Description

Summary

NAUH is a for-profit university offering predominantly online undergraduate degrees to non-traditional students.  NAUH’s has faced a challenging market in recent years as regulatory scrutiny on the sector increased, and this has had a predictable effect on the firm’s valuation. However, NAUH has continued to execute operationally, and has demonstrated sustainability of its cash flows.  With the lowest-quality firms forced to exit the market and scrutiny subsiding, NAUH can benefit from both less intense competition and more favourable investor perception to the sector.   

Background

NAUH operates 37 for-profit universities focusing on non-traditional students.  NAUH specialises in degrees in education, but also has large businesses in healthcare/nursing, IT, and business/accounting.  The school operates 37 individual schools employing ~650 faculty (mostly part-time) and ~900 administrative staff.  Approximately 10,000 students are enrolled, of while over 90% are undergraduate and the majority are enrolled in an online-only curriculum.  The average age of students is 35.

Regulatory risk

The for-profit education sector is pretty well-known to many value investors as the multiples on many similar business appear to be fairly low.  However, this is largely a reflection of the regulatory risk associated with an industry that often provides a poor service and is almost entirely government-funded.  A 2012 senate report into the for-profit education sector (http://www.help.senate.gov/imo/media/for_profit_report/Contents.pdf) was widely critical. For example, referring to Corinthian colleges (now bankrupt), the report states:

 The company also had unusually high rates of students defaulting on student loans during the period examined. It is unclear that Corinthian delivers an educational product worth the rapidly growing Federal investment taxpayers and students are making in the company.

 In contrast, referring to NAUH, it claims:

  the company’s performance, measured by student withdrawal and default rates, is one of the best of any company examined. It appears that many students are faring well at this degree-based for-profit college.

 NAUH’s current performance on the relevant metrics is improving.  Cohort default rates are measured by the Department of Education and reflect the proportion of students who default on their federal loans.  Schools with a 3-year cohort default rate above 25% face sanctions and potentially loss of access to federal funding.  NAUH's cohort default rate has decreased from a peak of 24.6% in 2010 to 20.8% in 2012 (results are lagged three years).  These are clearly pretty ugly numbers, but they're passable and they're improving.  The main point is simply that NAUH has passed the point of greatest risk of regulatory intervention.

Sustainability of earnings

For-profit education provides a necessary good to the US economy.  As noted, the average student is 35 and pursuing an undergraduate degree online.  Many are minorities and have poor engagement with public services.  These are not people who should ‘just go to community college’ or ‘just do a Coursera course’.  In Texas, the average graduation rate for a black student attending 2-year public college is 8.5%.  The rate for a 2-year for-profit college is 53.5%.  I’d encourage readers to look at the stats for various states (http://collegecompletion.chronicle.com/state).  NAUH had 88% course completion (not graduation) in the most recent quarter, and has seen term-to-term persistence ticking up.  Graduate placement rates have similarly increased over time from ~60% to 85% in the most recent cohort.  I can’t post images here, but the visuals are available on the latest IR slides for full trend data (http://www.national.edu/wp-content/uploads/2015/02/NAUH-Presentation-April-2015-FINAL.pdf). In summary, there is no evidence that for-profit colleges will no longer be needed in the future.

Growth & valuation

The enterprise value of NAUH is $50m.  The firm made $120m in revenue in the last twelve months and generated $12m of normalised EBIT (I’ve adjusted by removing some gains on sale of assets).  While revenues have declined 5% over 2014 figures and credit hour enrolment is down by 13% (see slides linked above for further details), this is not indicative of a secular decline.  Revenues were stable and growing in the prior years, even while the for-profit sector came under pressure.   As noted, the for-profit education sector in general fulfils a useful role, and education is becoming more important if anything.  There is a huge addressable market - only 40% of US males over 25 years of age have an associate’s degree or higher, and the rates for minorities are lower (see http://www.census.gov/hhes/socdemo/education/data/cps/2014/tables.html). 

In response to this decline, NAUH have launched a new branding campaign.  Conversion metrics are already reportedly improving.  Revenues have been maintained by a shift to higher value advanced degrees.  I expect enrolment figures to stabilise and return to growth, and revenues to trend above enrolment figures.

Capital allocation is reasonable.  The $25m in cash on the balance sheet partly realised from sales of excess real estate holdings (these were part of an unrelated apartment business – not related to the core educational segment).  The company pays out $4.5m per year in dividends (a 6% yield) and has not historically done anything terrible. 

Clearly, $50m in EV is too low a price for this type of business.  While the business is clearly in some ways flawed, it’s not even close to being as impaired as to warrant such a drastic discount.

Catalyst

Cash return

Return to growth