One couldn’t help but notice the sharp drop in Apollo (APOL – $61) a few days ago in response to a downgrade from Credit Suisse.   What’s more intriguing to us is the extreme change of view over a short 3 week period.

On April 1st analyst Kelly Flynn felt that concerns post the Q2 report were “overblown” and that concerns and less margin expansion were “already reflected” in valuation.  As for concerns coming on the regulatory front the were said to be “less credible than [they have been] for several years given management’s obvious constructive approach to educational quality and all regulatory issues.”  In the note the analyst went on to increase estimates and reiterate their Outperform rating and $95 price target.

Since the report we have been seeing matters of real concern about Apollo and written about them right here. Because we are short the name we were pleased to see Credit Suisse come out just 20 days later on April 21st with a downgrade of the shares.  But it’s still puzzling that now the analyst feels exactly the opposite regarding regulatory scrutiny and a slowing of the business going forward.

Our best guess is that the deeper you look the more problems you see.  Again it’s not that the company is bad but that the risk from more regulatory scrutiny and estimates that look simply too high argue for there being much more risk than most are factoring in.

Thankfully for Apollo shareholders Deutche Bank joined the cheerleading section by coming out with a Buy rating on the shares the same day as the Credit Suisse downgrade.  The analyst at DB must have felt odd watching the stock tank that day but able to use the well worn phrase “we loved it at $65 so we really love it down here at $60.”

Recently the current administration has been making clear noises about reform in the credit card industry.  This is just more evidence to us that the government will want to know that the debt that is being piled on students by for-profit educational companies is actually in their best interests.  Apollo has mounted a major advertising campaign to keep visibility and enrollments up but it will also ensure that they are in the sights of whomever might be interested in reforming questionable industry practices.

Lastly there’s something about feel that we can’t ignore with this company.  From the management commentary to the website the company comes off as a enrollment and degree granting *machine* which can be seen as a good thing if you stand to profit from the volume. It’s not very consistent with an institution of higher learning or even a trade school.  Everything shouts “enroll in a program” and it can be financed with student loans.   We realize that Apollo Group is a real company and many students and alumni get good value from their involvement with the company.  But it seems that a many, possibly a majority, do not and Apollo has business practices that don’t seem above reproach.

[Disclosure: As mentioned above Research 2.0 is unabashedly short some shares of Apollo Group based on what we see as a mis-pricing of risk in the market price of the stock.]

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.]

Shares of Apollo Group (NASDAQ: APOL – $66.88) are down over 14% today after their quarterly report last night.  We don’t follow the stock from a research standpoint but have taken an interest in the share price in the last few months as it has defied market gravity.

Most of the analyst reports we have seen so far are defending the shares here and see the concerns fueling the sell-off as overblown.  However the stock decline merely reflects a moderation of what have been near-perfect conditions for Apollo during the last few quarters.  Analysts tend to straight-line these trends into unrealistic expectations. Management outlined very sensible business plans going forward but they may produce less than historic upside and margin expansion.

Apollo has been blessed with rising prices and decreasing costs to put the wind at their back and create a string of solid execution and strong quarters.  Now there are some very minor blemishes in the future vision as 1) government programs are shifted to direct-to-student lending, 2) Apollo will be getting a bit more scrutiny from regulators, 3) the company says they will be making some investments to improve their technology and programs and while not yet evident in results per-se, 4) there are some signs that the economy is having a minor impact on Apollo.

So what does one do with Apollo here?  The simple view is that the price of the shares now looks fair at 16-17x current estimates.  The complicating factor is that most analysts that follow the stock continue to somewhat stubbornly defend it and some are (perversely) still raising forward estimates on the stock.  (Note to sell-side analysts: If you like a stock you want to keep estimates low and if you hate a stock you keep your estimates high.  It goes against peer pressure and conventional wisdom but that’s how it works.  You do your work with unpublished numbers and commentary.)

Before the report we saw some models that were suggesting a fairly strong accelerating in top-line growth.  It’s too soon to tell how things will settle out with consensus as we’ve only seen a few reports so far.  But the ones we saw are raising earnings estimates for the current year and the out year.

Based on what we know now it’s hard to imagine the company will make new 52-week highs this year.  So that suggests to us a stock that’s range-bound in the $75-55 band.  It’s a wide one but well within the 52-week high/low on the shares. The reason we think another 10 points of downside exists from here is that the company may transition into a “meets expectations” from a “beat and raise” sort of momentum stock.  That will attract a different type of investor at more GARP (growth at a reasonable price) style valuations.  The company also has $500M authorized for stock repurchasing so that could be a factor in the market at some point.

From a short perspective the home run possibility is that there is a major “hiccup” in the transition to direct-to-student loans which is a major shift.  Apollo certainly can navigate it without a hitch but as everyone knows any change brings some risks along with rewards.

Despite all the efforts of management we still feel that Phoenix retains the cloud of a “mail order degree” during a time when degrees of any sort (even Harvard) seem to matter less.

We think that future recruiting is more “show me what you can do” and less  “show me what you know.”  Not something we would make a stock call from but a trend that argues against taking on loans to get a piece of paper versus alternatives.

[Disclosure: Research 2.0 has a small short position in APOL.]

Apollo Group (APOL) has remained one of the few high-flying stocks in the market these days.  There are a few obvious reasons including:

The firm has continued to execute very well.  In their most recent quarterly report in January they posted solid results.  Revenue grew 24% and operating margins rose to an a very rich 31.6%. 

There is a belief that in a down economy characterized by job losses that online education companies like Apollo are in a very strong position and will be able to thrive while other parts of the economy swoon.  More people in transition means more opportunity for incremental education to help them get into a new job.

Most analysts and investors love the management team at Apollo and feel that they are one of the best in the business for sure and perhaps near the top for public companies in general.

About a month ago the notorious short seller Citron Research began to pick on Apollo Group with some comments suggesting that their business practices were questionable and might not be sustained.

We’d say that the concerns raised by Citron were largely dismissed by analysts and investors.  Although the shares have retreated a little bit, forward estimates and valuation all suppose that the company will be one of the few (the only?) to be able to grow right through the current economic environment.

Perhaps more concerning is a rasher of new documents and information released by Citron yesterday that point to more than a few eye brow raising practices at the company.  Since Apollo is dependent on government education loans their practices are likely to fall under greater scrutiny than other companies.

One can’t help but think in reading through these documents that the "enrollment counselors" at Apollo are a lot like the "mortgage officers" of the current banking crisis.  Paying people to "get people into the program" when that program is funded with government money is one of those things that gets a company or even a whole industry into trouble. 

The showdown seems to be on the way as analysts have recently raised forward estimates for APOL and have price targets in the vicinity of $95/share.  In fact most models we have seen are calling for an acceleration of top-line growth in 2009 and 2010.

According to S&P/CapitalIQ there are only 11M shares sold short out of about 159M.  The stock has come in a bit with the market and trades at a TEV/REV of 3.2x and about 23x earnings.  Insiders have been consistent sellers but continue to own large positions in the company.

We haven’t done any of the research here but we have reviewed what is out there on both sides of the argument.  Given the valuation and forward estimates for this company we think there is some cause for alarm.

[Disclosure: Research 2.0 has a small short position in the shares of APOL at the time of this writing.]

We don’t focus much of our research horsepower on short ideas but often need some as a hedge in our portfolios.  Fortunately we have been able to turn up some good ones in the past like Iron Mountain (IRM), Constant Contact (CTCT) and Symantec (SYMC.)

Actel is a little semiconductor company (2008 sales estimated at $218M) which is in the programmable chip segment.  (Similar companies are Altera (ALTR), Xilinx (XLNX), Atmel (ATML), Lattice Semiconductor (LSCC) and Quick Logic (QUIK.))

There’s nothing fundamentally wrong with Actel and it looks like a decent-enough little company. However this global semiconductor slowdown is not taking any prisoners and so far Actel estimates and the price of the stock suggest they will be spared.  The company lacks high growth and doesn’t have particularly high margins.

The crux of the current problem facing Actel is that on December 11, 2008 they pre-announced that results for the current quarter would be inline.  Two weeks later, on December 24th, 2008, they announced the regrettable death of their CFO.  (We’re not suggesting that the CFO tragedy has anything to do with the story here but we know we need to mention it since it will show up in any news searches on this name.)

Actel is not a well-followed stock but forward estimates for the company remain bullish and reflect revenue *growth* in the full year 2009 to $225M.    This appears to be impossible given that forward estimates for every other company in and around Actel calls for a revenue decline of 20%.  A more realistic scenario would probably be for revenues in the $185M range and a small loss for the current year.

Industry experts might (might) suggest that Actel has some advantages in their ability to make smaller units and/or consume less power per unit.  We can’t refute the claim and at least on the the surface the new "IGLOO" technology from Actel looks quite solid.  However nothing in the product family supports a view that Actel revenues and margins next year won’t be substantially different than competition.

From a stock supply/demand standpoint there little or no current short interest outstanding in the shares.  Insiders have been selling fairly steadily but not in huge volumes.  (31,000 shares sold in 12 transactions versus one 500 share purchase in the last six months.)

The company does have about $5/share in cash which place a solid floor under the stock but probably still meaningfully below current prices.   Our estimate is that the stock should be trading in the $8-9 range versus the current $11-12.  That potential doesn’t put it at the top of our list but in a market where shorts are needed it seems to be a decent candidate.

[We have a small short position in ACTL at the time of this writing.]

We’re out and about meeting companies and attending some technology conferences in Europe this week.  One thing we have heard a few times suggests that Salesforce.com may be looking more like legacy enterprise software than a new SaaS or PaaS platform.

To be clear nothing we heard suggests that it’s "game over" for Salesforce but rather that there appears to be a more robust market for more advanced, more flexible and lower-cost solutions in this market. 

It’s been over a year now since we first started hearing from corporate customers that their annual costs for Salesforce.com were out of line what they felt was justified and what they could get from other offerings.  Since people just about always prefer to pay less we didn’t think too much of it at the time.

Today we heard from some more organizations saying that they are finding Salesforce.com to actually be *hindering* and *slowing down* their sales process.  This was a bit of a surprise for us but when they took us through the reasoning it had much to do with the rather clunky interface of Salesforce and their continued lack of real integration.  (There is still a great deal of cutting and pasting involved in doing anything realistic.)

At the same time we are hearing from consultants and integrators that they are increasingly recommending to clients that the consider options and even build their own systems.

Although just a few pieces of evidence have some forward we generally find they are indicative of some emerging trends.  As more software gets developed and deployed in the cloud it becomes much easier to build applications based on open technology services.  This will put some pressure on Salesforce to modernize their products and architecture.  Their efforts to transform to a platform company isn’t looking very promising.

At the same time this is probably a more fertile area for new companies than we thought a few weeks ago.

There is an increasing number of discussions and recommendations about being short or long oil.  A number of innovative ETF vehicles have been springing up to provide ways of playing oil long or short, even leveraged in either direction.  At the same time the usual suspects are out there encouraging individuals to try their hand in the futures market.

To be up-front we are long DUG which is a leveraged short on a number of oil and gas related stocks.  A fair number of people have come out and questioned this as an "investment."   In the short-term of course it is not.  Nobody can be right in the short-term without inside information or luck.  (We’re up 20% in DUG but that’s just luck, see below for the true long-term story.)  But if one is looking out a few years and running a diversified portfolio vehicles like DUG and others can come in very handy.

First of all they are a hedge.  If you don’t have something to hedge against falling oil prices then don’t pretend this is a reason to be involved.  We invest fairly actively in next-generation energy technologies from batteries, to new power generation to infrastructure.  These investments are all qualified for our portfolio on oil at $150, or $100, or even $70.

However if oil goes down sharply we have seen that everything goes down with it; solar, wind, power management, and so on.  By being short "old" energy and long "new" energy we can insulate a bit during short-term swings.

Long-term we do think that being short oil here is an investment.  There’s a 100+ year data set on our ability to adjust to any high commodity price over time and drive it inexorably lower (on an inflation-adjusted basis) time after time. Oil will be no different.  It’s beyond the scope of a blog post but those interested should certainly pick a copy of The Ultimate Resource by Julian Simon.     We also don’t yet publish much of our energy work to individuals but for now can highly recommend the work that Tom Konrad the team  does over at altenergystocks.com.

Tags: Energy, DUG, DIG, USO, OIL

Juniper is a company that has amazed us with their ability to execute in a hyper-competitive market.

However lately there are bits of data coming in that suggest they are facing some fresh headwinds.  While they appear okay on the enterprise front the carrier business could be more punk.  Cisco continues to execute very well in the carrier area and 2nd tier vendors like Nortel (NT) are even winning some business in place of JNPR.

The other major concern we have on JNPR is high valuation.  At 5x sales and 30x earnings we find the stock at least 20% overvalued as we go into a period of what we expect to be somewhat soft conditions.

We prefer other names like Corning (GLW) on the networking side and Research in Motion (RIMM) on Mobile Internet.

[R2Capital is short shares of JNPR and long shares of GLW and RIMM.]

Tags: JNPR, Carrier, Shorts

A few days ago our friends over at New Constructs released their Most Dangerous Stocks for June list and we couldn’t help but note that SYMC was added to the large cap list.

The stock has had a great short term rally since we published our research note on April 30th, highlighting the challenges the company is facing in their core market according to their customers.  We recommended it as a short but on a fundamental versus a trading basis.

With the stock up from $17 and change to about $21 we feel the short is looking more attractive.  Our price target remains $14.

The company will be hosting their analyst meeting on June 12th and we expect more general enthusiasm around the meeting since management is very good at telling analysts and investors what they want to hear.

Insiders have been selling heavily with no buying.  The CEO, John Thompson, has taken $3.5M out in May alone.

Sentiment on the name has improved but there continues to be room for more upside if management gets more analysts over to their way of thinking around the meeting.  Despite the recent stock move analyst community is mostly at a Hold (20) with 12 at Strong Buy/Buy and 1 lone Sell rating.

We’re currently short the name but secretly hoping for some further share appreciation and further confirmation of our concerns on the fundamentals.

Anyone long or short SYMC should read the research note above as it contains quite a bit of customer data that loudly suggests management is out of the loop on the fundamentals.

– Kris Tuttle

Tags: SYMC, Short Ideas, Analyst Meeting

We did start the post on SYMC yesterday by stating we had no idea what the quarterly report would hold.  Investors were happy with posted results and guidance.   From our perspective it only makes the potential downside more acute if they company does nothing to improve their steady performance decline in customer environments.  Even though we don’t play for the quarterly reports we still focus on them to compare and contrast them with our longer-term thesis.

The company started the report by reclassifying a large number of business segments to present a different view of the business to the market.  (Why would you do this in a fiscal Q4 versus at the beginning of the next fiscal year?)  In any case we’ve lived in company environments like Symantec where “results” often depend more on presentation than execution.  This was the case at IBM during the years they tried to ignore the substantial declines in their business in the twilight of the 80′s.

The full transcript is available here to skim. As one can see lots of the statements and answers are either obscure or self-serving.  There are plenty of references to “double-digit” growth and “our <fill in the blank> business is doing great” along with repeated references to the “record” quarter.  Management even gets away with a revisionist positioning of saying they have now posted five straight quarters of stronger than expected results despite lowing guidance with the September 2007 quarter.

Clearly international was strong for the company.  We were more than a bit surprised that nobody had much of a reaction to the fact that 6 points of the 13% YoY growth was driven by foreign exchange.  Unless we misunderstood the statement it appears that the entire growth in deferred revenue came from currency effects.  Leading analysts actually said that the growth in deferred revenue was strong.  Are they even listening to the information being presented?

That said we don’t find fault with the report per se.  The company has a strong mix of businesses and recent acquisitions like Vontu are indeed best-of-breed point products.   At the same time nothing has changed in terms of our thesis on the company and the stock.  Management will be driving the field force to deliver more growth in license revenue this year at a time that existing customers are increasingly dissatisfied with Symantec and expect very little to no spending increases with them.  It could be a very interesting year for the company and investors.  To the degree that international business and currency benefits remain strong, the fundamental weakness will be masked.

Based on the quarter and the guidance we would expect the presentations on the analyst and investor day on June 12th to be another powerful marketing event which will help stoke enthusiasm for what looks like a turnaround.

We main focused on execution which we continue to see as bad enough to jeopardize business results in the next few quarters. Management closed their call stating that F09 is going to be “their year.”

– Kris Tuttle

Tags: Symantec, SYMC