jim chanos for profit valuex final
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8/6/2019 Jim Chanos for Profit VALUEx Final
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Short Selling is:
� Essential
� Not the opposite of going long
� A large alpha-creating strategy
� Important to theoretical finance
� Non-regulatory ³watchdog´ functions
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Short Selling: Some Recurring Themes
� Booms that go ³bust´
� Consumer fads
� Technological obsolescence
� Structurally-flawed accounting
� Selling $1.00 for $2.00
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The Value Trap
� Stock looks ³cheap´
± Low P/E multiple
± Cash flow generation at the moment
� Business fundamentals in decline
± ³E´ under constant pressure
± Deteriorating free cash flow
� Structural issues
± Competition / obsolescence
± Regulatory changes
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For-Profit Education : Classic Value Trap
� Stocks trading at ³cheap´ valuations
± Forward P/E multiples range from 4.6x to 14.2x1
± Trading at large discounts to 5 year average forward P/E multiples (11.1x - 27.8x1)
± Returns on assets comparable to best companies (Google, Microsoft, Coca-Cola, Apple)
� Free cash flow continues« for now
± Cash conversion rate over 100% (FCF / Net Income)
± Overall enrollment still growing
� ³All the bad news is out´
± Legislative scrutiny losing steam due to 2010 elections
± Regulatory rule ³events´ have occurred
Note: Based on Bloomberg estimates for APOL, BPI, CECO, COCO, DV, EDMC, ESI, STRA.
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For-Profit Education: Are They Really ³Cheap´?
� Structural earnings issues - new Program Integrity Rules
± Incentive compensation
± State authorization
± Misrepresentation accountability
� Revenue pressure going forward
± Product sold not bought
± Aggressive compensation for student growth no longer allowed
± Total enrollment growth masks increasing slowdown in new student growth
± Traditionally high churn rates increase pressure to maintain enrollment
� Earnings leverage works both ways
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Free Cash Flow Generation is a Fallacy
� Businesses funded by government largess
± Over 80% of revenues from federal government programs
± Asymmetry of risk for the federal government
± Risk is born by the taxpayer and the student (debt is not dischargeable)
� Timing of cash flow is a key element of free cash flow illusion
± Title IV rules allow cash draws in advance of students attending class
± Negative working capital model reverses benefit when growth turns negative
� Bill for high cost education comes due later
± Median debt levels of for-profit students far exceed debt levels for students inother sectors
± Disproportionate defaults come from the for-profit sector
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Title IV Funding: Well Drying Up?
� Temporary exceptions to 90/10 rules set to expire
± $2,000 Stafford Loan exception expires in July 2011
± Private student lending will no longer benefit 90/10 as of July 2012
� Accreditor scrutiny is intensifying
± The Higher Learning Commission (³HLC´) is the regional accreditor for most for-profits
± Head of HLC called to testify before Congress twice in the last two years
± Department of Education continues to scrutinize the role of accreditors
± HLC is tightening its standards ± Bridgepoint Education forced to seek accreditationelsewhere
� Manage statistics to lower Cohort Default Rates (³CDRs´)
± ³Default management´ servicers push students into deferment or forbearance to lower CDRs
± Big jump from 2-year to 3-year CDRs suggest that default rates are heavily managed ± Provisioning rates on private loans indicative of future risk for students
� Military enrollments are being used to comply with 90/10
± Department of Defense (³DoD´) education funds count towards 10% in 90/10
± Recent hearings in the Senate regarding DoD funding for-profit education
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Gainful Employment: Holding For-Profit Education Accountable
� Less stringent than the proposed rule, but still has teeth
� Students must maintain at least one of three metrics
± 35% Repayment rate,
± 30% Debt-to-discretionary income ratio,
± 12% Debt-to-total earnings
� The Department of Education estimates that 18% of for-profit programs will fail theGainful Employment test at least once in the next three years
� Fewer loopholes than appear on the surface
± Benefit from interest only loans limited to 3% of program total
± Real income data will be used to calculate earnings
� Schools required to disclose failure to comply with Gainful Employment
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Adaptability of For-Profit Education: Marketing is theModel
� Marketing (not education) is thereal core competency
� Educational outcomesquestionable
± High churn model produces poor graduation outcomes
± Focus on growth worsensprospects for graduates due toincreased competition in their chosen field
� High cost relative to other formsof postsecondary education
� Can the value proposition reallybe changed?
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ITT Educational Services (ESI): Prime Example of For-Profit Education Value Trap
� Looks ³cheap´ at first glance
± Forward P/E 7.8x1
± EBIT margins over 35%
± Cash conversion over 140% (FCF/Net Income)
� Structural earnings issues
± ITT¶s programs are considered expensive even in the for-profit universe
± New student growth has been negative for two consecutive quarters
� PEAKS Private Student Loan Program raises questions and enhances free cash flow
± PEAKS is an off balance sheet entity used to finance student debt
± ITT guarantees performance of the underlying PEAKS debt, yet does not consolidate it on itsbalance sheet
± PEAKS reserve rate appears to be substantially below historical default rates in the industry
� Regulatory pressure is increasing
± 2009 2-year Cohort Default Rate doubled year over year
± Securities and Exchange Commission has inquired about PEAKS
Note: Based on Bloomberg estimates.
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Thank You
VALUEx Vail 2011