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Strayer: Demand for Education Still Outstrips Supply

Peter Wahlstrom, CFA

Pete Wahlstrom: Hi, I'm Pete Wahlstrom, associate director of consumer cyclicals here at Morningstar. Today, with me I have Strayer Education's CEO and chairman, Rob Silberman.

Thank you very much for joining me today.

Rob Silberman: Glad to be here.

Wahlstrom: So, before we jump into a couple of the more granular topics, for those who are not totally familiar with the Strayer Education story, could you talk a little bit about the company's development and progression over the last, let's say, decade when the campus situation was probably a lot different than it is today?

Silberman: Yeah. When I took over 10 years ago, it was essentially a Washington, D.C., organization. It had been for more than 100 years. It was a very well-regarded, working adult focus, business-oriented university. What we've tried to do over the last 10 years is take what had been so successful for more than 100 years in Washington, D.C., and expand it throughout the entire United States. We're only about a third of the way there in terms of geography. We've just now gotten as far west as Chicago, as a matter of fact it's our most western, at least northwestern, location at this point. But we've gone from 12 campuses to 92 during that 10-year period and our student population has grown from about 10,000 to about 55,000.

Wahlstrom: If I remember correctly, you're going to open up eight new campuses in 2012, which will get you the century mark.

Silberman: That's exactly right.

Wahlstrom: It really bodes well from a long-term supply-and-demand perspective. As I think about Strayer, you seem to not only have a very good core group of mature campuses, but you also see pretty big expansion opportunities out west.

Silberman: Well, our view has always been that there is a fundamental demand for education. That at the post-secondary level, it seems to be the fulcrum at which people have a certain amount of economic security versus none. There just is not a great supply of opportunities for working adults. Strayer University has always been focused solely on working adults from its founding.

So our curricula, our locations, everything about our pedagogy is designed to deal with a 30- to 40-year-old student, and we've been sort of patiently and deliberately rolling that out into new markets. From a demand standpoint, yeah, we are fundamentally bullish. We think that demand for education continues to grow. The real tricky thing is making sure that you're providing a high-quality supply. That's really where we spend a lot time focusing on.

Wahlstrom: Yes. Certainly, over the last couple of years, there has been increased regulatory scrutiny or Congress and Department of Education concerns about what sort of individual is actually coming to enroll in some of these post-secondary educations institutions. But actually if I think about it, the community college articulation programs and corporate relationships that Strayer have, have helped to offset some of that potential softness in traditional student enrollments. Is that fair to say?

Silberman: That's absolutely fair. For a long time we've thought of community college graduates. Adults who go back to community college and earn associates degrees are among our finest students frankly. They just do better academically. So, a large number of our students come in with the associates degree and enroll at Strayer to earn their bachelor's degree in their third and fourth year. As you mentioned we have more than 100 articulation agreements with community colleges whereby, once a student is enrolled and matriculated at the community college, once they graduate, they matriculate automatically into Strayer University, as well.

On the corporate side, again if you're geared toward serving working adults, one of the best places to find them is where they work. So for decades we've had relations with large employers who send their employees to Strayer to complete their college or even to get a graduate degree. In many cases, those employers pay us directly which is obviously good from a credit standpoint for the university. But more importantly those students who come to us, having being sponsored by their employer, tend again to be much stronger students.

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Wahlstrom: They are probably a little bit stickier in terms of persistence as well and more likely to graduate down the road.

Silberman: I think that’s correct.

Wahlstrom: That actually dovetails nicely into the way that we try to think about things from Morningstar's perspective--the area of economic moats or a sustainable competitive advantage. One of the ideas that we thought about years ago was that pricing for the proprietary institutions really is almost protected by an umbrella that's created by a lot of the traditional universities. Could you talk a little bit about that relationship and where Strayer tends to price in the industry?

Silberman: Well, our pricing for a bachelor's degree tends to be sort of slightly above the level of an in-state student at a state school and below the level of an out-of-state student in a state school. Our pricing at the master's level is actually generally at or below what a state school's would be.

My view is that the pricing needs to part of a value chain. The price that you charge students has to be of a reasonable amount, such that the benefit they gain from the education is more than the price that they paid. Now, that's not difficult to do and there is the pricing umbrella that you described. We've never taken full advantage of that umbrella.

I mean, over the 10 years that I've been here, I think traditional universities price increases probably averaged double digits and ours has been 5% or lower. Over time, I think particularly in an extended economic downturn, I think that that pricing umbrella certainly gets a little bit lower. It's not quite as high as it was before.

So in general, we just try and think about having a tuition level which is commensurate with the value that we're creating. It's high enough so that we can provide the level of education that we want, to attract the kinds of professors that we want, and create a sufficient return on capital that we can attract the capital necessary to expand the university.

Wahlstrom: Absolutely, and the company has done a very good job of delivering solid returns on invested capital, kind of in the 30%-40% range, if not higher. When you do think about the cash flow generation and how you balance long-term investment in terms of new campuses--also at a time when you're paying a very healthy dividend and the stock price is below where it has been just the last couple of years--outside of what you always talk about on the conference calls as being good stewards of capital, how do you think about the priorities in terms of reinvesting in the business versus giving shareholders access to their cash?

Silberman: The difficult thing about capital allocation in our business, at least in our institution, is that there is an almost inexhaustible supply of opportunities to invest the capital in high-return activities within the business, except for the fact that there's a limited scale. When you think about a university, my belief has always been there's just a limit to the rate at which you can grow it. It's a human-capital business. Expanding at too fast a level, even though the individual projects, campuses if you will, are high-return investments, runs the risk of diluting the overall value of the enterprise and ending up with academic experiences for students that aren't as high as you want them to be.

So, we always start with putting as much capital to work as we can within the university, it's the highest return. But the limitation on that has been far lower than the amount of capital that we have.

So therefore, you end up with sort of almost a happy problem of having excess capital, even as you're a growth enterprise, that can be returned owners. Then from that standpoint, our view has been to have a fairly predictable dividend policy. You mentioned it's a rather high yield now. We don't really control the yield; we control the payout. And we've generally paid out as a dividend, somewhere between 25% and 40% of our distributable free cash, which tends to be about our net income anyway, in any given year.

Then the rest of that, the board makes available to me, to exercise share-repurchase authorizations. In that case, the real question is, the difference between the two, the relative priority, I actually almost think of them as the same activity. In both cases, I'm dividending to existing shareholders. When I'm repurchasing shares, I'm paying a dividend-in-kind to the remaining shareholders because they own more of the company. So the real issue is, how much of that do we want to do, where we take that decision away from the current shareholder, and how much do we want to leave to the current shareholders, so that they can make their own decision. We felt that around 25%-40% of cash flow is a fair range to do that, and we try to be as careful as we can in terms of exercising share repurchases to frankly do it at the most advantageous price for our remaining shareholders.

Wahlstrom: Very good. We'll leave it there. Rob, thank you watch very much for joining me today. I definitely appreciate it.

Silberman: Thank you, Peter.