For-Profit Colleges Rally As Government Test Looks Easy

Date : 06/02/2011 @ 9:48AM
Source : Dow Jones News
Stock : Capella Education Company (MM) (CPLA)
Quote : 79.75  0.25 (0.31%) @ 9:48AM

For-Profit Colleges Rally As Government Test Looks Easy

I T T Education (NYSE:ESI)
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Stocks of for-profit college operators soared in early trading after the U.S. Department of Education released a softer-than-expected regulation governing career training programs, known as the "gainful employment" rule.

The long-awaited rule punishes programs for graduating students with heavy debt loads by eliminating their access to federal financial aid dollars, an attempt to ensure the programs are preparing students for gainful legitimate jobs. But it is less severe than a draft released last summer, giving programs more opportunities to right themselves if they run afoul of the measure.

Shares of ITT Educational Services Inc. (ESI) jumped 27% to $90 pre-market, while Corinthian Colleges Inc. (COCO) gained 40.1% to $5.62 and Strayer Education Inc. (STRA) rose 25.5% to $153. Those schools were considered particularly vulnerable to punishment under the prior proposal. Other schools, including Education Management Corp. (EDMC), Career Education Corp. (CECO) and Apollo Group Inc. (APOL) also saw their stocks rise by more than 15%.

"It's a massive win," said Bob Wetenhall, an analyst at RBC Capital Markets. "Many investors now believe that the sector is investible, due to a combination of reasonable valuations and the removal of the regulatory overhang. I think it's definitely safe to swim."

One reason for the relief is that under the rule, which goes into effect in July 2012, no program could lose eligibility for financial aid until at least 2015. Programs must fail the debt-load tests three times in four years in order to be disqualified.

To remain eligible for aid, a program must pass one of three tests: at least 35% of former students are paying down their loan balances by at least $1, or a typical graduate's loan payment doesn't exceed 30% of his or her discretionary income or 12% of total earnings. The rule applies to most for-profit programs and certificate programs at non-profit and public institutions.

According to Department of Education calculations, 18% of for-profit programs are expected to fail the debt tests at some point, with 5% ultimately losing eligibility. Across all institutions, those figures are 8% and 2%, respectively.

Strayer, whose programs had been in some danger of losing eligibility under the earlier rule draft, should be in the clear now, analysts say. And because the debt-to-income ratios and repayment rates won't be calculated until a few years into repayment and include longer amortization terms, schools with an emphasis on advanced degrees stand to fare well. Their graduates may leave with more debt than students in associate's degree or certificate programs, but they also tend to earn more once they start their careers. That bodes well for Strayer, as well as Capella Education Inc. (CPLA) and Grand Canyon Education Inc. (LOPE), BMO Capital Markets said in an investor note early Thursday.

Though investors are expressing relief in the wake of the rule's release, schools aren't entirely free of challenges. A slew of states are investigating the schools, and new-student enrollments are declining as schools tighten admissions standards. Also, if schools cut their tuition to minimize debt and better comply with the gainful employment rule, they risk running afoul of the so-called 90/10 rule that limits federal aid to 90% of total revenue. Many are already bumping up against that ceiling. Meanwhile, potential cuts to Pell grant funding, an aid program for low-income students, could have an outsized effect on for-profit schools that have a high concentration of such students.

"Clarity on the almost-two-year gainful employment overhang is a notable event," Height Analytics wrote in a client note. "But critical regulatory issues will continue to impact the sector."

-By Melissa Korn, Dow Jones Newswires; 212-416-2271;

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