With America's student loans topping $1 trillion, it's hard to ignore the for-profit education industry, which has added to that debt load at a faster rate than other teaching institutions. And among for-profit schools, ITT Educational Services (ticker: ESI) exemplifies the challenge facing those trying to ward off the loan debacle warned of in this week's cover story, "What a Drag!"
Trade-school students take out more loans—97% of them borrow, compared with just 13% at community colleges—and default on them at twice the rate of their non-profit peers. With more than 140 locations, the company's ITT Technical Institute charges among the highest tuition in its industry. It also has the industry's highest rate of loans that go into default within two-years of attendance. Those high tuition charges yield robust profits, but ITT Educational shares have done as poorly as the rest of the for-profit education sector. Since Barron's warned of that industry's tragic flaws in a 2009 cover story ("Leveraging Up to Learn," Nov. 9, 2009), ITT Educational stock is down 34%, to a recent price of $63, while the Nasdaq Composite Index is up over 40%.
Sure, a recession and a saturated trade-school market have cooled the sector's enrollments. But the biggest chill on these stocks has been the Obama administration's new rules aimed at curbing boiler-room sales practices and saving students from taking on too much debt. More than any other large for-profit school, however, the Carmel, Ind.,-based ITT Tech has been surpassingly clever at rearranging its affairs to stay ahead of each new regulation.
"Their management team excels at two things," says Bradley Safalow, an independent New York stock analyst who's followed the company, skeptically, for years. "The first would be maximizing EPS at the expense of students. The second would be avoiding regulations."
When federal aid limitations seemed insufficient to support ITT Tech tuition levels in 2010, the company formed an off-balance-sheet entity to lend students the difference. As defaults became an issue across dozens of its federally registered units in 2011, ITT Educational consolidated those units into two unanalyzable entities and aggressively challenged the government's default measures. This year, when new regulations start measuring whether each trade school's graduates are earning enough to service their student-loan debt, the company is reformatting its curriculum in a way that could delay measurement of its employment outcomes until 2018.
"They are pulling every lever at their disposal," says Safalow, who distributes his work under the moniker PAA Research.
TT Educational executives declined to discuss the business or its regulatory issues with Barron's, citing a quiet period before releasing March quarter results on April 26.
FOR THE 30 YEARS before its 1994 initial public offering, ITT Tech was wholly owned by the ITT conglomerate. Like other trade-school operators, it enjoyed a sales boom under the indulgent tutelage of the last Bush administration. The company doubled enrollment and revenue between 2004 and 2010. The 80,000 students enrolled in 2010 brought in nearly $1.6 billion in revenue and yielded earnings of $374 million, or $11.17 per share. Such strong financial performance sent the New York-listed shares up 100% over the same period, to a high of $133. Among its happiest investors was Richard Blum, husband of Democratic Sen. Dianne Feinstein of California. His Blum Capital Partners is still ITT Educational's largest shareholder, with a 16% stake.
Last year, the for-profit education industry stopped growing to the sky. At ITT Educational, enrollment at the end of 2011 dropped to about 73,000 from almost 84,000 a year earlier, despite an increase in locations to 141 from 130. Revenue slipped 6% to $1.5 billion. Earnings per share edged down to $11.13. The dent in earnings per share would've been deeper had the company not plowed cash flow into share repurchases, $720 million worth in 2010 and 2011.
"They're dealing with market saturation," says Safalow. "It's more of a market-share game, where brand and price are all that matters."
Thanks to heavy television advertising, ITT Tech has a pretty good brand. But the company charges premium tuition prices, according to calculations by Deutsche Bank analyst Paul Ginocchio (see chart). The average cost of an ITT Tech bachelor's degree is about $77,000, by Ginocchio's estimate, or about $640 per credit. That's 16% higher than well-regarded rivals like DeVry (DV), and triple even an expensive community college, by our estimate based on the College Board's latest data. ITT Tech students mostly go for two-year programs, in fact. An associate's degree in network systems administration, according to an obscure ITT Tech disclosure, will set you back $45,000.
CEO Kevin Modany emphasized the upside during a Credit Suisse conference in March: "People have a misperception with regard to the value proposition that exists for our students. [T]he kind of income lift that they see, the type of return that they see."
STRONG EVIDENCE THAT trade schools raise tuition to whatever level federal aid can support was presented in a February 2012 working paper by Stephanie Riegg Cellini of George Washington University and Claudia Goldin of Harvard. The paper shows that for-profit schools eligible for federal student aid charged 75% more than comparable for-profit schools outside the aid program. The Department of Education and the new Consumer Financial Protection Bureau are attempting to improve their oversight of the debt piled on by trade-school students. At a January briefing, CFPB director Richard Cordray lamented that some for-profit schools anticipated 50% default rates even as they made loans to their students.
Last year, company-wide defaults on federally backed loans at ITT Tech reached 22.3% for students who finished school before September 2009, the highest level among publicly traded schools, according to Education Department data. That's up from 12.2% a year earlier. Insight about ITT Tech's most-troubled campuses, however, became impossible to find because in 2010 the company consolidated 26 of the units tracked by federal regulators into a single entity.
"Gerrymandering" is what analyst Safalow calls the maneuver, which he believes was intended to prevent troubled units from losing access to federal aid programs.
The for-profit industry recently received the government's tentative measure of default rates for the first three years of repayment: ITT Tech's was 34%. CEO Modany has said he's challenging the government's measures, which the company believes are biased by bad counting and poor servicing of student loans by the government's direct-lending program.
In September, trade schools of every stripe will see the first reports under the new "gainful employment" rule, showing whether graduates of specific degree programs earn enough to service their loans over the subsequent three years. Some schools have reduced tuition ahead of the rule, but ITT Tech is revamping its curriculum and speeding students through more credits in less time. Analysts wonder if these "new" programs will allow the company to argue that it needs three extra years of outcome data before it becomes subject to the "gainful employment" standards.
"The rule has clearly sent a message to industry that their students' outcomes matter," says Debbie Cochrane, program director at the Institute for College Access & Success. "It has had a positive effect already, but how extensive that positive effect will be, remains to be seen."