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KAREN GIBBS: Summer's over, and depending on your frame of reference, that could mean back to school, peace and quiet, or cold sweats worrying about tuition payments. Education, a great investment in our children, but also an $800 billion industry, one that's not just for kids anymore. The no-frills, for-profit universities have moved from the inside of matchbook covers to Wall Street, where they've been running laps around the rest of the market. Is it too late to enroll is these stocks?
Jeff Silber, managing director of Harris Nesbitt, and Gerald Odening, managing director of Jeffries and Company, have been grading the entire industry. And in just a little while we'll meet the CEO of one of the leading for-profit companies. Jerry, Jeff, thanks very much for joining us. Well, let me start with you, Jeff. There's $275 billion spent on post-secondary education and $30 million possible for-profit students. Can you talk to me about the potential for this industry?
JEFF SILBER: I still think that the numbers you're talking about are still going to be dominated by the traditional not-for-profit schools. But there is a significant opportunity for the for-profits to take share. If I remember correctly, if you look at it based on the number of students, the for-profit sector has probably doubled their share from about 2 percent to 4 percent, if I'm not mistaken, over the past decade or so. Could they double from here? I think they could, and especially over the next year or so. And if you look at what's going on from the state budget perspective, there's a big crisis going on. So if those type of schools are their chief competition, the competition is getting weaker by the day. I think that's a very bullish signal for the for-profit companies going forward.
GERALD ODENING: That's absolutely true. There is no new capacity coming on stream of any size in the public non-profit sector in the next five to eight years. I've actually calculated that there could be as many as 45 to 50 million adults -- these are people who started but did not finish a college degree. Those are the typical students that are the market for the for-profit colleges for working adults who have a job but want to go back to school conveniently, either online or from a campus that may be only 20 minutes away. So the market is huge and it's expanding every year.
GIBBS: So what is the appeal of for-profit schools? We asked some students to tell us why they choose for-profit schools over traditional universities.
(Start of pre-taped segment)
Casey Arnett was working as a photographer when she decided her career needed a jumpstart. She sought training that would broaden the outlook on her career but didn't have much time to spare with five children. Gibbs College, a for-profit school, offered an associates degree in graphic arts, which provided the type of training and flexible schedule she was looking for.
CASEY ARNETT: It's an 18-month program, and having limited time to complete a college education this really seems the way to go.
KAREN GIBBS: Classes and schedules are small and flexible and the mission is all about getting a job.
ANDREW HANKE: What you decide to do is what they train you in. You don't waste too much time doing classes you don't need to take.
KAREN GIBBS: Gibbs is one of the Career Education Corporation's seventy five schools located in North America, Europe and the Middle East where students prepare for careers from designing internet sites to cooking culinary delights. Enrollment at career colleges has increased 55 percent from 1995 to 2002. The sector has benefitted from the nation's economic woes, as workers desperate to avoid layoffs polish their skills.
MELISSA WECKEMAN: I started off as a secretary and worked my way up to an analyst, and I decided while putting together a pitch that I really liked the design element of it. When I look at a job description, I feel very satisfied with being able to do anything.
(End pre-taped segment)
GIBBS: And joining us now is John Larson, CEO of Career Education, the parent of Gibbs College. And in the interest of full disclosure, I have no financial interest in Gibbs College. We just share the name. Mr Larson, welcome.
JOHN LARSON: Thank you.
GIBBS: A lot of people look at this as seeing these for-profit schools as being really focused on technical or vocational, and not so much the traditional liberal arts or maybe even the post graduate work. How do you address those criticisms?
LARSON: Well, what we try to do is we try and serve every market. We certainly have a lot of our students that are looking for a diploma. Many first-time learners want an associate degree. A lot of our students, about 35 percent, are going after bachelor degrees. And we have a very serious segment that also is looking for their masters degrees. We also have a college that offers a doctorate degree. So we're trying to offer programs that really suit the needs of students and frankly try to fit it to what the economic needs are. So we have programs certainly in the technical area, but we also have them in the visual communications area. We do MBAs. There's a masters degree of education. So it really does cover a very wide sector.
ODENING: Jack, you know you've had tremendous success in the years past from acquisitions. Can you just talk a little bit about the outlook for acquisitions?
LARSON: We have found it to be really an excellent way to buy some name brands, to be able to help those name brands grow. And we've got a very full pipeline. We certainly have done a number of acquisitions this year. We've done acquisitions almost every year in the history of our 10-year period, and we expect certainly to do some as we go forward in the future.
GIBBS: Jack, now shares of career education hit a new 52-week high just last week, and it seems like Wall Street does have quite a love affair going on with this industry. But are you afraid that with the acquisitions Wall Street may take a little dimmer look at that?
LARSON: No, because we've always been an organization that promises, made promises kept to Wall Street. We certainly have delivered some very, very excellent results. We've done some 26 acquisitions, and I think we've been able to show in each one of the cases it offered some really immense value to the overall organization. So we know how to do acquisitions, we know how to bring them into our system, and we know how to support them.
GIBBS: Jerry, let me talk about some of the other competitors to career education. What do you like?
ODENING: Well, right now we have a buy rating on Apollo Group and University of Phoenix Online. They are the leaders in working adults right now with over 175, 180,000 students. And they are growing rapidly with very high margins. We also are looking at a very similar company to Career Education, which is Corinthian Colleges. They too have made acquisitions in the past several years and they've done very well in the same, similar areas of business, healthcare, and are moving into the automotive technician business. In addition, we have also been recommending a company called Education Management. Education Management is similar to Career Education. It has one of the widest programs in terms of both students, programs, across diplomas, on up to graduate and doctoral degrees. And that kind of diversity in my mind serves the management of any of these companies well, because at any given time programs do run out of favor. You have to make sure that you can replace them with high growth programs.
GIBBS: Jeff, you look at the same numbers that Jerry does. What do you think? Do you agree with him?
SILBER: Our favorite stock actually in the group right now is Career Education, and I'm not just saying that because Jack's on the other line here. But we just love the fact that they're so diversified, and they're going to get probably more leverage out of their online program than some of the other companies out there. They've just moved from a business that really wasn't making any money to a business that now is going to be pretty profitable. So if you're looking for a way to leverage the whole theme of distance education, CECO would be the way to go.
Generally what we're telling investors, I mean as a group these stocks are not cheap, but they really have never been cheap. I could have been here a year or two ago. I would have said the same thing and you would have missed all the upside from here. So we tell investors, look at the group, pick out the themes that you like within the group, and then wait for the opportunity to buy them on dips. And we certainly have those opportunities. A lot of these stocks move together. We had an issue with Corinthian where basically the guidance may not have been as stellar as some folks might have wanted. That stock sold off. So did the whole group. That's your opportunity to buy the rest of the group, and Corinthian bounced back as well. So buy on the dips.
GIBBS: Jack, you've got this whole thing in front of you now, and I'm also noticing that the for-profit education industry pretty much covers the whole gamut from coast to coast. You've got Illinois-based companies, you've got, of course, Maryland-based companies, and of course in Phoenix, Arizona as well as in California. Do you see that this demographic shift will impact the success of for-profit schools?
LARSON: Well, the demographics look excellent. Of course the baby boomers have had kids and they're pouring out of the high schools in record-breaking numbers. They'll continue to do this through 2008 in just very, very large numbers. So that certainly does very well for our industry. It kind of gives us a guaranteed share of a very large market. But also there's lots of young adults, older students, working adults. And I think people are hungry for education. It drives the economy. I think there's lots of opportunities in these various areas.
GIBBS: All right. John Larson, CEO of Career Education, thank you very much for joining us. And Jeff and Gerald, before I let you go, I need to get some housekeeping things out of the way, disclosures on any of those companies that you mentioned.
ODENING: Sure. I am an analyst that does hold a position in Apollo Group, University of Phoenix, Education Management, and all the stocks that I mentioned. As far as I know, Jeffries has no banking relationship with any of those companies.
SILBER: And I do not own any of the stocks that I talked about and my firm also does not have any current banking relationship with any of the companies we spoke of.
GIBBS: All right. Jeff Silber, Jerry Odening, thank you very much.
SILBER: Thank you.
ODENING: Thank you.
FORTUNE writers roundtable
GEOFF COLVIN: Every week we bring you investing wisdom from money managers, analysts, and CEOs. They're the tried and true sources of investing ideas. But another group of people is out there with a different perspective, doing a tremendous amount of original reporting and independent thinking, gathering facts, insights, and ideas you won't hear anywhere else, and those are my colleagues at FORTUNE magazine. When they have found something particularly interesting or useful, we'll check in with them, as we are doing tonight.
In San Diego, columnist Herb Greenberg has discovered a company with a revolutionary procedure for osteoporosis, a terrific stock he found through a difficult family ordeal. Senior writer Marc Gunther thinks this past week was actually historic for companies and shareholders, and he'll tell us why. And senior writer Stephanie Mehta in New York looks at who is profiting now as kids go back to school. Stephanie, what's surprising about who's profiting now?
STEPHANIE MEHTA: Well, what's surprising is that it's the companies that are catering to the parents as well as the students. Retailers are always trying to capture what the youth market wants, what the hot trends are. But I think we've reached a point where students and parents increasingly are going to have to come to a compromise on what the kids wear to school. There was a great piece in The Wall Street Journal several weeks ago that tried to identify a couple of items that both Mom and the kids could agree on, especially with some of the fashions becoming increasingly risque, especially for young women. So I think that there are retailers that understand that the parents still control the pocketbooks are doing well, and a great example of that is a company that has had its share of problems capturing the trends and trying to understand what the youth market wants, and that's Gap. This season they're featuring items that are not exactly basics, which used to be their big thing, but are more trendy, but not too cutting edge.
COLVIN: Corduroy, right?
MEHTA: Corduroy...
COLVIN: Who thought corduroy would rescue the economy? But that seems to be what's happening.
MEHTA: Corduroy not only for pants, but corduroy for bags -- the hobo bag at The Gap is a really hot seller I'm told. And of course, there's the perennial cargo pants, which seems to be popular yet again this season.
COLVIN: Still selling after all these years.
MEHTA: Still selling, and they really are sort of year-round items that you can wear. So it's not like purchasing something that you can only wear for the fall season and that you'll have to put away when winter comes. The kids are wearing them year round.
COLVIN: Who else in the way of apparel?
MEHTA: I think Kohl's is another brand name that you're seeing doing pretty well. They again had a little bit of sluggishness in the first part of the last 12 months, but in the last six months the stock has outperformed the S&P. And again it's a company that markets to a value-oriented family shopper. So while they will have the jeans and the cargo pants and the cute purses and the layers that kids want, it's a place where Mom and Dad and the kids can find something to agree on.
COLVIN: Well, it's been a great summer for both Gap and Kohl's stock, and any trend that suggests teenagers might want to listen to their parents is one I'm in favor of. Now what do kids put in the cargo pockets of those cargo pants these days?
MEHTA: Well, it's really interesting, because for such a long time the consumer electronics business really counted on the Christmas season to be their big season. But increasingly we're seeing that back to school is a big deal, particularly for wireless companies. And I talked to a couple of the wireless telecommunications companies, and they're finding that back to school is sort of a right of passage time for young people, that as kids go back to school, the schedules of the family get much busier, and so it's a time for parents to think about putting their kids on a calling plan with the family, or perhaps getting their kid their own phone with a prepaid calling plan that allows them to monitor the kid's minutes.
COLVIN: We are seeing more and more of that. Marc, I gather that you think this rather sleepy, hot week in August was actually a historic one. How come?
MARC GUNTHER: Well, I think it's capping really a very good year for shareholders. And I'm not talking about the fact that the market has been up for six consecutive months.
But the MCI plan to come out of bankruptcy really is a road map for good governance, and it really, if it works it will really be the first big FORTUNE 500 company that you could say has an ideal governance structure. What MCI's current management and board are agreeing to is a situation where CEO Mike Capellas is going to give up the chairman job. He's now chairman and CEO. That's a good thing, because it makes the board more independent.
COLVIN: Right. Although at the vast majority of companies, the CEO is still the chairman.
GUNTHER: That's right, and most people don't think that will change until people actually leave the CEO job, and then you fill it with two rather than one. But he has said, "Okay, I'll give up my chairman's job." He's also agreed not to serve on any other boards. That's a good thing, because you don't want CEOs sitting on each other's boards, all driving collectively CEO pay up. They're also paying the directors more, which is a good thing. Their pay would go from $35,000 to $150,000 a year, but in exchange they'd really have to do the job of being a director. Eight meetings a year, visiting various sites, talking to employees, meeting frequently without management, listening to shareholders. They're talking about setting up an Internet site, a kind of town hall for shareholders where directors could communicate, particularly with institutional shareholders.
COLVIN: There was another big governance development this week, which had to do with the Siebel company, a big software company. What was that all about?
GUNTHER: Well, they were notorious for outlandish CEO pay. Tom Siebel, the founder of the company, one of the best-paid CEOs of the '90s, he voluntarily gave up 26 million options earlier this year, but that wasn't enough. Shareholders sued, and as part of the settlement in the suit announced this week, they've agreed to limit pay, they've agreed to allow shareholders to vote on pay, they've agreed to appoint a new director directly responsible to shareholders. The idea really is to make shareholder democracy a reality, not an oxymoron.
COLVIN: Okay. Now are these developments going to put pressure on other companies to follow suit?
GUNTHER: If they don't, they're not very significant. Yeah, the whole idea here would be the combination of shareholder suits, institutional activism and public pressure is going to ideally move all of the big companies into a situation where you have truly independent boards, which we don't have now. It's an incremental process, but these are important steps along the way.
COLVIN: Fascinating. Herb, you have discovered a stock, but you discovered it in a remarkable way. Can you tell us what happened?
HERB GREENBERG: Sure. My mother, who's 84, lives in Florida, and she was mugged, and it was pretty horrible. She was dragged down some stairs. When the thugs got away with her purse, they had nothing in the purse. But what happened was her back, which already had been ailing with one pain or the other, fractured a small vertebra and she had a very hard time walking. So she -- her doctor told her about a procedure called kyphoplasty. This is a procedure whereby they put a, it's sort of like angioplasty for the heart, where a balloon goes into the heart and opens up the artery. Well, this balloon goes into your back and gets the fracture back into shape, and then they spray some cement in there. And, you know, you're out of the hospital and walking around within a day.
I was mentioning this to some people. I didn't know there was a public company that did this. And they said, "Yeah, we know the company. It's a public company (Kyphon)." And I did some work, and this was back in June. The stock was about $11 or $12. I wrote about it in a publication called The Street View, which I write for TheStreet.com, and the stock just sort of hung in there for awhile. And then the company, which was losing money, turned around with a miraculous profit, its first profit ever, which was very strong, stronger than people expected. And this company, it turns out, is getting very strong appeal because of the way it deals with osteoporosis and the injuries dealt with by osteoporosis in older people. The company now seems to be doing tens of thousands of these procedures. They make the instruments for the procedures.
COLVIN: Well, I was going to ask, Herb, because osteoporosis of course is a huge problem. With an aging population, it's only going to get more widespread. But what is it about this company that enables it to extract a profit, to make money from the procedure where others can't?
GREENBERG: It makes the equipment. And what's interesting that it really has, which you didn't see in angioplasty the same way, it has some, really what appear to be rock-solid patents.
Now there is a competing technology that's been out since the 1980s. It's called -- it's a tough (pronounciation), I'm going to stumble over it if I say it -- but it's done by radiologists, interventional radiologists rather than orthopedic surgeons, but it doesn't use the balloon. So it doesn't get the fracture back into place.
And what's really interesting is the leverage for the profits seem to be high. And I have to tell you, I'm a skeptical guy, and most of what I write tends to be negative. So if I see something positive, I keep saying, "What's wrong? What's wrong?" This company came out with profits. I looked at the numbers trying to find some problem. Couldn't find the problem.
And what's really interesting is the company says that over the next few years -- if it can get regulatory approval in Japan, it thinks its growth in Japan can be stronger than its growth in the U.S. And this is very interesting, because you know in Japan there's not a lot of calcium, there's not a lot of milk that people drink, and there's a lot of osteoporosis over there. So that is a market this company sees for future growth sometime out.
Now I must tell you what really intrigues me here is if you've ever followed medical device companies, and I've written about many of them over the years, one of two things usually happens: Either they grow, they hit the wall, and they blow up; or if they really have something good, at some point, you know, they're like the farm leagues, and they end up getting acquired by the big guys. So at some point down the road, here you have a stock that's gone from $11 to $24. Analysts have actually downgraded it, or you know, put it on hold because it looks expensive. But at some point, the question is, will this be viewed as cheap?
COLVIN: It wouldn't be too surprising. Japan of course also has an even older population than the United States. Now there are a few bears on the stock, though. There are a few shorts. What are they saying?
GREENBERG: Well, the shorts. You know, I haven't fully understood the shorts story, and I think some of the shorts' story has gone away. I continue to ask myself, what can go wrong here? And, you know, the cement they use, for instance, is not yet approved by the FDA for the label to use it for this purpose. However, you know, the doctors are free to use cement any way they choose. So there are always regulatory risks that you have to think about.
And also, you know, can they grow they way they expect to? Will there be some calamity with the technology? But the complications rate apparently is much lower than the preceding technology. And I'm not a doctor, and I know there's some doctors out there who could be saying, "This guy doesn't know what he's talking about." So I tread carefully. But look, I know from personal experience, my mother has other pains, but one pain she doesn't have is the pain she had after this horrible incident. And she's up, and she was driving her car within three weeks.
COLVIN: Well, that is a wonderful ending to hear of the story. Of course you do have to be careful of stocks you come across through personal experience.
GREENBERG: Well, you know, they can always seem great. It's like the restaurant you go to and you say, "Look at the lines," but that doesn't necessarily mean that the stock's going to be a great stock. So you always have to keep that in mind, and you have to look at the valuations. And I once asked Peter Lynch this many years ago when somebody said, "Oh, but I love the restaurant, I love the product." And in the end he said, "Well, yeah, but you have to also look at the fundamentals, and after awhile the fundamentals can run in against you."
COLVIN: It can always happen. Herb, thanks so much for your views. Marc Gunther, thank you to you. Stephanie, thanks to you.
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