower fixed cost base than it would otherwise require with a brick and mortar focused school strategy.

CTU enrollment trends have been lumpy but stable-to-growing overall:

AIU is the other core school that CECO will restructure itself around. AIU offers 59 programs with 57 of the 59 at the Bachelor’s or Master’s degree levels. AIU is also accredited by the HLC through 2022. 92% of AIU students are fully online.

AIU enrollment trends have been down but the company believes AIU can close the gap with CTU:

While its ongoing business will consist of its two key online schools, CECO will be teaching out all of its schools that have a predominantly physical campus-oriented strategy. “Teaching out” is the process of ceasing new enrollments at a school and shutting it down over time while enabling existing students complete their course of study. CECO intends to teach out its Le Cordon Bleu (LCB), Briarcliffe College, Collins College, Harrington College, International Academy of Design & Technology and Sanford-Brown schools. These schools are being taught out because they are either unprofitable, largely as a result of the relatively high fixed costs of operating schools at physical locations, or they are unlikely to continue to be compliant with the new Gainful Employment regulations expected to go into effect later this year. For better or for worse, CECO has considerable experience teaching out schools and we believe the company’s experience in this area mitigates some of the execution risk in its business plan.

Physical campus teach-outs typically take an average of 18 months and are earnings and cash flow generative in the first 6 months as advertising and admissions costs are eliminated upon the decision to conduct a teach-out. Teach-outs become earnings and cash flow negative after the first six months as the declining student enrollment at a given campus cannot offset the fixed overhead of operating the physical location. These teach-out costs are real but obfuscate the earnings power of the remaining CTU and AIU franchises.

We have summarized the financial performance of CECO’s core ongoing businesses below:

From a legal and regulatory standpoint, we believe CECO is reasonably positioned. The company has certainly not been without fault, but we believe the core CTU and AIU schools will not be materially affected by the implementation of GE 2.0. CTU and AIU are compliant with the 90/10 rule and CECO just reported a financial responsibility composite score of 1.5 (“financially responsible” as opposed to in “the zone” or “not financially responsible”) despite a misguided short report’s assertion that CECO would be categorized as “not financially respon201sible”.

Assuming stable enrollment, stable program pricing and moderate corporate G&A improvement as teach-outs tail off, we believe that CECO shares could be worth more than $12 assuming a 7x EV/EBITDA multiple.

Catalyst

·         Potential monetization of LCB brand (not factored into above valuation)

·         Stable trends in new student enrollments

·         Consistent teach-out execution

·         Improvement in AIU profitability

·         Forced selling pressure from Blum Capital’s recent exit abates

·         Potential equity research initiation (presented at CS conference in March)