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Industry Analysis: Educational Services
The Educational Services Industry is composed of establishments that provide instruction and training on a wide variety of subjects.
Theses institutions, including schools, colleges, universities and training centers, are either privately or publicly owned. Private institutions may be further classified as "for-profit" or "not-for-profit". We report on publicly traded, for-profit schools that have a focus on post-secondary education. According to the most recent data provided by the U.S. Department of Education, post-secondary education is being provided to about 18.2 million students. Of that population, some 1.4 million are receiving their education through for-profit schools.
Educational Services is widely considered a counter-cyclical industry. That is to say, typically, when the economy is doing poorly and unemployment is rising, more working adults, as their career prospects start to dim, decide to upgrade their education. This, in turn, leads to higher enrollment and increased profit at the schools. We note that traditional undergraduate education for young students is generally non-cyclical. Culinary arts schools, however, can be labeled as moderately cyclical. Also, certain types of educational institutions do perform largely in sync with the broader economy. For example, providers of information technology instruction benefit in good times, when companies are likely to boost related investment.
There is a growth element to this industry. Education companies are reporting a trend of rising demand from working adults. More and more employers are requiring college degrees for a greater range of jobs. Enrollment rates are tracking higher at most schools. To an 18-year old, thinking about the future, or a 30-year old without a college degree, looking for a career boost, diplomas are becoming the standard rather than the exception.
Schools are seeing improving enrollment rates in both the traditional and online formats. Traditional schooling caters to young students that have just graduated from high school. Online instruction is more tailored to working adults who prefer to attend classes at evening time or during weekends. Web classes typically carry higher margins than the traditional classroom setting, since professors can connect to a significantly larger number of students and there are no direct brick-and-mortar costs. Globalization also augurs well for the industry. Due to global outsourcing, there is increasing pressure on workers in developed countries to enhance their skills.
There are two other important trends running in the industry's favor. As the U.S. continues to transition from a manufacturing-based economy to one heavily reliant on the service sector, for-profit educators stand to gain from offering courses in information technology, healthcare and business management. And, companies have the opportunity to tap an enormous under-educated segment of the world population. Lucrative markets include China, Brazil and other developing nations. A few educators have already established beachheads in promising overseas regions.
Regulation and Competition
Companies in this industry adhere closely to the Higher Education Act. Compliance with the Act is critical to maintain accreditation; it provides the ability to operate in various states. Accreditation allows a school's students to apply for financial aid under Title IV (low income) of the Act, the Pell Grant, and the G.I. Bill. This is important since a majority of students receive some sort of aid. Notably, the Act, and other regulation, has been fairly successful in shutting down and prohibiting "diploma mills", thus ensuring a fairly high overall quality of instruction.
Competition among these schools for prospective students is intensifying. Expenses of new-student leads and marketing continue to rise. Barriers to entry in this industry are significant. It is very expensive for a potential market entrant to build a school from scratch. The start-up phase can be difficult, especially without a substantial government-supported student base. Also, IT investment can be complex and quite costly, particularly for online operations. Financial constraints can limit a school's ability to expand. Schools prefer to tap the equity market, when their share prices are at elevated levels, rather than issue debt.
There are several things to look for when investing in individual companies in the Educational Services Industry. Investors should seek schools that have steadily rising enrollment, which typically leads to strong revenue and earnings growth. Favorable new-student starts and high conversion rates (from inquiries to enrollment) are good indicators of a company's prospects. Schools that have tapped or have plans to enter emerging markets will likely have a "first-mover" advantage and solid long-term growth potential. Institutions that have a sizeable mix of top-quality online business can better lever expanding demand at the bottom line.
Capable management is also an important consideration in weighing these stocks for investment. The industry is susceptible to "headline" risk. An adverse ruling, or even just the hint of an investigation, from the U.S. Department of Education can cause a sharp decline in valuation. Such problems are frequently the result of inadequate compliance or misleading enrollment figures. If news breaks that a particular company is under investigation for reporting irregularities, its stock, and those of its peers, could be affected. Too, a strong, experienced leadership team is necessary when companies merge. (The industry has undergone substantial consolidation in recent years.) Often, operating results will suffer from a combination during an initial integration period. A proven track record strengthens the chance of long-term success.