We recently conducted a survey of privately-held for-profit postsecondary education institutions.  Our goal was to gain a better understanding of enrollment trends, identify which programs are resonating most with the education consumer, evaluate lead flow trends, learn more about cost-per-lead expectations in 2010, and to determine how institutions are preparing for the transition from a 2-year to 3-year calculation of the cohort default rates. 

The Profile of the Respondents – Feedback Most Applicable to Schools Owned by COCO, CECO, DV (Apollo College), ESI, LINC, and WPO

Senior executives from approximately 35-40 privately held for-profit institutions responded to our survey.  All of the schools captured in the survey are nationally accredited.  We think the results of the survey are most applicable to schools owned by COCO, CECO, DV (Apollo College), ESI, LINC, and WPO based on the program mix by degree level and industry and the overall size of the schools that responded.  In the table below we outline the average school size  based on total enrollments.  Overall, almost 80% of respondents work at an institution with a total student population of less than 1,000.

Respondents Program Offering Mix Is Heavily Weighted Towards Diploma and Associate’s Degree Programs

The schools we surveyed offer a high percentage of diploma and associate’s degree programs.  81% of respondents offer diploma programs, while more than 65% offer associate’s degree programs.

Most Schools Offer Allied Health, Business, and IT Programs

Among program offerings, allied health was the most common, with more than 75% of respondents indicating their school offered some allied health programs, followed by business and IT.  The mix of programs offered at the schools that responded suggests that the results of the survey would have the most relevance for COCO and WPO, beyond the companies we previously mentioned.  It is interesting to note that very few schools offer programs in a single field of study.  When we first started to follow the space a decade ago, there were many schools that were pure play allied health, business, or IT institutions.  Today, most companies have successfully introduced “cross-pollination” programs whereby a school introduces a new program at an existing institution that is currently being offered at another institution owned by the same company.  Program “cross pollination” has been an effective tool used to drive enrollment growth over the past 7-10 years, it also has substantially increased industry capacity.  Think about it this way: ESI has more than 110 ITT Tech locations nationwide and 7-8 years ago almost none of those instituions offered programs in business or criminal justice. Now almost all of them do.  We think the benefits of program “cross-pollination” have reached their peak at this stage.  Incremental growth opportunities using this strategy will be contingent upon schools identifying new programs that can be easily transplanted, target a similar student demographic, and require a low level of capital investment (is there anything cheaper than introducing a business program?).  For now, we can think of few programs that meet that criteria. 

Enrollment Growth, Starts, and Lead Flow for the Winter Term Remain Strong

Overall the results of our survey were very “bullish” for those focused exclusively on enrollment trends.  Based on the feedback we have received from the schools we surveyed: lead flow remains strong, conversion rates are high, and student persistence continues to increase on a YOY basis. All of these factors contributed to strong enrollment growth at the schools we surveyed for the winter term.  There has been some moderation of new student start growth, but in general  it appears that the enrollment growth momentum that started 9-12 months ago continued for the winter term. 

Winter Term Enrollment Growth Appears to be On-Par With that of the Fall Term

 For the winter term, approximately 40% of the schools we surveyed witnessed enrollment growth in excess of 20%.  For the most part, enrollment growth for the winter term was on-par with that witnessed in the fall term for the schools we surveyed.  The results of our survey corroborate the strong enrollment intake for ESI for the company’s winter term.  For now it does not appear that enrollment growth momentum has stalled in the for-profit postsecondary education sector.

Start Growth For Some Schools Has Moderated, but Otherwise Remains Robust

Although more than 35% of total respondents generated new student start growth in excess of 20%, a slightly surprising 33% witnessed start growth below 5%.   This suggests that enrollment growth could slow in the next several quarters, especially for those schools with a heavier mix of diploma programs. Is this the first sign that the industry is poised to witness significant mean reversion in growth or an outright enrollment decline?  Only time will tell. (Please note in the chart below where labels are missing the reader should assume that each data point is in an increment of 5%, so for example 22% of respondents witnessed start growth of 0-5%).

 

Lead Flow Levels Have Not Declined in the Past 3-Months

Aside from start growth, we attempt to get as many anecdotal data points on lead flow as possible (outside of COCO, no other publicly traded for-profit postsecondary education company discloses leads) to determine if a meaningful shift in enrollment trends is imminent.  Even though it appears that start growth has already started to slow for some schools, it does not appear that lead flow is the primary problem.  The majority of respondents to our survey indicated lead flow was stronger for the winter term than it was for the fall term. 

Increased Student Persistance Has Led to Faster Enrollment Growth for the Majority of Schools

The two primary drivers of enrollment growth are: starts and student persistence.  Historically in stronger job-markets students have dropped out of school to pursue employment opportunities.  Student retention rates have been positively correlated to the unemployment rate.  Given that state of the economy it’s safe to say that very few students are dropping out of school because they secured a new job.   While many of the schools we surveyed have not benefited from positive trends in student persistence, more than 50% have witnessed a YOY increase.  It will be interesting to see if schools can continue to improve on student persistence rates as the unemployment rate flattens out.

Allied Health Programs Are Currently Witnessing the Fastest Enrollment Growth

A surprising 83% of respondents indicated that allied health programs were witnessing faster enrollment growth than the average at their school.  In the past during economic downturns students have typically gravitated towards programs that are not dependent on the economic cycle for job growth or have some other secular trend that will drive employment prospects. For example, DV went through a 3-4 year period in which the company was unable to generate interest in its IT programs due to the fallout from the tech boom.  In this downturn, it does not appear that there is any one sector whose employment prospects are weaker than others, at least to the education consumer. As a result it appears students have gravitated towards allied health, which is viewed as a safe haven.  The results of our survey are bullish for the near term enrollment prospects of COCO.

IT, Media/Design, and Criminal Justice Are Generating Slower Enrollment Growth

The natural offset to strong demand for allied health programs as a result of the economic environment is the RELATIVE weakness in demand for business, criminal justice, media/design, and IT programs.  We were somewhat surprised to see criminal justice on this list. In theory job prospects in that field are not necessarily pro-cyclical.

Private Loan Availability Remains Challenging

 The dearth of private student loan availability has been and remains a significant operational challenge for the for-profit postsecondary sector.  Far too many companies in the space have increased tuition to the point where affordability has been stretched and return on educational investment has been compromised.  This model works in an environment in which student loan availability is ample and school’s are able to offload the credit risk to private players. Over the past two years, most meaningfully providers of private student loans have substantially reduced their exposure to students attending for-profit postsecondary institutions given their typical credit profile and higher default rate risk.  Based on the feedback from our survey, it does not appear that this trend has changed over the past three-months.  More than 40% of respondents indicated that the availability of private student loans had declined in the past three months.  We would not use ESI’s recent “private student loan announcement“ , as an example of improved access to credit for students attending for-profit institutions. ESI retains all of the credit risks, so the structure enables ESI to offload receivables from its balance sheet and reduce bad-debt expense in the near term.

Privately Held Operators Expect Enrollment Growth to Slow Over the Course of 2010

Most of the operators we spoke with are bullish on enrollment growth prospects for the remainder of 2010.  However, it appears that most of the respondents to our survey expect some slowdown in enrollment growth over the course of the year.  Based on the feedback we have received, it appears that executives at the schools we surveyed expect enrollment growth to slow to the high-single-digit/low-double-digit range by the end of 2010.  For-profit postsecondary education companies have superior enrollment and revenue visibility, so we would be surprised if actual student population trends differed materially from what the executives we surveyed expect.

Rising Unemployment Is the Single Largest Factor Contributing to Enrollment Growth

For a period of time, there was some debate as to whether or not postsecondary education demand trends were acyclical or counter-cyclical. It appears the most recent downturn and the commensurate explosion in demand for higher education programs has resolved that argument.  Five to ten years ago, for-profit providers of postsecondary education were in the early stages of a secular growth trend as their geographic expansion, development of new program offerings, and expansion of online offerings increased access to potential students and drove enrollment growth even during strong economic periods. We think the space has reached a level of maturity now, which makes the industry more reliant on economic cycles in our opinion.  Apparently, operators in the space agree.  75% of respondents identified rising unemployment as the strongest driver of enrollment growth at their school or campus over the past year.  The bigger question now is whether or not it is the absolute level of unemployment that serves as a driver of enrollment growth or the magnitude of change.  This could very well determine the overall demand environment for operators in this sector in the coming 6-12 months. 

Survey Respondents Expect Modest Lead Cost Inflation

 ESI and other publicly traded for-profit education companies have indicated that they expect the advertising environment to “normalize” which should lead to an increase in lead costs in 2010. ESI, guided to a 15% increase in advertising spending in 2010.  The respondents to our survey have indicated that they expect cost-per-lead to increase in 2010, but only a modest amount.  54% of respondents expect cost-per-lead to increase 0-5% in 2010. 

Operators Continue to Invest in More Capacity – Is there a Saturation Point?

Despite growing signs that enrollment growth could slow down over the next 2-3 quarters, a majority of the f0r-profit education institutions we surveyed expect new program offerings and square footage expansion to be their biggest areas of investment in 2010.  It is also interesting to note that 37% of respondents plan to increase their investment in default management services.  It’s clear that the rapid rise in cohort default rates have become a real area of regulatory concern for most operators in the sector.  Increased investment in default management services is the least costly way to address a cohort default rate issue, but it is not the only and certainly not the most effective way. 

Taking a step back, we ask the question: when will there be too much capacity in the higher education space?  We started to express our concerns about the overall magnitude of bricks and mortar campus expansion as far back as 2004.  Clearly, the economic downturn has masked any industry-wide issues with excess capacity.  However, all of the top 50 MSA’shave at least 7-8 for-profit education institutions located in those cities.  It appears that every school in the industry has tried to maximize the number of program offerings at each individual campus.  Capacity has been expanded from both a bricks and mortar perspective and online.  Consider the following:

• More than 80% of schools that receive Title IV funds have some sort of online program offerings
• ESI’s newest ITT Tech locations were opened in Akron, OH and Johnson City, TN, not exactly a list of booming metropolises.  It’s safe to say we’re past the point of low hanging fruit for ESI’s branch campus expansion strategy.
• In 2000 there were 530 ACICS accredited institutions with 365,000 students enrolled, as of 6/30/09 there were 770 institutions with more than 700,000 students enrolled
• Overall, the number of borrowers in repayment for all of Title IV increased from 2,399,774 as of FY00 to 3,345,534 as of FY07.  Some of the increase in enrollments has been driven by the “echo baby boom”, but it’s clear a great deal of this is capacity expansion driven.
• 10-years ago APOL had 100,000 students enrolled, today the company has more than 400,000 students enrolled
• 10-years ago Kaplan University Online and Bridgepoint Education, didn’t exist. Today they have more than 60,000 and 50,000 students enrolled exclusively online respectively.

Interestingly enough, the number of institutions that receive Title IV funds has actually declined in the past decade (from 6,450 to 5,776), but that number does not reflect the actual growth in physical branch campuses and online universities. For more than a decade now, the mantra of operators in the for-profit postsecondary education space has been increase and expand – increase the number of program offerings at existing locations and expand the number of branches and online offerings.  We are growing increasingly concerned that the industry has overexpanded to the point where any normalization in demand will lead to a rapid reduction in capacity utilization and compression in operating margins. 

The Transition to a 3-Year Cohort Default Rate Calculation Presents Substantial Challenges to Privately Held Operators – “Self Regulation” Is Here

There are a number of operating challenges operators in the for-profit postsecondary education sector will face over the coming years based on the current set of regulations, the most meaningful of which we think is the transition from a 2-year to a 3-year cohort default rate calculation.  The 2-year cohort default rate was a favorable regulatory construct for the for-profit postsecondary education industry because it understated actual default levels and was relatively easy to manage through forebearance/deferrment and other default management remedies.  Following the release of the unofficial 3-year cohort default rate data, we think a number of institutions have found themselves “scrambling” a bit to determine which actions to take to bring their cohort default rates into the range of regulatory compliance.  It has been our opinion that many institutions would take “self regulation” actions, which would reduce enrollment growth in the short term, but ensure effective regulatory compliance in the longer term. APOL has indicated recently that it plans to “cull the herd” over the next several quarters to reduce the number of risky students in its system.  Based on the responses to our survey, it appears APOL is not alone.  When asked what steps their institution was taking to prepare for a 3-year cohort deafult environment, 76% of respondents indicated that they were spending more on default management services and 67% expect to increase hiring of job placement professionals. This is not a surprise and those remedies seem like the most obvious and easiset to implement to help reduce cohort default rates. 

However, 24% of respondents indicated they have already reduced the number of high risk students their institution enrolls and 14% of respondents have changed their admissions policies.  This data suggests a number of schools have already introduced “self-regulation” policies in order to ensure compliance with standards under the 3-year cohort default rate calculation.  We have argued in the past that “self regulation” can have the same negative impact on enrollment trends as would explicit regulatory action from an accrediting agency or the Department of Education.  Students enrolled in any school TODAY will be captured in the first set of official 3-year cohort default rate calculations.  Schools that have particularly high cohort default rates need to implement “self regulation” policies today in order to ensure they will remain within regulatory compliance stanards. Based on the feedback from our survey it appears a large number of privately held for-profit postsecondary education institutions understand the severity of the situation.  We would speculate that the senior management teams of COCO, LINC, and WPO are having similar conversations currently.

In the coming days and weeks a number of publicly traded for-profit postsecondaryeducation providers will report earnings. Based on the results or our survey, the companies should report strong results.  We would use any strength in COCO, ESI, and WPO as an opportuntiy to sell shares based on the following: 1) Mounting evidence that fundemental headwinds (slwoing enrollment growth, higher lead costs) could increase over the course of the year, 2) Rapidly rising cohort default rates, which should continue to remain an overhang on the group (preliminary 2-year cohort default data will be released Feb 8th), 3) Slower enrollment growth due to “self regulation” actions taken in advance of the transition to a 3-year cohort default rate standard, 4) the potential for lower demand for those programs and schools that have violated the “more you learn, the more you earn” student covenant”, and 5) the likelihood that the Department of Education will implement new regulatory standards that significantly change marketing practices in the space, reduce the number of high risk students enrolled, and hinder programs with high tuition and low returns on educational investment.

As always, please act accordingly…