Analysis Tough love to trigger U.S. education shakeout

BANGALORE Fri Sep 17, 2010 12:07pm EDT

BANGALORE (Reuters) - The $118 billion U.S. for-profit education industry faces a shake-up as authorities, fed up with lax governance and a heavy graduate debt burden, plan tough rules that will likely drive some small firms to the wall.

Those institutions with relatively high ex-student loan repayment rates, such as American Public Education (APEI.O), Bridgepoint Education (BPI.N), Grand Canyon (LOPE.O) and Universal Technical Institute (UTI.N), should emerge as winners.

But, as firms come under pressure to take in fewer students and cut back the courses they offer, those such as Apollo Group (APOL.O), Capella Education (CPLA.O), Career Education (CECO.O), DeVry (DV.N) and Education Management (EDMC.O) are likely to have to spend to grow.

"The market is still there. Demand is still growing and will go to a smaller number of schools," said Brandon Dobell, analyst at William Blair.

Demand for education is growing as people seek the skills or re-training needed to equip them for battle in a weak jobs market, and a widening supply-demand gap may also put pressure on President Barack Obama's ambitious goal of ensuring every American has at least one year of college education.

Dobell predicts stricter rules -- a final draft of these is expected by November -- will trigger consolidation across the private sector.

"There will be a smaller number of schools, and there will be programs and students the sector does not address anymore," he said.

The failures will be among the hundreds of smaller, unlisted colleges that cater to 500-1,000 students, analysts say.

The United States had 2,944 private for-profit institutions in the 2009-10 academic year, according to the National Center for Education Statistics. Fewer than 15 are publicly traded.

The changing dynamics of a sector that fared relatively well in the financial crisis -- but which has virtually halved since April .15GSPEDUS -- are a result of the government's get-tough approach on an industry that was turning out students who were poorly prepared for work and struggled to repay big loans.

For-profit schools enroll around 12 percent of all U.S. post- secondary students, but receive 23 percent of all federal student aid.

Enrollment at for-profit colleges topped 3.2 million students in 2008-09, a fifth higher than a year earlier, and as the rest of the economy was smarting from the post-crisis downturn.

Apollo, which runs the largest U.S. for-profit college, had about 476,500 students as of its latest quarter.

The government is expected to pay out $145 billion in aid to post-secondary students this year, according to Department of Education data.

To get more bang for the federal buck, the government insists on so-called gainful employment -- where schools must show they prepare students for the workplace before they can receive federal grants and loans.

TOO BIG TO FAIL?

The larger for-profit institutions, analysts say, are too big to go under, given their enrollment numbers and flexible program offerings.

Life will be tougher for those who fall near or below the government's planned cut-off levels. They are the ones that will have to fund acquisitions to ensure future growth.

"Their earnings will be significantly lower than today's projections, though I think they will survive," said Sterne, Agee & Leach analyst Arvind Bhatia.

To be eligible for federal aid -- which accounts for the lion's share of for-profit schools' revenue -- colleges must ensure 45 percent of former students are paying down debt. If that rate falls below 35 percent, schools stand to lose aid.

Corinthian Colleges (COCO.O), among those where ex-student debt repayments are flashing the warning signals, is voluntarily cutting down the number of new students it is taking in.

"Corinthian could certainly be in trouble given how low their repayment rates are," said Bhatia. "Its business is deteriorating at a rapid pace."

Analysts said Corinthian should slim down, and may become a prime target for takeover by a bigger rival.

Corinthian spokesman Kent Jenkins said the company does not comment on speculation.

As colleges look to streamline the programs they can offer -- those most at risk are the slightly less academic short-term courses such as criminal justice and cooking -- they may look to acquisitions to drive enrollment and revenue.

DeVry CEO Daniel Hamburger has warned that the government proposals could mean the loss of 300,000 new students each year.

"The bigger schools ... will have to buy their way into new program areas because growth restrictions on new programs may be difficult to work with," said Dobell, predicting consolidation will move apace late next year and into 2012.

Some struggling smaller colleges may seek buyers to avoid going bust, and some smaller listed firms may go private.

Investment banker Todd Parchman, a partner at Parchman, Vaughan & Co, said the pace of deals is likely to be slow until the new regulations are clearer.

"It's a little bit like the banking industry after the (financial crisis) crash. You want to see how these people are going to look after the crash is gone," he said.

The last big deal in the industry was four years ago, when private equity firms paid $3.4 billion for Education Management. The company, 38 percent-held by Goldman Sachs, went public in 2009 and has a current market value of $1.5 billion. (Reporting by A.Ananthalakshmi and Megha Mandavia in Bangalore, Editing by Ian Geoghegan)