No Safe Landing for Apollo

Apollo Group (APOL — $60), par­ent com­pany of the Uni­ver­sity of Phoenix (UoP), has never been one to wel­come scrutiny and this time the inten­sity and impact may be greater than ever.  The new admin­is­tra­tion is smarter and the US Depart­ment of Edu­ca­tion (DOE) is more aggres­sive about allo­cat­ing the bil­lions of tax­payer dol­lars to ensure effi­cient and effec­tive results.

While there are plenty of inef­fi­cien­cies in the edu­ca­tion indus­try, the Apollo sit­u­a­tion appears acute.  It’s already known that Apollo has ille­gally com­pen­sated “enroll­ment coun­selors” in vio­la­tion of reg­u­la­tions for those receiv­ing so-called Title IV dol­lars from the US DOE.  There have also been a num­ber of smaller set­tled law­suits for vio­la­tions of labor laws, unequal-opportunity employ­ment, non-payment of stu­dent refunds, fail­ure to meet teach­ing sched­ule require­ments and even invest­ment fraud (over­turned later by a higher court.)  We men­tion these not to sug­gest that any of it is new but to indi­cate that the com­pany is no stranger to oper­at­ing out­side the lim­its of fair and legal practice.

The is some new bad news for Apollo will have to be digested and fac­tored into the share price from here.  Court doc­u­ments that have just recently been unsealed allege that Apollo actu­ally went so far as to main­tain two dis­tinct sets of books and records to pacify inves­ti­ga­tors at the US DOE and hide their ille­gal prac­tices of reward­ing enroll­ment staff with com­mis­sions, bonuses and other incen­tives based on num­bers.  Staff was given direct incen­tives to get stu­dents regard­less of their qual­i­fi­ca­tions or the suit­abil­ity of the pro­grams offered to their objec­tives.  At the same time Apollo cre­ated and main­tained a set of files that showed enroll­ment coun­selor eval­u­a­tion cri­te­ria in line with what the DOE wants to see.

Here’s how it works: A would-be stu­dent sees an inspir­ing com­mer­cial from the Uni­ver­sity of Phoenix and calls an 800 num­ber.  They are told that yes, they can change their life and get a valu­able col­lege degree from UOP.  And the best news of all is that they are eli­gi­ble to receive stu­dent loans from the gov­ern­ment to pay for it!  All good news but for one thing, Apollo gets to keep the money, the stu­dent gets a dubi­ous edu­ca­tion (most don’t com­plete a degree pro­gram) and even those that do more often than not won’t get a job with the UOP degree.  The stu­dent then ends up sad­dled with debt that they owe to the gov­ern­ment while Apollo staff, exec­u­tives and share­hold­ers keep the prof­its. The money machine works very well which is why so many investors and sell-side ana­lysts have loved the stock.  (Sound familiar?)

More than 1/2 of all Apollo rev­enue comes directly from gov­ern­ment finan­cial aid pro­grams.    There remains an unre­solved set of alle­ga­tions about Apollo that includes writ­ten tes­ti­mony about their inten­tional decep­tion of DOE offi­cials that is sched­uled for trial in March of 2010.  At an even more fun­da­men­tal level the Apollo engine of using some­times mar­ginal stu­dents to take on debt and trans­fer the money to them in exchange for a degree pro­gram of ques­tion­able value (in terms of both prob­a­bil­ity of com­ple­tion and oppor­tu­nity for a bet­ter job and/or higher pay) feels like it’s not going to run as well in this econ­omy and admin­is­tra­tion as it has in the past.  Most pub­lished esti­mates indi­cate oth­er­wise; ana­lysts are look­ing for con­tin­ued 20%+ rev­enue growth and esti­mates have con­tin­ued to trend up although even man­age­ment has been cau­tion­ing that busi­ness con­di­tions may not be as favor­able for them in the back half of this fis­cal year.

So accord­ing to just about every­one the future is only bright for the com­pany and now the com­pany looks fairly val­ued if not cheap on cur­rent esti­mates.  How­ever we think that the risk fac­tors touched on here merit some real atten­tion and argue for lower growth (if not much worse) going for­ward.  Even though noth­ing reviewed here is an absolute, the com­pany has a his­tory of vio­la­tions and set­tle­ments across dif­fer­ent prac­tice areas and the dura­bil­ity of the charges and strength of evi­dence pre­sented sug­gests that there is a prob­a­bil­ity much greater than zero that the piece of the Apollo busi­ness financed with tax­payer dol­lars may be at risk.   A real­iza­tion of this out­come would have the effect of cut­ting the Apollo busi­ness about in half and elim­i­nat­ing most if not all his­tor­i­cal and prospec­tive prof­its.   Apollo would be able to stay in busi­ness but would have to com­pete more on equal foot­ing to other uni­ver­si­ties, col­leges and trade schools, not to men­tion good old fash­ioned on the job training.

[Dis­clo­sure:  Based on what appear to be real risks for APOL, Research 2.0 has estab­lished a short posi­tion in the shares of Apollo Group.  Please see our web­site for addi­tional impor­tant disclaimers.]

Tagged as: Apollo Group, Education, Short Ideas