Warren Buffet accumulated a position in the Washington Post Company in

the early 1970’s and his influence on the management style, compensation
policies and accounting is apparent. The Washington Post Company (NYSE:
WPO) is a conglomerate with assets in education, cable, broadcasting and
publishing businesses. The Company, under the leadership of Katherine
Graham went public in 1971, primarily with publishing and broadcasting
assets. In the 1980’s the company diversified and entered the education and
cable businesses, which have grown and become a major part of the
Company under the leadership of Donald Graham, who became CEO of the
Company in 1991. Today, the education assets account for a majority of
WPO's profitability. These assets are at a very high risk because of the
increasing default rates.

Kaplan Higher Education

Kaplan was founded by the legendary Stanley Kaplan, and bought by the
Washington Post Company in 1984 for $45 million. Kaplan was primarily
engaged in the test prep business but over the years it has entered and
prospered in the for-profit education business. The higher education division,
which is the biggest, now accounts for 38% of Washington Post’s revenues
and 62% of its operating income. The company invested heavily in this
business during the late 1990’s and finally turned a profit in 2002. On
average, the division, organically and through acquisitions, has since, grown
revenues at 25%, and importantly, increased operating margins.

The Good
Kaplan’s Higher Education division within the for-profit sector exists to serve
the market demand to educate individuals who the traditional schools have
failed to satisfy. As the US economy transitions more and more into a service
economy, and new employment opportunities require post-secondary
schooling, higher education becomes essential for an individual to maintain
their living standards. Kaplan and others provide individuals with the
convenience of continuing with their present occupation while pursuing
further education to enhance their credentials. The option to take courses
online has further lit a fire under the growth engine and accelerated Kaplan’s
growth. Their success is evident from the increase in market share of for-
profit institutions, measured by degrees granted, which has gone from 2.3%
in 1997 to nearly 6% in 2006 and rising. Furthermore, enrollments have
grown exponentially in 2009 due to unemployment and, consequently, an
increased interest in higher education. The growth in revenues in this
division has mostly come from: (a) growing enrollments, and (b) tuition
increases.

Kaplan Higher Education, through Kaplan University, Kaplan Colleges and

Kaplan Career Institute operates in a fragmented industry with many
competitors. Kaplan itself has few, if any, competitive advantages, but the
industry as a whole is experiencing tailwinds due to pent up demand from
the non-traditional student and the convenience of online education. Kaplan
and others, however, have a few distinct advantages over traditional schools.

• First, their marketing prowess is unmatched. They advertise

extensively. Non-traditional students are often not aware of the
student aid available and consequently, are not sure if they can enroll
in higher education. Kaplan admissions counselors help students with
the paperwork and make the process effortless.
• Second, traditional schools do not have an extensive online offering,
while Kaplan has a very advanced online education portal. Online
education makes it very convenient for a student to obtain a degree as
students can study and attend classes when they want and where they
want. Importantly, it takes a lot of time and capital to develop and
offer comprehensive, trusted, high quality online curriculum.
• Third, they are more responsive in academic program changes - their
program offerings change as market conditions change. The
bureaucracy and the public nature of most traditional schools cannot
match the agile nature of for-profits.
• Fourth, because Kaplan is geared towards non-traditional students,
they understand their customers and their special requirements. If
students require extra help in the beginning or added counseling, it will
be provided.
• Fifth, although the costs of an online school are comparable to an out
of state public school, there can be many cost-saving advantages to
attending an online school. With an online education there are no room
and board expenses, travel expenses or other ancillary expenses

Kaplan competitively differentiates itself with: (a) a trusted brand name

(which is due to test prep), (b) extensive offering, which is illustrated by its
ranking as 4th among online universities in the number of degrees offered, (c)
quality, where it is ranked in the top 10 among online for-profit universities
by various sources, and (d) regional accreditation, which is superior to
national accreditation as credits are transferable. Furthermore, Kaplan can
and does raise tuition rates along with the budget constrained public
schools, which have to raise rates to remain feasible. Psychologically, an
expensive education is considered superior and this also helps Kaplan raise
rates, but the rates will have to remain competitive with public institutions.

The Bad
The for-profit higher education industry, in which Kaplan Higher Education
operates, has little to no barriers to entry. Accreditation, while difficult to
obtain organically, can be bought, as evidenced by the sale of Waldorf
College in May 2009. It is today a segregated industry. There are many other
struggling colleges in the US which, as they capitulate, can be bought to
expand or obtain accreditation by for-profits. In addition, the non-profit
public and private universities are entering the online education market.
Arizona State University (ASU), for example, has lenient admission standards
and an extensive offering of online courses; the degree obtained by the
online students is not distinguished from students who attend the brick and
mortar school. Long term, as more and more traditional schools enter the
fray the only students who attend non-profits will be the ones who are
unable to get into a traditional school. Then given the admissions standards,
how does a degree from Kaplan university fare compared to a degree from
an online traditional school? Comparatively, what is the customer’s ROI on
education? After talking to two admissions advisors from Kaplan, and after
repeated attempts, I could not get any information on placement rates.
Kaplan tuition rates are already at the high end of a public out-of-state
college rates. Having said that, public schools, being public, will be slow to
respond, will probably not be adept at dealing with non-traditional students,
and will probably take a long time to widely enter the online education
market. Moreover, there will always be a sect of students, those moving up
in a small company for example, who will benefit from an education provided
by for-profits. So, although there is a place for for-profit institutions, but long
term, it is not a place that harbors 25% growth and 15% margins. For-profit
institutions in this environment will only prosper based on the quality of their
curriculum, placement rates and marketing. They will nevertheless, retain
their distinct advantages in vocational programs. However, Kaplan’s
presence is mostly in the non-vocational degree programs.

In addition to the increased competition from public and for-profits alike,

Kaplan had a weighted average retention rate of less than 70% and a weight
average graduation rate of 42% in 2007. This means that in order to just
maintain the revenue levels these students have to be replaced, while even
more students need to be added to grow. The story is similar among other
non-profit institutions. Although the non-traditional student demographic is
large, it is still finite. One has to question the long term sustainability of this
business model.

And The Ugly

Kaplan and most other for-profit universities exist on the back of government
funding. In 2008, Kaplan University derived 85% of its receipts from the Title
IV programs. An institution with revenues exceeding 90% for a single fiscal
year is subject to enforcement, which leads to ineligibility in participating in
Title IV funding. Kaplan has hired additional personnel to manage these risks,
and I believe it is a risk they can manage as they can filter students with a
very high proportion of Title IV funding.

Also, during 2008, funds received under the Title IV programs accounted for
approximately $904 million, or approximately 71%, of total Kaplan Higher
Education revenues, and 39% of Kaplan, Inc. revenues. The business
overwhelmingly depends on Title IV funding. Starting in 2009, in order to
remain eligible for Title IV funding Kaplan has to maintain 3 year cohort
default rates (CDR) below 30% (increased from 25% and 2 year) for three
consecutive and below 40% for one year. Below is a table presenting the
cohort default rate for various Kaplan institutions in 2007.

Trial
2
Retenti 3
Year
on Graduation Enrollm Year
Name City Defa
Rate Rate ent Defa
ult
(FT) ult
Rate
Rate
Kaplan Davenpor
University t 66.0 35.0 53,212 13.3 23.2%
Kaplan
College Phoenix 77.0 49.0 587 18.0 25.7%
Kaplan 27.5
College Stockton 97.0 67.0 1,043 14.4 %
Kaplan Hollywoo
College d 92.0 85.0 1,328 17.0 12.2%
Kaplan San
College Diego 89.0 74.0 2,239 8.1 15.3%
Kaplan 27.7
College Salida 86.0 66.0 1,364 14.8 %
Kaplan Sacrame 33.5
College nto 79.0 52.0 861 18.8 %
Kaplan
College Vista 92.0 69.0 1,686 13.2 23.1%
Kaplan Panoram 28.7
College a 94.0 74.0 520 17.6 %
Kaplan Merrillvill 28.6
College e 57.0 20.0 676 17.3 %
Kaplan Indianapo
College lis 75.0 60.0 1,702 12.5 22.1%
Kaplan Las 31.5
College Vegas 69.0 48.0 832 21.2 %
Kaplan Columbu 32.8
College s 61.0 30.0 931 22.8 %
Kaplan C. 31.6
Institute Boston 37.0 68.0 792 15.3 %
Kaplan C. 37.7
Institute Brooklyn 65.0 65.0 1,105 16.8 %
Kaplan C. Harrisbur 35.3
Institute g 73.0 58.0 916 20.4 %
Kaplan C. Harrisbur 35.3
Institute g 73.0 59.0 916 20.4 %
 Kaplan C. Pittsburg 37.9
Institute h 86.0 34.0 1,827 21.9 %
Kaplan C.
Institute Nashville 57.0 47.0 616 7.9 22.2%
Kaplan C. San 29.8
Institute Antonio 68.0 67.0 1,986 16.4 %
Source: Department of Education and NCES

As we can see from the above, the 3 year CDR’s for some of the institutions
are already higher than 30% and many are very close to the 30% mark.
Please note that these statistics are from 2007. Here is a table showing the
trend in Kaplan CDR’s:

Kaplan University 2 year CDR

Fiscal Year 2005 2,006 2,007
Default rate 5.90% 9.20% 13.30%
Source: NCES

The trend, in this case, is clearly not favorable. With increasing

unemployment and general economic malaise, I would expect the CDR’s for
2008 and 2009 to be much higher. Kaplan is in serious risk of losing its Title
IV funding under the new rules. Kaplan will have to change its enrolment
strategies in the immediate term to recruit students at a lower risk of
default. This again shows that growth will (should) taper, there are no signs
however, that it is. Moreover, there is only so much Kaplan can do to stem
the rise of CDR’s, Kaplan cannot, for example, control the macroeconomic
environment. The Department of Education will not impose sanctions based
on rates calculated under this new methodology until three consecutive
years of rates have been calculated, which is expected to occur in 2014.
Furthermore, the company is facing three separate lawsuits related to Title
IV funding.

Although the company has a prudent board and an intelligent management,

the rise in the rate of CDR’s cannot be ignored. It is quite ironic that such
discrepancies occurred under such conservative leadership. Make no
mistake, the cable assets in Cable One and Kaplan test prep are very
profitable divisions, but when the higher education business accounts for
68% of the operating profit, and is at such high risk, one has to be careful.

Disclosure: No Position