Analysis: New rule clears growth track for for-profit colleges

BANGALORE Thu Jun 2, 2011 12:21pm EDT

BANGALORE (Reuters) - A watered down rule for the U.S. for-profit education industry ends more than a year of uncertainty that has weighed on the colleges and their stocks, and sets the stage for renewed earnings growth and potential industry consolidation.

The Education Department earlier released a softened final version of the 'gainful employment' rule that determines whether for-profit colleges qualify for federal student aid -- which accounts for around 90 percent of their revenue.

Many colleges, which had been at risk of losing access to federal aid based on the initial proposal, should now meet the required metrics, allowing them to pursue profit growth without many restrictions.

The rule is part of the Obama administration's crackdown on for-profit schools, which have been criticized for overcharging students, burdening them with debt and not fully preparing them for jobs.

Colleges could now return to aggressive admission strategies without fretting over student loan repayment rates, as most already meet the re-drafted rule. Some schools will be free to raise tuition fees.

Earnings this year, however, will be hit as colleges absorb the impact of measures they had taken to pre-empt the earlier, tougher, reforms.

Analysts said the latest changes were a big win for the for-profit industry, which has been under the cosh for more than a year as the government sought tougher regulation. Many colleges saw a sharp drop in the number of new students signing up for their courses.

"This sector is going to be a growth sector again, as it was in the past," said Sandy Mehta of Value Investment Principals Ltd, which holds positions in Apollo Group.

"We believe this is significantly positive for for-profit education stocks, which have been excessively shorted and have priced in Draconian regulations and extreme bearishness."

As the uncertainty over the new rules weighed, the sector sub-index had dropped more than 41 percent since April last year when the reforms were mooted.

On Thursday, the index rebounded as much as 16 percent.

Another Apollo shareholder, Jason Subotky of The Yacktman Funds, said the company could roll back some of the measures it has taken recently to tighten its admission standards.

"Looking to next year, you will see much stronger enrollment and earnings growth," Subotky said.

EVERYONE WINS

With the changes, most publicly-traded for-profit education companies would qualify for federal aid based on the repayment rate published last year.

"Most of the changes should benefit the entire sector, especially the delay in the implementation timeframe," BMO Capital Markets analyst Jeff Silber said.

"However, we expect the industry to continue to fight these regulations, with further lobbying and a potential lawsuit."

Companies like Apollo, Capella Education, Education Management, Career Education and Lincoln, which had been in a 'restricted zone' to access federal aid, can now grow their student base unrestricted.

Last year, Apollo and Corinthian moved to admit only students who had a better chance of paying back debt. This significantly hurt enrollment numbers, and their outlook.

Strayer Education will be among the biggest winners as the final rule changes the way repayment rates are calculated, increasing the company's chances of qualifying for federal aid.

Heights Analytics' Jarrel Price said Corinthian Colleges and Washington Post's Kaplan education unit looked to remain most directly under threat, though they, too, would have more time to adapt to the new rules.

With more clarity on future earnings potential, the industry could see some consolidation.

Private equity players, who have been waiting for the final rules to be put in place before making any moves, could scout the market for those companies that have historically shown aggressive growth rates.

(Reporting by A. Ananthalakshmi and Megha Mandavia in Bangalore, Editing by Roshni Menon and Ian Geoghegan)

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