December 12, 2018

From the financial community Updated Sector Thoughts as Gainful Employment Saga Continues

william blair 2

Updated Sector Thoughts as Gainful Employment Saga Continues

Viewpoint: The second set of negotiations for “Gainful Employment 2.0” resulted in no
consensus, as expected, but rather a contentious few days between advocates with little
common ground followed by a decision to extend the rule-making sessions into December,
with the Department of Education agreeing to provide data and support for its proposed
student loan default and repayment metrics in the meantime. We believe that most
investors have begun and will continue to ignore the tail risk the rule presents to private
sector schools in light of the significant regulatory risk that is already embedded in the
stocks, the extended duration of the gainful employment negotiations (four years and
counting, with no potential program closures until 2019 or later), the increasing likelihood
of a successful legal or regulatory challenge from the private sector schools that would
block some or all pieces of the final rule, the numerous positive changes already made in
the sector to improve student return on investment and school regulatory profiles, and the
recent strength in fundamentals and associated recovery in the stocks

Where Do Things Stand With Gainful Employment?
The Higher Education Act (the governing document for postsecondary schools that access
the government’s Title IV student loan program) states that for-profit college (both
certificate and degree) programs and nondegree (certificate) programs at nonprofit
colleges must prepare students for “gainful employment.” In 2009, a few key staffers
(who are no longer involved in the process) at the Department of Education (Ed) saw big
enrollment and profit growth and anecdotal evidence of student abuse at for-profit
colleges and decided that something needed to be done. In a bit of an end-around attack,
they reinterpreted the simple phrase “gainful employment” into a set of rules that created
complex student loan debt-to-income and repayment thresholds for for-profit college
students, which, if not met, could result in a loss of access to Title IV loans (which
accounts for about 80% of the sector’s revenue).

In a perfect storm for the sector, the introduction of potentially game-changing regulation
coincided with peak U.S. unemployment (and the end of an increase in college
applications associated with these job losses); the lapping of significant Pell grant and
Title IV loan limit

expansions from 2007 to 2009; the tail-end of a dramatic spike in forprofit
school capacity, programs, and tuitions along with an influx of private equity
dollars into the sector; and the beginning of a national conversation questioning the value
of a college degree as student loan debt surged near $1 trillion.
With the threat of largely unquantifiable legislation and the associated change in the
playing field, the enterprise value for the 15 publicly traded companies in the sector
dropped from $46 billion in the first quarter of 2010 to $8 billion in late 2012 as new
enrollment declined and total enrollment and profitability followed (enrollment is down
roughly 30% from peak levels and operating margins are down from the mid-20s to the
low double digits). Not until early this year did the sector show signs of a recovery, with
starts inflecting toward positive (and turning positive for a third of the schools) on price
reductions and a tailwind from a bit more regulatory clarity, and an investor recognition
that the schools were adapting business models and the 30% of the market capitalization
that lay in net cash was safe. The stocks have outperformed the market by 60% this year.

In the four years since gainful employment rule-making was introduced, Ed negotiated a set of harsh debt-to-income and
repayment draft rules in 2010, introduced a much softer final rule in 2011, released supporting data in 2012 that saw most of
the schools pass the tests with flying colors on surprisingly strong debt-to-income metrics, and then later in 2012 saw a
private sector college lawsuit strike the rule down on a federal judge’s view that Ed’s proposed repayment metric was
Ed went back to the drawing board and began another round of negotiated rule-making in fall 2013. Ed’s most recent
proposal, as in 2010, was a set of harsh debt-to-income and loan repayment standards. A (likely softened) final rule is
expected to be released late in 2014 with the rules going into effect in 2015. At-risk programs could be eliminated in 2019 and
Is There Risk for the Stocks?
Unlike in 2010 and 2011, when education stocks hung on every move from the Department of Education and legislative
opponent Senator Tom Harkin (D-Iowa) and 10% moves on policy speculation were a frequent event, over the past year, the
stocks have become immune to policy noise, good or bad. We note that attendance from both the buy- and sell-side at the
latest round of negotiations was a fraction of that seen in previous rounds. In many ways, the stocks have been left for dead
and remain uninvestable in the eyes of many long-only investors who were burned by the sector in past years. In that context,
we remain long-biased on the space, and note that:
1. New enrollment is gradually improving, with a third of the stocks in the space growing starts, a third in the down
single-digit range, and the rest getting “less worse.”
2. Most schools in the space have increased the value proposition of their degrees through brand-building efforts,
stronger retention and graduation, improved job placement rates, price cuts, enrollment restrictions like mandatory
orientation, low-ROI program elimination, and even money-back policies on first classes.
3. Public colleges have increased prices in real terms in excess of 5% annually over the past decade, and the increases
have continued despite declining enrollment, offering for-profit schools a bit of a price umbrella.
4. Most schools in the space have moved out (either partly or entirely) of the lead aggregator channel, which has
sometimes produced low quality student inquiries and at times resulted in high dropout rates (churn).
5. Retention increases at the schools have been largely masked by the graduation “bubble,” a result of the large incoming
classes of students in the 2008 to 2010 period reaching the end of their tenure at the schools, but these retention
gains should eventually allow total enrollment to grow well in excess of new enrollment and produce strong
incremental margins even on moderate top-line growth.
6. “Halo” schools like Grand Canyon University (LOPE $44.15; Outperform), which offers a traditional ground campus
and Division 1 athletic programs, and Capella University (CPLA $64.30; Outperform), one of the highest-quality online
degrees in the country (as recognized by its accreditor), are repairing the sector’s image among both policy-makers
and investors.
7. Many schools in the space have cut significant cost out of the business, but the magnitude of the cost cuts has varied
widely, leading us to believe there is significant further cost-cutting potential and margin leverage ahead for many
8. The potential range of negative regulatory outcomes has narrowed significantly, with the focus on gainful
employment and 90/10 (a legislative effort to exclude military funding dollars from the 10% of nonfederal money
required by this ratio) resulting in a much more manageable set of outcomes than the wide range of a few years ago
(with proposed marketing spending or even operating margin caps).
9. The sector trades at just over six times EBITDA, a significant discount in a market where inexpensive stocks are
increasingly hard to come by.

But we note that from an operator’s perspective, gainful employment still presents substantial risk—in its most punitive form,
the proposed rules could result in the closure of more than 10% of for-profit programs and likely costly changes even to
passing programs. While we believe most management teams remain in a holding pattern and are not making any operational
changes in the near term, we believe the rulemaking

Link to full report:

Timo Connor, CFA

William Blair & Company, L.L.C.

Key Points From the Fourth Day of Gainful Employment 2.0 Negotiations


Key Points From the Fourth Day of Gainful Employment 2.0 Negotiations
The fourth day of negotiations for gainful employment 2.0 offered little news or common
ground from the public- and private-sector college participants, and we expect the
Department of Education to proceed with unilateral action and produce a set of studentloan-
debt-to-income-and-repayment thresholds that will look similar to the first version
of gainful employment, released in 2011 but subsequently struck down by a federal judge
following a private-sector industry appeal.
Key Points
• Consensus remains unlikely to be reached through negotiation given the wide gap
between the private sector and public college representatives in attendance. Both
sides appeared to be positioning as if they expect the Department of Education (ED)
to proceed on its own in writing a final rule, particularly given the wide variance in
the draft rules proposed thus far and the lack of data and objectivity supporting the
process to date. We believe ED remains committed to releasing a final rule in 2014
that will go into effect in 2015. While it is unlikely that ED will combine gainful
employment rule-making with Higher Education Act (HEA) reauthorization, we
believe private-sector participants (with Republican support) will likely mount both
a legal challenge of the rules as well as a legislative challenge through the HEA
reauthorization process, which began in October but will likely take years to finalize.
• Public college advocates in particular appear more interested in derailing the
negotiating process than reaching a consensus, likely because they view a
unilateral approach to rule-making by ED in the likely event consensus is not
reached through negotiation as a positive scenario for most public colleges.
• Private-sector advocates, realizing their voice is being largely ignored at the
negotiating table, are pushing for a broadening of the rule to include all colleges
and are trying to raise questions on the legitimacy of ED’s major assumptions and
the quality and availability of the data supporting these assumptions. This is the
likely foundation for a formal legal challenge.
• Advocates of community colleges, for which certificate programs are subject to
gainful employment rules, appear to be gradually realizing that these rules could
harm their schools as well, and we expect this realization to become a potential
sticking point for ED in implementing a punitive rule (closing even a few
community college programs would be politically unpopular).
• The major wrinkle in the latest proposals from ED is the reinclusion of student loan
repayment metrics, which were included in the final rule proposed in 2011, but not
in the initial draft rules for gainful employment 2.0, released in August.
November 18, 2013

Based on commentary in the hearings today, we believe ED is now focused on including some form of a default/repayment metric as well as a debt-to-income metric. We note that the repayment test included in the

previous set of rules did not withstand legal review and was the major reason the initial set of rules was overturned,
so we are a bit surprised ED is heading back in this direction and believe it will need to show stronger quantitative
support for the metric to withstand another legal challenge.
• We believe the rules will likely be softened in the final iteration, as they were the first time around, with ED unlikely to
want to go through another extended legal battle with the private-sector colleges. And even though rule-making is not
a legislative process, a take-no-prisoners approach seems unlikely given the administration’s continued focus on
increasing the number of college graduates in the United States and the damage to the private sector that has already
been inflicted by the threat of the rules (enrollment is down 20% to 30% across the sector).

Author:  Timo Connor,
William Blair & Company, L.L.C.

Timo Connor, CFA, joined William Blair & Company in 2010 and focuses on education services and technology. Previously, he worked as a fixed-income analyst at Bank of America and BNY Mellon. Mr. Connor received a B.A. in economics from Northwestern University.

Gainful Employment negotiated rule-making is rescheduled for November 18-20, 2013

dept of education

The U.S. Department of Education has announced that the second session of gainful employment negotiated rulemaking is rescheduled for November 18-20, 2013. The negotiated rulemaking committee will convene from 9:00 am to 5:00 pm on each of the three days of the session at the Department’s offices on 1990 K Street, N.W. in Washington, D.C.

The Department postponed the second session, originally scheduled for October 21-23, 2013, because of the shutdown of the Federal government.

U.S. Department of Education held the first gainful employment negotiated rulemaking session

dept of educationYesterday, the U.S. Department of Education held the first gainful employment negotiated rule-making session.  Here are some highlights from the proceedings.

  • The morning portion was filled with procedural discussions and yada yada…  The panel rejected three additional representatives to the committee, including:  Florida Coastal School of Law,  U.S. Chamber of Commerce,  Bridgepoint Education.
  • Barmak Nassirian, representing public four-year institutions on behalf of AASCU raised the idea of gainful employment being an upfront requirement giving the Department the ultimate authority to decide what programs should exist at what institutions based on a review of factors, such as market needs, pay sufficiently above the minimum wage to justify the cost, etc.
  • Brian Jones, the general counsel at Strayer University and negotiator on behalf of publicly-held institutions explained the new program approval process and the role of accreditors in response to Nassirian’s proposal.
  • Ray Testa, from Empire Education Group, questioned whether there is a need to define gainful employment since it has been around for a long period of time.
  • Belle Wheelan, the president of the Southern Association of Colleges and Schools Commission on Colleges, raised a similiar issue when talking about being unable to control the economy or availability of jobs.
  • Testa raised concern on an institution’s inability to limit borrowing by students. In the previous GE regulation, the Department recognized this problem and allowed for amounts to be limited to tuition and fees in the calculation. That cap was deleted in the new proposal put forward by the Department.
  • The community college negotiator also raised concerns with students over borrowing for living expenses and not for education expenses – a common theme.
  • Marc Jerome from Monroe College explained why the debt-to-earnings ratios don’t work, in part, because of the retroactive nature of the calculation. Changes an institution makes today to reduce debt won’t help the student who has already completed; since debt is all that matters, programs may fail the calculation even though institutions have reduced debt for current students.
  • Nassirian suggested that when institutions have programs in the zone (not passing but not failing) institutions should be required to take action such as, post a letter of credit, not pay dividends or freeze executive compensation.
  • Nassirian turned the discussion to marketing and advertising and suggested targeting institutions that spend more on those activities than on education/instruction.

Testa raised several issues directed at the retrenching of the Department in this version of the regulation as compared to the previous one. He challenged the use of the eight percent standard for the annual debt-to-earnings ratio; the exclusion of non-Title IV students and the reduction in cohort size from 30 to 10, among other things.

Media coverage
The Chronicle of Higher Education, Inside Higher Ed and Politico were all in attendance for various portions of the session, we will circulate their coverage tomorrow in the APSCU morning media clips, as well as tomorrow’s update. Bloomberg, PoliticoNPR and Inside Higher Ed all published preview stories this morning.

APSCU content
APSCU continues to push messages and content that supports the press statements we made on September 5 and August 30. In advance of today’s session, we provided a list of questions to the negotiators for our institutions. Many of the issues were raised in this afternoon’s opening discussions.


McCain sends a letter to Arne Duncan strongly suggesting removal of gainful employment