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Strayer Education: An In-Depth Analysis

by Michael Shearn on October 17, 2013

The following write-up is taken from the letter to partners of Time Value of Money, LP, dated
October 17, 2013.
Introduction
The main reason the fund has underperformed the S&P 500 over the last couple of years is
due to our more than 30 percent allocation in Strayer Education. We first purchased Strayer
for $125 per share toward the end of 2010 and it has since dropped in price to $41.52 per
share at the end of the quarter. Our average cost basis is $69.71 per share.

We believe that it is easier to be patient with an investment holding that declines in price
when one intimately understands the investment holding. From that perspective, we want to
give you our detailed investment thesis on Strayer so you can better understand why we
continue to allocate a large percentage of the portfolio to this investment.
What is your investment thesis for Strayer and how has it changed over
the years?
We first began buying Strayer when the for-profit education industry was suffering from
regulatory scrutiny and negative publicity about the value of obtaining a for-profit college
degree. At the time, Senator Tom Harkin (D-Iowa) who heads the Senate Committee on
Health, Education, Labor, and Pensions was investigating the for-profit education industry.
Many students were failing to graduate from for-profit colleges and accumulating debt which
they could not pay back. In fact, more than half of the students who enrolled in those
colleges in 2008-9 left without a degree or diploma, and half of them lasted less than 4
months.
In addition, during the third quarter of 2010 the Department of Education (DOE) launched its
own investigation of for-profit colleges because they were concerned about the growing
percentage and amount of financial aid that was going to for-profit students. In 2001, only
12.2 percent of DOE program funds (loans and grants) went to for-profit students compared
to 25 percent of funds in 2010, even though for-profit students represented just 10 percent
of all the students the DOE funded over this same period of time. The total amount of Pell
grants (government grants of up to $5,975 to help the neediest students) given to for-profit
students also increased during this period from $1.1 billion in 2000-01 to $7.5 billion in
2009-10. Finally, this small group of for-profit students accounted for over 47 percent of
federal student loan defaults. This was because on average, 22 percent of for-profit
students defaulted on their loans compared to 9 percent of students attending non-profit
universities.
These investigations and the news that followed caused the stock prices of the majority of
the publicly traded for-profit education companies to drop by over 50 percent. At the time,
we believed that Strayer was the proverbial baby being thrown out with the bathwater
because Strayer did not engage in the same practices as its for-profit peers. Most notably,
they did not play the churn and burn game of enrolling as many students as possible
without regard to whether their education would result in better job prospects. For example,
at Bridgepoint Education, an online only for-profit college, enrollment grew from 968
students to 95,000 students from 2005 to 2012 after a private equity firm purchased the
college. By comparison, enrollment at Strayer grew from 27,305 to 49,323 during this same
period. Bridgepoint grew its enrollment rapidly by paying sales commissions to its recruiters,
which motivated them to make false promises to students. In some cases, recruiters told
potential students that they could easily double their salary by attending Bridgepoint’s online
program without any evidence that its graduates were achieving this outcome.
Our confidence in Strayer was further bolstered during the recession, when new student
enrollment actually increased from 2008 to 2010, so we continued to buy the stock as it
declined in price, believing that the regulatory and publicity issues facing the industry would
not impact the fundamental value of Strayer.
Our original thesis about institutional quality was validated during the second quarter of
2013, as the DOE Review Program found nothing materially adverse and required no action
from Strayer, unlike its for-profit peers who were saddled with various kinds of restrictions.
Even Senator Harkin singled out Strayer in a report, saying, “Strayer’s performance,
measured by student withdrawal and default rates, is one of the best of any company
examined, and it appears that students are faring well at this degree based for-profit
college.”
Even though our original thesis was correct, we were completely wrong in thinking that
Strayer’s fundamentals would not deteriorate.
Beginning in 2011, Strayer began to encounter fundamental demand issues and reported
that new student enrollment had declined by over 20 percent. This 20 percent decline
continued for three straight quarters which caused earnings per share to drop from $9.70
per share at the end of 2010 to $5.76 per share at the end of 2012. During this period the
stock price declined from $150 per share to $61 per share. We continued to buy the stock
as it decreased in price because we believed that the decline in new student demand was a
short-term issue, mainly because we saw that enrollments in 2012 had stabilized and had
begun to grow. Then, in 2013, new student enrollment growth turned negative again,
declining 14 percent in the first quarter and 17 percent in the second quarter. This caused
the stock price to drop even further from over $61 per share to $40 per share. The mistake
we made is that we underestimated the length of time it would take for student enrollment to
fully recover.
Our current investment thesis is that Strayer is suffering from a cyclical low which will
reverse in the intermediate future as the high level of unemployment begins to decline,
uncertainty with legislative and regulatory proposals clears up, the economy begins to grow
and consumer confidence increases. At the end of quarter stock price of $41.52 per share,
we believe we are not paying for any upside potential which is why we continue to hold the
stock. Furthermore, we believe that as student enrollment stabilizes and begins to grow that
Strayer is potentially a multi-bagger investment because of its ability to easily double its free
cash flows with small changes in student enrollment growth.
What are the reasons behind the decline in demand in students for
Strayer?
Historically, new student enrollment grew predictably at each campus Strayer opened. The
problem in the last two years is student enrollment has actually declined at mature
campuses and slowed at new campuses. We believe the main reason for this decline in
demand is the sustained level of high unemployment and the resulting decreased
confidence in job prospects.
The typical student of a for-profit institution tends to be older and have a family to support. If
they are out of work, they need to be looking for work in order to support their families. The
decision to enroll in school is also not so much about money as it is about investing the
necessary time to get an undergraduate degree which economic uncertainty makes even
more difficult.
What are the various scenarios for Strayer’s valuation, specifically in
2013?
We believe it is important to think about various scenarios when valuing a business and that
valuation is dynamic rather than static. Although we are optimistic that student enrollment
will grow in the intermediate future, we are also aware that our investment thesis may not
work out and that a different scenario may unfold. It may take more time, for example, for
student enrollment to stabilize and begin to grow. Luckily, Strayer’s business model allows
us to look out 1 to 2 years ahead, as Strayer’s new student enrollment in a given year has
always been a good leading indicator of total student enrollment in future years.
Strayer’s management team provides a financial model to help us understand how changes
in student enrollment impact the bottom line. In management’s model for 2013, a 1 percent
change in revenue would have an approximately 50 basis point impact on the operating
margin, resulting in a $0.20 per share change in book earnings. Because we already know
the enrollment numbers for the first three quarters of 2013, we can use the model to predict
what earnings per share will look like using various scenarios in student enrollment for the
final two quarters of 2013. The assumptions we use are that revenue per student averages
$11,400 and at the end of the year Strayer has 10.8 million shares outstanding. The
earnings per share estimate for 2013 under these assumptions ranges from a low of $3.92
per share if student growth declines 20 percent in the fall quarter (compared to the same
quarter in the prior year) to a high of $5.48 per share if student growth increases 10 percent
in the next quarter. Using a 10 times earnings multiple for the stock, this would imply that
the stock price would range from a low of $40 per share to $55 per share, compared to an
end of quarter price of $41 per share.
This wide range in earnings per share estimates for 2013 highlights Strayer’s tremendous
operating leverage. The reason for this is that Strayer has a high fixed cost structure
because it must offer a certain number of classes, regardless of student enrollment
numbers. In other words, it cannot eliminate certain classes that students require to
progress through their degree programs.
What is the catalyst for Strayer?
The main catalyst for Strayer will be when the number of new students each semester
stabilizes and begins to grow. The timing of this is difficult to forecast, as is the rate of
growth. For example, in the last three quarters of 2012 new student enrollment grew, but
the new students were not growing as quickly as they shrunk the year before. Full recovery
will be further delayed by the declines in new students in the first two quarters of 2013. By
the end of this month, when Strayer reports its enrollment growth for the fall term, we will
have a better picture of what earnings are likely to be in the intermediate future. If we
believe student growth is going to be pushed further out than our intermediate horizon, we
will have to think about reducing Strayer’s allocation in the portfolio.
Why do you believe that demand will return and earnings will improve
in the future?
First, we strongly believe that student demand should improve with a decrease in the
unemployment rate. With broadest measures of unemployment currently at 20 to 25
percent, we believe potential students do not have the willingness to invest time and money
in a college degree.
Below is a chart of several unemployment rates including two Bureau of Labor Statistics
(BLS) rates. The lowest, the BLS U-3 unemployment rate, is the one most commonly
reported in news stories. The BLS U-6 rate is broader, and includes short-term discouraged
and other marginally-attached workers, as well as those forced to work part-time because
they cannot find full-time employment. The highest rate, published by private publisher
ShadowStats, includes those who have not looked for work for a year or more.


By comparing the trends in these three rates to Strayer’s new student growth rate we found
many similarities. For example, in the periods where unemployment is relatively stable such
as from 2001 to 2008, enrollment growth reliably followed the rate at which Strayer was
opening campuses. It was not until 2009, when there was a sharp spike in unemployment
that Strayer began to experience a slowdown in new student growth. As unemployment
begins to stabilize and improve we believe Strayer’s new student enrollment will begin to
grow.
Second, Strayer encountered a similar period of low demand from 2004 to 2006 (we believe
this is similar to the period 2011 to 2013). Most for-profits, including Strayer, grew during the
recessionary period after 2001, looking countercyclical. Then, from 2004 to 2006, as the
economy began to stabilize and improve, new student enrollment growth slowed. By mid to
late 2007 new student enrollment growth began to accelerate once again, producing record
enrollments in the next few years.
Third, the decline in new student enrollments has been broad based for all universities,
colleges, and community colleges, whether they are non-profit or for-profit or even by
program (i.e., declines are not specific to one degree program such as criminal justice or
business). In fact, in 2012 for the first time since statistics have been kept by the National
Student Clearinghouse Research Center, there are fewer students enrolled in all colleges
and universities than the year before (a decline of 1.8 percent in the fall of 2012).
Fourth, we believe that Strayer’s cost structure is inflated due to its rapid new campus
expansion openings over the last 4 years, but will naturally decrease as these campuses
mature. Over the last 5 years Strayer opened 40 new campuses in markets in which Strayer
does not have an established reputation or academic recognition. To put this in perspective
Strayer currently has 100 campuses compared to 14 campuses in 2001 (majority of
campuses were in the Washington D.C. area). This means that approximately 46 percent of
its campuses have been opened in the last 5 years. As these campuses begin to mature,
they will positively contribute to free cash flows.
According to Strayer’s management, it takes 6 to 12 months to get a campus up and
running. Strayer’s new campuses typically have operating losses in the first 2 years, until
they reach 200 to 250 students, at which point the campus begins to break even.
Campuses then grow by 100 students or so each year until they reach full maturity of 1,000
students, typically by the tenth year, generating a 50 percent operating margin.
The length of time to profitability hinges on new student starts. From 2004 to 2010 Strayer’s
new campuses reached profitability within two years. From the period 2006 to 2008, new
campuses reached profitability in as little as two quarters. Beginning in 2011, new
campuses began to take longer than two years to break even, although this varies by
geography. The new Texas campuses, for example, are reaching profitability within two
years while those in the Midwest (Chicago, Kansas City, St. Louis) are not. New campus
student starts in 2012 and 2013 have been much lower, some as much as 20 to 30 percent
lower. As a result, Strayer is incurring excess expenditures as it takes longer for these new
campuses to break even.
Fifth, there are many secular trends which should support future growth, albeit at lower
levels than the past. The National Center for Education Statistics (NCES), projects that
student enrollment will grow at a roughly 1.1 percent annual rate, compared to a 2.7 percent
annual rate in the previous 40 years (it is important to note that the NCES often understates
potential growth). There are various drivers for growth such as increasing employer-driven
demand for skilled professionals, increasing employee-driven demand as a result of
potential earnings premium, and increased acceptance of online degrees. The NCES also
projects that students aged 25-44 (typical age of a for-profit student) are expected to
increase 28.1 percent reaching 9.6 million in fall 2020 from 8.1 million in the fall 2009.
Finally, we note that as of 2010, only 30.4 percent of the U.S. population older than 25 has
a bachelor’s degree. Although this number will never reach 100 percent there is still large
implied long term demand.
Sixth, we believe the ability of students to afford a college education may affect revenues in
the future. Historically, Strayer has been able to increase its tuition 5 percent on an annual
basis. We do not believe that Strayer will be able to increase its tuition in the intermediate
future at similar rates, which will contribute to lower revenues per student. In fact, in 2013
Strayer froze the tuition for all current students through 2014 and has also offered new
scholarship programs which discount tuition as much as 40 percent. We don’t believe that
these tuition discounts will persist for the next 10 years but do believe in the next 1 to 3 year
period they will persist; at least until the unemployment rate drops to more normalized
levels. One silver lining is that students applying to for-profit schools are more interested in
future career opportunities than cost.
There is hidden value in the recently acquired Jack Welch Management
Institute
Regardless of which scenario unfolds, we believe there is hidden value in the recently
acquired Jack Welch Management Institute which continues to have strong ties to former
CEO of General Electric Jack Welch. In addition to his involvement with the school, Welch
contributed about 30 percent to the purchase price, so he is also invested along with
Strayer. We believe the Jack Welch Executive MBA program serves as a great brand
builder for Strayer’s other programs since it increases the knowledge and awareness of
Strayer University in those organizations that typically hire undergraduates and graduate
students from Strayer.
Strayer is currently growing the Jack Welch Executive MBA program with a goal of enrolling
5,000 students in the next 5 years. A relatively new degree program, it had over 500
students this fall. If they are successful in meeting this goal, this program could be
potentially worth $100 million on a net present value basis, or about 20 percent of the end of
quarter market capitalization of Strayer. This is not counting any value from the Jack Welch
Way Management Training business which is a non-degree corporate and management
training business, which should grow in size as corporate training budgets are increased.
The $100 million valuation was calculated as follows: 5,000 graduate students (70 percent
of the students in 2011 funded the education themselves) paying $36,000 (current tuition
from Strayer’s website) over a two year period translates to $90 million in revenue per year.
At a two times revenue multiple five years from today, this means that the Jack Welch
program would be worth $180 million. If we then discount the $180 million using a 10
percent discount rate over a five year period this results in a $100 million net present value.
Understanding Strayer from the Customer Perspective
One of the most difficult and important things to do in investing is to view a business from
the customer perspective instead of one’s own perspective. We believe most investors
misunderstand Strayer because they don’t understand why a student would attend Strayer
when there are other universities with better reputations (such as those they attended). By
viewing the school through the perspective of its students, we can avoid making
assumptions about the reputation of the degree, and gain some insight into why students
choose this route.
What type of student attends Strayer University?
Strayer’s students are typically working adults (average age is 35 and two-thirds are female)
who are returning to school to advance their careers. These working adults are usually
called non-traditional students, which means that they are generally older than average,
have dependents other than a spouse, and are independent of their parents. They may
have delayed college, and may be attending part-time or working full-time while enrolled.
The reason they prefer Strayer to other universities is that these students want to be sitting
in a classroom with other 35 year olds like them.
Of the students enrolled in Strayer at the beginning of 2012’s fall quarter, 66 percent were
age 31 or older and approximately 69 percent of students reporting were minorities (47
percent African American, 18 percent other ethnicities, 4 percent Hispanic) and 31 percent
were white. Most of Strayer’s students are part-time (86 percent), typically taking two
classes per semester. 3 percent are active duty military, 1 percent are international
students, and 7 percent of students are currently unemployed.
Where do the students come from (by type)?
Students come from a variety of places. Below is a breakdown of sources of students:
 25 percent come from corporate and government institutional relationships
 20 percent of new students come from community college partners
 20-25 percent are media generated/pay per lead otherwise known as non-affiliated students
 20 to 25 percent are referred by current and previous Strayer students (source is student
surveys)
Although there is overlap with the categories above, we also have the following data on
students:
 10 percent are military which includes active duty, veterans, GI Bill and Yellow Ribbon
programs
 10 percent are online only
Let’s examine the three sources that account for the largest percentage of students in more
depth:
Corporate and government institution (25 percent of students)
Students from national accounts (corporate and institutional) represent about 25 percent of
the student body. These are students that come from corporations or government
institutions that have an established relationship with Strayer, such as Starbucks, United
States Postal Service, American Express, and FedEx. These employers typically reimburse
15 to 20 percent of the tuition. This is the most valuable student for Strayer because
corporate sponsored students tend to graduate at a higher rate due to the affirmation from
their place of employment. We believe as the economy recovers and labor markets tighten,
employee sponsored tuition reimbursement programs will increase, potentially boosting
enrollment growth rates.
Community college partners (20 percent of students)
Strayer has articulation agreements with more than 200 community colleges, including nine
statewide compacts covering 1,000 colleges and campuses throughout the United States
whereby credits transfer from the community college to Strayer. Strayer’s students who
enroll after getting their community college associate’s degree tend to graduate at a higher
rate. As a result of this, Strayer’s management does not view community colleges as
competition and even allows local community colleges to utilize Strayer’s campuses during
the day free of charge (Strayer’s campuses are mostly used at night).
Non-affiliated students (20 to 25 percent of students)
Non-affiliated students tend to come from media generated leads, or those who heard an
advertising message from Strayer and enrolled. These are the students with the largest
current drop in demand. The non-affiliated student has the lowest graduation rate,
averaging 15 percent, because most of these students need developmental courses (extra
coursework just to be ready for college credit courses). They also typically have zero to
limited transfer credits or college experience.
It is important to point out that Strayer does not have a lot of exposure to student leads
purchased from third party lead generation firms, which we estimate to represent 10-15
percent of Strayer’s non-affiliated student base. This lowers the risk for Strayer because
higher exposure to third-party leads results in less control of student flow. For example,
Apollo Group (University of Phoenix) has little control over the type and volume of students
because more than 60 percent of its enrollment is from third party lead generation firms.
Where do the students come from (by geography)?
Strayer students are mainly from the eastern U.S. (source: NCES College Navigator, Fall
2011 data):
 Virginia 22 percent
 Georgia 13 percent
 North Carolina 9.7 percent
 Maryland 9.0 percent
 Global Online 8.7 percent
 Florida 7.3 percent
 Pennsylvania 5.9 percent
 South Carolina 5.0 percent
 Tennessee 4.9 percent
 D.C. 3.9 percent
 Ohio 2.2 percent
 Alabama 2.2 percent
 Texas 1.7 percent
What is the experience like for the average student at Strayer?
The overriding goal of Strayer is workforce preparation. Strayer offers coursework that
graduates can apply immediately in their professional fields. Strayer offers a practical set of
academic majors with 70 percent of students majoring in business or accounting, 15
percent majoring in information systems programs, and 7 percent majoring in criminal
justice. Strayer uses a combination of classroom learning and online learning which allows it
to reach more students and also allows students to choose the learning mode that is most
effective for them. Having the option of taking a class online gives many students more
flexibility. In any given quarter (11 weeks long), 55 percent of campus-based students will
be taking their courses online but this number can change as students decide to go back
and forth between the on-ground campus and online modality. In 2012, roughly 30 percent
of students in a given semester took all of their courses online (this is true for the last 5
years, even though 90 percent live near a campus). In 2012, about 20 percent of students
took all of their courses in a physical classroom. Classes at physical locations typically meet
once a week (4.5 hours one night a week) for ten weeks then have one week for exams.
That leaves the remaining 50 percent of students who take a combination of both online and
physical classroom courses.
We believe the physical campuses give Strayer a competitive advantage over online only
schools, because we do not believe that online education will fully replace classroom-based
learning. In an online modality there is limited peer to peer and faculty interactions which
are key ingredients in education.
What percentage of students graduate?
On average, students at Strayer take about 6 years to receive their bachelor’s degree.
Because it is such a huge undertaking, many students drop out of Strayer. Management
recently reported Strayer’s graduation rates during a second quarter 2013 conference call.
Graduate students, who represent 30 percent of students, have the highest graduation rates
which range from mid-60 percent to 70 percent. Undergraduate students, which represent
65 percent to 70 percent of students, have lower graduation rates which range from 15
percent to 55 percent, depending on the number of transfer credits they bring in. For
example, if a student comes in with a year or more of college credit (which represents
approximately 40 percent of new students), their graduation rate within 6 years is in the 50
to 55 percent range. As a student brings in fewer transfer credits this begins to drop, falling
to 15 percent for students who have no transfer credit whatsoever. On a fully blended basis
for both master’s and bachelor’s students the graduation rate is 40 percent which compares
favorably to the average at for-profit schools of 32 percent. For means of comparison the
average graduation rate at public not-for-profit schools, such as UT Austin, is 56 percent
and at private not-for-profit schools, such as Harvard, it is 65 percent (source: National
Center for Education Statistics).
How does Strayer’s tuition compare to other universities?
To attend Strayer, or any other university for that matter, requires a big financial
commitment. If you think about it, college tuition is probably the second or third largest
purchase people make in their lives, with home mortgages being the largest. As a result,
cost is a big factor for a student when considering attending a for-profit institution. Recently,
affordability has become a larger issue as potential students consider whether they can pay
loans back or benefit financially from the education they receive. In essence, college price
tags can’t outrun the gain students expect from increased salaries after graduation. In fact,
one of the big risks to Strayer in the future is rising interest rates, which would increase the
cost of attending Strayer, and might affect enrollment. For example, a 1 percent increase in
rates will lead to a 5 percent increase in monthly loan payments on a 10-year loan and a 9
percent increase on a 20-year loan.
At Strayer the total cost for a bachelor’s degree in Business Administration is $72,400, a
master’s degree in Business Administration is $28,820 and an associate’s business degree
is $36,500. The best way to put this cost in perspective is to compare it to other for-profit
colleges, community colleges and non-profit colleges on a per credit hour basis. For
example, Strayer’s part-time undergraduate tuition rates for 2012 averaged $394 per credit
hour (if you include discounts it is $367 for 2012). In the for-profit industry (which represents
30 colleges) Strayer’s tuition stands in the middle of the pack. The lowest cost per credit
hour in the for-profit industry is at American Public Education (APEI) which primarily serves
military students and charges $225 per credit hour. The highest is the University of Phoenix
which charges $585 per credit hour.
Tuition rates per credit hour at community colleges (such as El Paso Community College)
are typically $154 which are the lowest because most of the costs are subsidized by the
government. At public non-profit schools (such as UT Austin) the tuition ranges from $200
to $250 per credit hour. The highest tuition rates tend to be at private non-profit schools
(such as Princeton) which can charge in excess of $1,500 per credit hour.
How does Strayer meet our investment criteria?
We continue to believe Strayer is a compound machine rather than an opportunistic
investment. The reason for this is that Strayer has high organic growth opportunities with
the potential to grow both the number of students at its existing campuses and a long
runway to open new campuses in new geographic locations. The average number of
students at existing campuses is 508 as of the end of 2012, compared to 1,000 for a mature
campus. We believe as Strayer gains more brand recognition and its referral network
grows, the number of students at existing campuses will continue to increase.
Strayer also has the ability to double the size of its campus footprint as it currently has
campuses in only 24 states. It is interesting to note that out of the top 50 MSAs
(Metropolitan Statistical Area) Strayer currently operates in 30 of them, leaving 20 of the top
50 MSAs in which it can expand, including such cities as Boston, San Francisco, Phoenix,
Detroit, Seattle, and Minneapolis.
Strayer has historically generated a high return on invested capital (calculated using net
operating profit after tax divided by average invested capital) which has exceeded 40
percent for the last 4 years (2012: 42.4 percent; 2011: 68.5 percent; 2010: 62 percent;
2009: 45.6 percent).
Another necessary ingredient for a compound machine is a management team with strong
capital allocation skills. We believe Strayer’s Executive Chairman Robert Silberman has
historically shown strong capital allocation skills, such as buying back stock at opportunistic
prices, growing in a disciplined manner, and making a home-run acquisition. Let’s review
these capital allocation decisions in more depth.
Strayer’s management team historically has only repurchased stock when it believes the
stock price is undervalued. For example, in 2011 it repurchased 1.58 million shares for
$202.7 million (average stock price of $128.15 per share) because at the time the dividend
yield on the stock exceeded 4 percent and Strayer was able to borrow funds at 3.1 percent
to help finance these repurchases, thus profiting from this spread. From 2003 to 2012,
Strayer’s management team repurchased 5.2 million shares for a total of $683 million
(average price $131.25). Interestingly, this total exceeds Strayer’s end of quarter stock
market valuation by 1.6 times. Even though management’s historical stock repurchases
don’t look opportunistic today, we believe when the cycle turns they will have added a lot of
value. For example, had management not made these share repurchases then earnings per
share would be lower by 20 percent today. We are concerned, though, that management
did not repurchase any stock during the second quarter of 2013, even though Strayer had
the available cash balance and had previously been buying back 5 percent of shares
outstanding each quarter.
Another concern is that Executive Chairman Robert Silberman has a strong track record of
being a good capital allocator but he has not been buying stock with his personal money.
Since 2004, Silberman has received cash proceeds from option sales of Strayer stock of
$77 million (after 35 percent tax this would net $50 million). In other words, he has plenty of
capital to buy the stock.
Strayer’s management team follows a disciplined growth strategy in which it sets its new
campus growth rate on the availability of its human talent (the number of people it has to
staff a new campus with) so that it can ensure a high level of academic quality. Strayer also
grows in geographically contiguous markets (e.g., first opening campuses in Louisiana and
then Texas) so that it always has the ability to access talent in markets that are close by. As
of 2013, Strayer’s management team said they will not be adding any new campuses until
they believe they have the ability to predict growth in enrollment.
The only acquisition made under the current management’s tenure is the Jack Welch
Institute, which Strayer paid $9.1 million for in December 27, 2011. This acquisition appears
to be a home-run as Strayer has successfully increased the number of students from fewer
than 35 when it acquired the Institute to more than 536 students as of October 2013. As we
previously mentioned, we believe this acquisition has the potential to be worth over $100
million on a net present value basis.
The product is good for the customer
One of the key questions we ask when evaluating a business is whether the product or
service is good for the customer. A college education is still the greatest enabler of social
mobility in the United States and continues to be on a relative basis the single most
important predictor of economic success. According to the Bureau of Labor Statistics the
number of jobs requiring postsecondary education increased from one-third of the overall
labor market in the 1970s to two-thirds today. Consider the significant impact that the most
recent recession had on job prospects for those without undergraduate degrees. According
to the Bureau of Labor Statistics, unemployment rates in 2012 for those without a college
degree were four times higher than for those individuals with a degree.
The primary purpose of a for-profit college is to give students the support and tools they
need to learn and secure a degree that is valued in the job marketplace. In other words,
colleges should be providing students with relevant, practical skill sets that employers are
willing to pay a higher salary to attract. The best way to measure if a for-profit college is
succeeding in this effort is to examine the income a student generates before they earn a
for-profit college degree and the earnings they make after they graduate. The average
student at Strayer comes in with an annual salary in the high $20,000 to low $30,000 range.
Strayer graduates have salaries ranging from $50,000 to $60,000 (higher salary is typically
a master’s degree holder and keep in mind that 60 percent of students drop out so these
figures are for graduates only). The median debt for a Strayer student to acquire this degree
is $22,000 (lower than full tuition because many students transfer in with college credit). We
believe it is important to point out that on the Department of Education website the median
debt for a Strayer student to acquire a degree is shown as $31,000 versus $22,000. The
main reason for the difference is that the DOE’s data includes living expenses which they
believe should be included in order to represent the true cost of an education.
The management team is customer oriented
Customers are the lifeblood of a business so it is critical that a management team has a
customer’s best interests in mind. Strayer is a student-focused university where the
management team is focused on the quality of education first rather than on maximizing the
short-term profitability of the business. Strayer’s management team clearly understands that
the value of Strayer is directly correlated with the quality of education it gives its students.
As Executive Chairman of Strayer Robert Silberman says, “If you are going to have a
successful business, first you have to have a successful university.”
The way the management team ensures that it places the interest of its students
(customers) first is as follows:
First, the management team operates the university through a unique bifurcated
management structure. This serves Strayer’s dual mission of maintaining success as an
academic institution while also being an effective steward of shareholder’s capital. What this
means is that there are two leaders that run the university, a campus dean and a campus
director. The campus dean is responsible for all academic elements such as hiring the
faculty, scheduling the classes, and coordinating the delivery of the various academic
support services like advising and tutoring. Missing from this job description is responsibility
for the profit and loss statement. Instead, this responsibility falls on the campus director who
is in charge of managing the enrollment process such as the financial aid application
process, corporate reimbursement process, and facility management. The main advantage
of this dual leadership structure is that it allows the campus dean to make decisions that are
in the best interests of students, without having to worry if the decision is profitable to the
university.
Second, Strayer has an independent board of trustees that oversees the academic quality
of Strayer’s classes and makes sure that Strayer upholds high standards. The independent
trustees have staggered terms and serve a longer term than other trustees affiliated with
Strayer. Only independent trustees can make nominations for replacement to the main
board of trustees. Current independent trustees include the founding Chief Executive Officer
of the Community College of the District of Columbia, the former President of Central Penn
College, and the former Vice Chancellor for Academic Affairs at State University of New
York.
Third, Strayer’s management recently raised the standards for developmental students
(those who have not yet passed English and math exams) by restricting their enrollment in
online classes. Additionally, if students fail these tests more than once, they are disenrolled
from the university. What is noteworthy about this action is that it will hurt enrollment growth
in the near future at a time when enrollment growth is already suffering. Therefore,
management has demonstrated that it is avoiding the temptation to lower standards as a
way of increasing new student numbers. Strayer is supplementing this stricter admissions
standard by requiring that faculty who teach developmental classes to spend the vast
majority of their class time working in small groups instead of lecturing. Strayer is also
offering free unlimited advising and tutoring to help students pass these developmental
courses.
Fourth, admissions officers have never been compensated on the number of students they
bring in and therefore are not salespeople as compared to other for-profit competitors. In
fact, this practice has caused most of the problems in the for-profit education industry. This
incentive structure created a boiler-room atmosphere where hitting an enrollment quota was
a recruiter’s highest priority. This practice was eventually banned by the Department of
Education in mid-2011. Strayer employs fewer recruiters which it calls academic advisors
compared to other for-profit colleges. Strayer has one recruiter for every 154 students,
whereas the industry average is one recruiter for every 53 students.
Fifth, Strayer’s marketing strategy (the way it spends its advertising dollars) is geared
towards allowing a potential student to self select into Strayer instead of actively convincing
students to enroll.
Sixth, Strayer employs more student service representatives per student than any other for-
profit college, which has played a significant role in the success of its students. Student
services staff assist with tutoring and library resources, career services and the like. In
2010, each student services staffer was responsible for 125 students. Contrast this to for-
profit competitors who typically employ 1 student services staffer for every 200 students. In
fact, Strayer employs more career counselors per student than any of its for-profit
competitors. These staffers help students with resume writing, career exploration, and
employer networking. In 2010, each career counselor at Strayer was responsible for 368
students whereas at for-profit competitor Apollo Group (University of Phoenix) there are no
career services employees. Bridgepoint has only 1 career services employee. The closest
competitor is DeVry which has one career counselor for every 557 students.
Seventh, there are some recent technological innovations that Strayer is beginning to
implement which should help it with its student retention and satisfaction rate. Strayer’s
management is now better able to predict which students need help, which students will fail,
and which students are doing well in classes by the 8th day of the academic term. This will
allow Strayer to step in early and help students graduate.
Eighth, Strayer’s management is committed to creating a hassle-free experience for its
students outside of the classroom. Their goal is to be easy to do business with. The thinking
behind this is that the students have already committed an enormous amount of time to the
academic program, so Strayer makes the other elements, such as enrolling for classes or
financial aid, easy to manage.
Strayer’s management team has good relationships with employees
A business cannot execute its strategies if its employees have not bought into the culture of
the business. We believe the top management team at Strayer has created a strong culture.
First, management only promotes employees from within, which ensures that employees
have a strong belief in Strayer’s core values. Second, Strayer operates a flat organization
(i.e., no bureaucracy) with only 2 layers of regional managers for 100 campuses. For
example, a campus director reports to one Regional Vice President and then to the CEO.
Finally, Strayer has extremely low employee turnover for academic and administrative staff.
The senior management team has a long tenure at the business and is relatively young
Management’s long tenure at a business often helps limit the risk that a management team
will fail in executing its strategies. The bullets below show the age and tenure that each
senior manager has at Strayer:
 Executive Chairman Robert Silberman (age 55) since 2001
 CEO Karl McDonnell (age 46) since 2006
 President of Strayer University Dr. Michael Plater (age 56) since March 2010
 Chief Financial Officer Mark Brown (age 53) since 2001
 Chief Administrative Officer Kelly Bozarth (age 44) since 2008
 Provost Randi Reich Cosentino (age 39) since 2001
Other ways Strayer meets our criteria
 The bench strength of employees needed to open new campuses is improving and this will
allow Strayer to open campuses at a faster rate in the future when the economy improves.
 Over the last three years Strayer’s management team has eliminated many discretionary
expenses.
 As of 2013 there are not any underperforming campuses or any markets where there are
too many campuses.
 Free cash flows continue to be strong. In the first six months of 2013 free cash flows were
$41.4 million which represents a 10 percent free cash flow yield at the end of quarter stock
price.
 Historically, Strayer has generated significant amounts of free cash flow. The evidence for
this is the taxes it has paid to the IRS in recent years. In 2010, Strayer wrote a check for
$85 million which implies $214 million in taxable income using a 39.5 percent tax rate. In
2011, Strayer paid $65 million which implies $163 million in taxable income. In 2012, they
paid $44 million which implies $110 million in taxable income.
 Conservative balance sheet. As of the end of 2012 there is a $125 million term loan facility
that has a fixed interest rate of 3.1 percent. This loan matures December 31, 2016 and the
covenants are that the leverage ratios not exceed 2.0:1.0 with a coverage ratio of not less
than 1.75:1.00, which Strayer meets even if free cash flows were to drop by 80 percent from
2012 levels.
Strayer has limited competition
A few Wall Street analysts have been reporting that the recent decline in student demand at
for-profit universities is due to increased competition from non-profit universities, such as
Arizona State University or Duke University, which have both started new online programs.
They suggest that enrollments in these online programs have been growing rapidly by
taking students away from for-profit universities. We do not agree with this assessment for
the following reasons:
First, the rapid growth in the online programs at non-profit universities such as Arizona
State has been from existing students who are already enrolled at the university. These
existing students are basically choosing to take some of their courses online.
Second, when a student leaves a university for another university they must transfer their
transcript. As a result, Strayer knows where its students are going when they leave the
university. The management team recently reported that Strayer students have not been
transferring to non-profit competitors.
Third, many non-profit universities have attempted to target for-profit students in the past,
with limited success. Universities such as Drexel and the University of Massachusetts
recently failed in offering online programs for working adult students. The fact is that
working adult students (average age 30 and above) and traditional college students
(average age of 18 to 25) are very different and have different needs. One of the reasons
that for-profit education came about was because most non-profit universities
could not serve the needs of working adults. Non-profit universities have a difficult time
tailoring their academic curriculum to the needs of corporations in the area. Another
challenge that traditional universities face is tenured faculty (often in charge of hiring other
faculty) who are typically reluctant to fully utilize adjunct or contract faculty at the university.
Fourth, there is substantial evidence that Strayer can succeed even in markets saturated
with traditional universities that have successful night and extension programs. In Maryland,
Strayer successfully competes with the University of Maryland which has one of the most
successful working-adult focused extension programs.
Fifth, many analysts believe that in the future Strayer will face more competition from
MOOCs (Massive Open Online Courses). We believe that the notion of not going to school
and instead completing a MOOC is akin to telling somebody to just read a textbook.
MOOCs cannot replace the student support, study groups that are needed to ensure
successful academic outcomes. Further evidence is that the completion rates on these
courses are extremely low, often averaging less than 1 percent. MOOCs in general also
cannot replace the accredited credential, making the effect of a MOOC on employability
low. In other words, employers are not likely to give a job promotion to an employee who
has completed a series of MOOCs.
Regulatory environment
Over the last 2 years, there have been a lot of regulatory issues that have contributed to
Strayer’s low stock price and have also distracted the senior management team from
focusing on the core business. These regulatory issues include the reauthorization of the
law governing federal student grants and loans, new rulemaking proposals from the
Department of Education (DOE), and a recent White House proposal to promote a college
rating system. Educational spending has become a big issue because according to the
Consumer Finance Protection Bureau, the cumulative student loan debt (from both federal
and private sources) has crossed the $1 trillion threshold making it the largest component of
debt in the U.S., surpassing auto loans at $730 billion and credit cards at $693 billion. The
for-profit industry has been singled out because according to the U.S. Department of
Education data, 96 percent of for-profit students take out student loans compared to 13
percent of students at community colleges, 48 percent at 4-year public schools, and 57
percent at 4-year private non-profit colleges.
We want to give you a better understanding of what regulatory issues Strayer is facing and
more importantly the impact they have on Strayer’s business.
Loan funding
Some investors are concerned that the for-profit industry may face government cuts to
funding for student loans, otherwise known as Title IV loans. The reality is that the
government (through the Department of Education) is not cutting access to loans but
instead is attempting to raise the bar for outcomes at schools where federal loan dollars are
going.
We do not believe that the government will ever cut student loans because we believe that
Title IV lending may actually be a profit center, or at least does not operate at a large loss
for the U.S. government. The overall default rate on Title IV loans is around 14 to 16
percent on average, which means 85 percent of loans get repaid. Meanwhile, the U.S.
government earns interest on these loans and can borrow at extremely low rates. Also, the
Department of Education and Congress are intensely interested in producing more U.S.
college graduates, not fewer. In fact, the Secretary of Education recently stated in August
2013 that the North Star guiding the DOE was to lead the world in college graduation.
Gainful employment standards
One of the best ways to understand if a for-profit college degree is helping its graduates
gain meaningful changes in salary is to look at the gainful employment data. This measures
the earnings of graduates of for-profit universities and compares those earnings to the debt
level the graduates incurred to finance their education.
Proposed in 2010 and released in 2011, the DOE attempted to establish three new rules to
determine whether a for-profit university could access Title IV funding based on gainful
employment standards:
 35 percent of former students must be in satisfactory repayment status three to four years
after entering repayment, meaning their loan balances declined by at least $1.00 over the
course of the year.
 Loan payments each year should not exceed 30 percent of discretionary income in the third
or fourth year after graduation.
 Loan payments each year should not exceed 12 percent of annual earnings in the third or
fourth year after graduation.
The first rule was tossed out by a federal court in 2012, but the DOE has subsequently
announced a new round of negotiated rule-making, with new draft standards to consider.
We believe Strayer will be able to comply with the old standards as well as the new
proposed rules which are less aggressive in some ways than those proposed in 2010.
Default rates
Congress, the Department of Education and the White House are also targeting colleges
with high loan default rates. To measure default rates, regulators take a group of students in
one year and simply follow the same students, noting the percentage in default after a
certain time period. Regulators are currently transitioning from calculating the number of
defaults over a two-year period to a more representative three-year period. Colleges
currently can lose funding if their two-year default rates exceed 25 percent for 3 consecutive
years or if they exceed 40 percent in one year.
The three-year default rate of all 30 for-profit colleges examined by Senator Harkin
increased each fiscal year between 2005 and 2008 from 17.1 percent to 22.6 percent.
Although Strayer’s 3-year default rate has gradually increased over the last 4 years,
growing from 9.4 percent for students entering repayment in 2005 to 12.8 percent for
students entering repayment in 2008, overall, Strayer’s default rate is far below the 22.3
percent average 3-year default rate for the for-profit education sector and closely tracks the
default rate for all schools (includes non-profit universities).
Pell Grant funding
Pell Grants (government grants of up to $5,645 to help the neediest students) are the single
largest source of federal grant aid supporting postsecondary education students. The
program provided over $35.7 billion to approximately 9.7 million undergraduate students in
2011, with grants to students attending for-profit schools making up 22 percent of
distributions in the 2011-2012 school year. For-profit providers receive a relatively greater
amount of Pell Grant dollars, because they generally cater to a lower-income student when
compared to non-profit peers. Strayer generated 17 percent of its revenues from Pell Grants
in 2012, up from 7 percent in 2007, so a cut in Pell Grants could negatively impact Strayer.
Interestingly, when Executive Chairman of Strayer Robert Silberman was asked about the
risk of the government cutting Pell Grants he said in a first quarter 2011 conference call,
“We are not concerned about Pell Grants as a source driving students towards Strayer
University. We find that the more the students have invested in their own education the
more likely it is that the student is going to be successful. We’re not concerned about that
being lowered. As a matter of fact, we’re frankly mildly in favor of that.”
Post 9/11 GI bill and Department of Defense tuition assistance
For-profit universities receive the largest share of military educational benefits. These
benefits are always at risk of being cut. As of 2012, 37 percent of post-9/11 GI bill benefits
and 50 percent of Department of Defense tuition assistance benefits went to for-profits. In
fact, Strayer is one of the top 10 recipients of post-9/11 GI bill funds because 10 percent of
its students are affiliated with the military (includes active duty, veterans, GI Bill and Yellow
Ribbon Programs). Revenue received from the Department of Defense and Veterans Affairs
education programs accounted for 7.1 percent of Strayer’s revenue in 2010 (latest data
available).
Prohibiting federal funds from being used for marketing
Senator Harkin’s committee recommends prohibiting institutions from funding marketing,
advertising, and recruiting activities with federal financial aid dollars. Strayer currently
allocates 17.5 percent of its 2012 revenue to marketing, advertising and recruiting activities
and generates close to 25 percent of its revenue from non-federal financial aid dollars, so
even if this proposal were to pass, Strayer would be able to meet this regulatory standard.
The Harkin committee found that for-profits on average spent 22.7 percent of revenues on
marketing alone. Strayer’s total sales and marketing costs are lower than its other for-profit
peers because Strayer has a higher exposure to corporate alliance students and community
college students.
Raising threshold of non-federal revenues from 10 percent to 15 percent
Senator Harkin’s committee also recommends requiring that for-profit colleges receive at
least 15 percent of revenues from sources other than federal funds. In 2011, Strayer
reported 76 percent of revenue from Title IV financial aid programs. We believe Strayer will
be able to comply with this rule because 25 percent of Strayer’s students receive tuition
help from their employers or associations, which is a great source of non-federal financial
aid revenue.