Are For-Profit Colleges Scams Worthy of Shorting?

For-profit institutions are notorious for being unable to place alumni into the workforce. While their businesses grow, their reputations sink. It is interesting to note the discrepancy: people who attended traditional schools dislike for-profits, but those without traditonal options seem to embrace the for-profit route despite knowing the statistics.

The business model may or may not be sustainable in the future. Eventually, people are going to realize that for-profit education is not nearly as helpful as it claims to be, and enrollment could very well decrease significantly. While this prediction has not played out in the last few years, now may be the start of significant downtrends in the for-profit eduction industry.

Capella Education Company CPLA is a small-cap for-profit institution that operates franchises known as Capella University. It offers certifications, bachelor's, master's and doctoral degrees to nearly 40,000 students. However, is now a good time to short Capella or the industry itself?

Up about $3 since its debut on the stock market, Capella's operations have been slowing down over the last three quarters. In Q4 2010, revenues peaked at $115 million; since then, revenues declined to $111 million in Q1 2011 and $106 million in Q2. Interestingly, COGS increased from $42 million to $43 million in the same time period. To counteract the downward pressure, the company has cut down on operating expenses, down from $44 million to $40 million. Income taxes and other non-operating expenses have been static, and net income is down from $18 million to $16 million.

Over the last three quarters, Capella Education's balance sheet has shrunk. Notably, its cash reserves dwindled from $218 million to $197 million. Without strategic investments being made, it is possible that the cash is declining simply to support operations while revenues decline as well. Moreover, Capella opened a revolving credit facility in early October 2011, which may be a sign that it needs short-term funding to maintain growth.

The firm's current assets like receivables also decreased during the last few quarters. Property, plant, and equipment were virtually unchanged, and holistically, total assets decreased from $263 million to $244 million. Capella's current liabilities decreased along with assets. Payable accounts decreased, but accrued liabilities increased. Overall, current liabilities decreased from $41 million to $37 million. In non-current liabilities, the company increased its deferred tax liability account, which means that it will eventually have to pay the difference between GAAP taxable amount and the Tax Code taxable amount in the future. Overall, liabilities increased from $54 million to $55 million.

In shareholders' equity, Capella's additional paid-in capital decreased from $115 million to $66 million, which signifies the losses in stock price. On the other hand, retained earnings increased from $93 million to $123 million. Capella's cash position has been increasingly volatile over the last few quarters. In Q4 2010, cash flow from operations was $88 million, in Q1 2011, it was $23 million, and in Q2 2011, it was $45 million. This variance occurred mainly due to fluctuations in net income, although depreciation and amortization was volatile too. In the year ended 2010, significant capital expenditures were incurred; since then, capital expenditures were offset by sales of previous investments. Lastly, significant stock repurchase programs increased cash used by financing activities in the last three quarters. Totally, cash has flowed out of the firm in teh past three quarters.

When comparing Capella to its direct competitors, Capella is cheaper in terms of price/earnings but more expensive in terms of price/book value and price/sales. Likewise, Capella has a higher operating and net margin.

In terms of growth factors, Capella has had higher revenue growth over three years, but lower EPS growth over the same time period. It also has a higher return on equity. While all these factors seem positive for the company, they take into account a long time of increasing operations. It was only in the last few quarters during which Capella has started to underperform.

Various equity research analysts have also lowered price targets for Capella, including the likes of Piper Jaffray, Wunderlich, Citi, and First Analysis.

Many citizens dislike the concept of for-profit education, and while the industry has been profitable since its inception, the time may be approaching for certain companies when they start to lose customers, and ultimately, profits. Traders need to keep an eye on Capella Education; it may break through technical support levels and experience further downside. It is also looking weak from a fundamental perspective.

Capella Education Company is currently trading at $28.54, down over 57% for 2011.