Even after working through the impact of impending regulations, valuations for the for-profit educators are far higher than where they are trading today, says RS Investments manager Joe Wolf.
Ryan Leggio: Hi. I am Ryan Leggio. I'm a mutual fund analyst at Morningstar, and with me today is Joe Wolf. He is a co-portfolio manager at RS Investments. They're based in San Francisco, and they run a number of value mutual funds from small-cap, mid-cap, large-cap, and all-cap. Their all-cap fund is RS Large Cap Alpha.
Joe, thanks so much for joining us today.
Joe Wolf: Thanks for having me.
Leggio: Well, one of the items in the news, the Education Department released their rules for for-profit colleges, and a lot of those names Apollo, Corinthian, are up substantially today. You own a few of those names in your small or mid-cap products. Any thoughts on what this means for the industry?
Wolf: Sure. This has been a very controversial, highly debated topic for a number of years now, different forms. For us, the post secondary space is a very good business profile for us. You have very high returns on invested capital. You have very little maintenance capex. You have very good predictability and durability. And these are businesses in the big scheme of things that are actually fairly easy to fix, in that you have a certain cohort of students and as those students cycle through you're able to make changes and effect business change fairly quickly.
For us the investments have always been a function of downside protection. I mean, everything you'll hear from our group, we fixate on downside protection. We spend 80% of our time figuring out how much money we can lose and very little time quantifying how much money we can make. Our obsession is around finding businesses that are going through structural change that will lead to improving returns.
So for the post-secondary education space and why we have reinitiated positions in the teeth of everything that's been going on, is that when you do a stress case tested downside analysis of these businesses, we're buying them well below any type of draconian case that could prevail after these regulations.
If you take a business like Corinthian Colleges, we took around a 30% haircut to EBITDA, and still arrive at stock prices that are meaningfully higher than where they're currently trading today, and so these regulations are very complex. The devil will be in the detail. This is an initial draft, there will be a comment period, and this is not final law. But it's our view that when we work through all of this you're still going to arrive at valuations that are far, far improved versus current expectations. And once we get this reset, these businesses are going to be able to re-establish their trajectory upward in terms of cash flow growth and return on invested capital improvements.
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Leggio: So good businesses from an investor's point of view. I guess, the other big issue that's been in the news is whether or not they're good investments from a student's point of view, and it's your case that they are good investments for not only the students, but also the taxpayers?
Wolf: Yes. I think our contention would be that if you look at the demographic that they serve, and you compare community colleges, to traditionally black schools, to the types of institutions that cover similar types of students, yes, both the outcomes are favorable for the not-for-profits, and the cost to the taxpayers are favorable.
You have to take into account not just the loans, but also the cost of running the institutions themselves, and we would argue that for-profit education provides a very good value proposition to both students and to the taxpayers in aggregate, but like anything, there are bad apples, there are bad industry participants, and regulation is a good for the overall population. It will benefit the stronger participants. It will hurt the less impressive participants, and for our institutions that's going to be a net positive.
