Strayer had their quarterly earnings announcement yesterday morning and there were a couple interesting announcements. Someone asked me for a comment on the report. I listened to the call this morning and here are some notes along with my basic comment in reply…

Here are some notes:

  • Enrollments for fall term 2013 decreased 17% to 43,192 (last year it was 51,727)
  • Continuing student enrollment decreased 14%
  • New student enrollment decreased 23%
  • Revenues continue to fall—down 11% in Q3 2013
  • Earnings are down 23% yoy
  • Cash on balance sheet is now $85mn. They didn’t repurchase shares and let cash build throughout the quarter.
  • Even with the declining revenue, the business is still quite profitable. Company produced $18mn of FCF last quarter. They continue to hold back on capex, spending only $7mn in Q3. Seem interested in protecting capital at this point.
  • The 2 big announcements this quarter:
    • Instituting a new 20% cut in tuition costs for new students
    • Closing 20 physical locations
    • This will lead to a charge of $45-$55 million in Q4 ($10mn of which is cash, the rest will be non-cash)
  • These closures will affect about 2300 students, but most will be able to continue online. Management estimates that the closures will save an estimated $50mn of operating expenses annually, which is quite significant

First off, the environment remains tough for Strayer, but I wasn’t really surprised by the results in terms of sales and enrollment trends. I’m expecting some more of that in the near term. However, I was surprised (but not upset) by the announcement regarding their plans to close 20 physical locations as well as the tuition price cut.

I actually viewed this positively (maybe differently than the market). One secondary reason I own the stock (aside from it being very cheap based on cash flow) is the fact I really like the management team. It’s always difficult for management teams to shrink their territory. By nature, management wants to grow. I thought this was a prudent decision on Silberman’s part, and although it remains to be seen how this plays out, I think he’s planning way ahead, and not worried about the next few quarters, or even the next year or two.

I listened to the call yesterday, and Silberman said something to the effect of “We plan to be here 100 years from now (the company–obviously not the management team) :)

The stock got hit yesterday, which I found interesting. The market typically is looking ahead 2-3 quarters, and they certainly see a bleak future in that short time frame. The question is what does this look like 2-3 years and beyond. What happens if enrollments stabilize even at a significantly lower level? Management seems committed to adapting to whatever that level is. If they were stubborn with their capital allocation and investment plans, I’d think of this much differently.

Silberman mentioned numerous times that they take seriously the stewardship of shareholder capital and the decision to close the locations was because they weren’t producing adequate returns. Very few managers truly make these types of decisions (although many say they do). It is clear (to me at least) that Silberman is truly focused on creating and increasing intrinsic value per share. He’s very ROC oriented and is not worried about growth, but rather the highest and best use of shareholder capital. That’s the kind of management you want, especially in a business where capital allocation will be crucial in the next few years.

Of course, his good intentions don’t mean that the company will be successful in translating these cost cutting initiatives into value, but I think given the history of Strayer producing high returns on shareholder’s capital, they have a very good probability of success. But note: it might not be pretty in the near term.

The good news is they’ll save about $50mn per year in operating expenses, and that will mitigate some of the enrollment and revenue declines. At some point, it all comes down to stabilizing enrollment, and that is the challenge. But over time, Strayer has proven to be a business model that has worked (it’s been in business for over 100 years).

As with most stocks that are cheap, there are challenges here, but I think at these prices there remains an interesting possibility for asymmetric outcomes.

The business made $18 million in free cash flow last quarter and has produced about $65 million FCF so far in 2013 through 9 months. They are on pace to make about $85 million in free cash flow this year thanks to cutting back on their capex. They are going to take a charge in Q4 related to the closures, but the majority of the charge will be non-cash (according to management).

Even if we have another year of 25% decreases in net income, that would still leave somewhere around $65 million of free cash flow, which equates to about a P/FCF of around 6 at these prices. There is a lot of bad news priced into this stock, in my opinion.

Disclosure: Please note–I own STRA for myself and for clients. This is not a recommendation. Please conduct your own due diligence.

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5 Responses to Some Notes on Strayer’s Cost Cutting Plans

  1. Henry says:

    John, given enrollments and revenues will be down in 2014 and little visibility on future enrollments (which is priced in for STRA and its peers), other than starting cost cutting and programs on retention, I think STRA may be better served if it can discuss/plan other strategic initiatives on its products and services, e.g., new programs, focus on institutional clients & graduate students, career assistance to land jobs at graduation, job postings/portals. The markets understand the murky outlook of the industry but seem to reward those with in-place and/or planned strategic initiatives to rectify the slide. STRA didn’t seem to offer such plans (perhaps one reason why its stock got hit yesterday).

  2. Nicolò says:

    Hi John,

    first of thank you for the interesting comments on STRA 3Q results, I have been following (and studying) closely the stock since you first talked about it a month ago and I agree with you in terms of closing down excessive capacity and focusing on addressing the underlying affordability issue. I believe that, as of now, the company (and the entire industry) is facing an incredibly tough environment with a persistently low labor participation rate which is hindering an already weak environment (if we look at the true unemployment rate, including those people who are not actively pursuing employment anymore, the environment is getting tougher, not easier) and that it may be quite some time before we see improving trends in new enrollments (let alone total enrollments). In addition I am worried that rising interest rates on student loans could also hurt Strayer, especially if we look a few years down the road. On the other hand, I am convinced that this is a highly cash generative business with fantastic economics which should, at some point, show up in the IS and thus be rewarded by the market. It is however going to be a long and volatile path as the market, as of now, is just projecting the near past into the future indefinitely.
    Given your knowledge on the stock and the industry I would like to ask for your opinion on a point which has been troubling me (and my bullish thesis on STRA):
    The industry is changing (regulation under scrutiny, falling profitability and price pressure) and while it is hard to make any serious forecast I believe that the for-profit education sector could be materially different in a few years down the road. While STRA is more of a quality play, is there a chance that the market is effectively right by applying a significant discount to the fair value of the stock? In other words are we being too optimistic? Even considering the quality of the management could we be ignoring the saying “When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”?
    Regards

    Nicolò

  3. John Huber says:

    Both good comments. I don’t have a lot of time to reply in detail, but a couple quick points… I do think management came out with a plan to attack the decline in enrollments. A 20% price cut is significant. I think the market punished the stock because of the implications that has on top line revenue over the next few quarters, but long term, I think that should have a positive effect on enrollment. To go along with the top line cuts, they are closing stores and reducing headcount.

    Basically shrinking the business for now… hopefully to set it up for stable growth in the future. I actually was very encouraged by the plan. As I say in the post, very few managers steward shareholder capital in this manner (shrink the territory). But sometimes this can create much more long term value. As Buffett said, not all growth is good and not all shrinkage is bad. It’s all about value.

    We’ll see how their plan actually unfolds, but I was pleased they are proactively trying to adapt to the lower enrollments.

    As for the regs, STRA is one of the best businesses in the sector and is very much in line with all of those new regs coming down the pike over the next few years.

    I think the market punished the stock simply because the next 6-12 months are going to be very challenging for STRA.

    I agree with the market that the near term outlook is bleak, but the difference is that I think at 6 times free cash flow, I’m not paying for any expectations at all…

    Regarding the Buffett quote on management, I’ve thought of that as well, but when you look at the economics of this business, it’s actually a really great business. High margins (even now), high free cash flow, low capex requirement, high returns on tangible capital, etc… So although the top line revenue is the key driver of the stock currently, the underlying economics of the business are very good (in my opinion).

    But don’t take my opinion… please due your own research and pick my thesis apart! :)

    Thanks for the comments. Always good to hear counterpoints.

  4. DTEJD1997 says:

    Could it be that STRA is getting ahead of the industry in general by lowering the cost by 20%?

    Could it be that the street is worried this is the first shot in a price war?

    Up until now, cost was simply no object in education. Costs ALWAYS went up, frequently well above the rate of inflation. Now that has changed.

    What happens if COCO or DV decide to “one up” STRA and they lower tuition by 25% AND they hire a few career placement people?

    I think word is finally starting to get out that education in general is a VERY POOR investment.

    The New York Federal Reserve reported recently that, for the first time, the homeownership rate among college graduates was less than non-grads. This was shocking to me at first, but it really makes sense. if you have $50k or more in student loans, buying a house will be pretty far down on your list of things to do.

    The big thing is that cost of education is now an acknowledged factor by management of a company. This is a tremendous change!

    • G says:

      Home price has always gone up until it doesn’t, which you argue that it’s similar to these for profit university. While the main worry is that a price war may be triggered here, I would argue that there are private universities, public universities, online only universities, and non profit universities that has been and always will compete on not only price but on the complete package of quality and quantity for the students. The bet here to me is that this 20% price cut is bold enough to set the equilibrium pricing to stabilize enrollment, and thereby the stock price. Any growth from that will hopefully skyrocket this stock many times over, but that’s probably a couple years to a few years down the road. Big Money are made in bear markets where opportunities abound. ..

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