Thursday, April 06, 2006

CECO Revisited- The Clouds are Parting

Exactly one month ago, I wrote a post on the Education Stocks, "Getting an Education in Education Stocks" where I had highlighted the attractive valuations that existed, as well as the interest of private equity capital in this sector.Career Education (CECO) has provided some good news and decent returns since that time.

Let's review what has gone right and what concerns remain.

Yesterday, CECO announced that the MidWest office of the SEC was no longer seeking enforcement action (for the 10-K's of 2003 and 2004) and that this office was recommending the termination of further investigations. One of the class-action lawsuits was dismissed by a U.S. District Court last week, though it may resurface again.

Other class-action suits remain. Finally, in a California case specific to CECO's Brooks Institute business, a judge ruled that a CA regulatory agency had improperly sanctioned the division with a "Conditional Approval to Operate."What remains on the regulatory front? The most serious problem for CECO appears to be the probationary status of AIU, American Intercontinental University, which is operating on a probationary basis, a situation that threatens its accreditation (by the Southern Association of Colleges and Schools,) and has obviously impacted enrollment negatively. Management appears to be addressing the specific concerns by adding administrative staff, qualified admissions staff as well as full time faculty. The school's accreditation will be reviewed again in December according to an excellent William Blair brokerage report (authored by analysts Litfin, Steinke, and McHugh) dated yesterday where the firm upgraded the stock to a "market perform."

The Department of Education has refused to approve CECO applications for adding new locations or making acquisitions until it completes its review, this remains an overhang on the stock. As well, there remains a Department of Justice investigation as well as an investigation by the Pennsylvania Attorney-General.

Again, it is important to remind ourselves that these sorts of investigations are endemic to this industry. Enrollment and recruitment of students, packaging of financial aid, and procedures to deal with student complaints have previously resulted in examinations of ITT Educational (ESI) as well as Apollo Group (APOL.)

The legal and regulatory clouds seem to be dispersing at least partially and CECO's valuation, in my opinion, still incorporates a great deal of doubt. EV/EBIT remains below 10 times, a significant discount to APOL at 11.8 times, or ESI at 14.2 times.

Disclaimer: Several clients are currently long CECO. Neither I, nor my family, or clients have a position in ESI or APOL.


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