May 3, 2010 The Big Future of E-Learning: Beyond a Countercyclical Bump and a Student Loan Scare


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Education stocks have had a strong run YTD, as continued high unemployment is sparking accelerating enrollment at post-secondary institutions. Of late, the sector has been volatile, as fears of tighter thresholds on government sponsored student lending for occupational training ebb and flow. While the countercyclical nature of education spending and the threat to vocational programs are crucial near term factors, we believe secular trends favoring internet-based education at all levels may be an even bigger long-term factor driving outperformance in this sector.

Specifically, we expect that the spread of broadband connectivity, technology advances, favorable government policy and inherent cost advantages will drive share gain, and thus, unusual growth for the on-line, for-profit segment for years to come. We favor companies focused on e-learning, with a particular interest in 4-year and post-graduate degree granting programs, K-12 education, and e-learning software. Examples include Capella, Strayer, Apollo, DeVry, Bridgepoint, Grand Canyon Education, K12, Archipelago, Blackboard and SkillSoft.

The Dept. of Education will soon issue new guidelines on institutional eligibility for government sponsored Title IV lending, based on thresholds for the “gainful employment” of graduates and their projected ability to repay their loans. Companies disproportionately focused on 2-year occupational programs and those with a particularly high dependence on government sponsored Title IV lending will be the most vulnerable to any restrictions on lending. These companies include Corinthian Colleges, Lincoln Educational Services, Career Education Corporation and Universal Technical Institute.

The tuition for the average 4-year institution has risen more than 30% above inflation over the last 5 years. Against this, for-profit on-line programs have clear cost advantages, particularly given sharply rising enrollments, and have 46% lower tuition than private not-for-profit schools. Internet-based programs save students time and travel costs and do not require physical space or the labor that goes with it. Moreover, on-line programs are easily scalable, offer more flexibility for scheduling and can serve a geographically dispersed population, including foreign students that would require F-1 visas to attend traditional institutions. These factors are inherent in the 17% growth of on-line enrollment, far exceeding the 1.2% growth in the total student population.

On-line programs for K-12 education face a minefield of opposition led by teachers’ unions and textbook publishers. Nonetheless, a change-friendly Department of Education has improved prospects for on-line programs, which offer many cost and efficacy advantages over locally developed curricula. Budget crises at the state and local level may also create opportunities for internet-based programs.

The FCC’s goal of ubiquitous availability of 4Mbps+ broadband and explicit support for e-learning initiatives should be a further spur to on-line programs for both post-secondary and K-12 students. Currently, 5% of US households do not have access broadband. Moreover, a second goal, that at least 100 million US households should have access to networks with speeds of at least 50 Mbps by 2015 and 100 Mbps by 2020, if achieved, would dramatically enhance the quality of an e-learning experience and further boost potential enrollment.

While most IT companies have a stake in some way in the e-learning market, those providing e-learning specific applications and tools are the most levered to the trend toward on-line education. At the heart of the distance learning market is a battle between open source learning management systems (LMS) Moodle and Sakai vs. the proprietary market leader Blackboard, which despite share loss to the open source platforms is still growing its sales at better than 20% annually. Beyond the LMS market, are more specialized companies offering e-learning tools and content, such as Rosetta Stone, SkillSoft and Renaisance Learning.

In the post-secondary category, we prefer companies that are 1) predominately online vs. brick-and-mortar based, 2) focused on 4-year and post-graduate degree programs rather than 2-year vocational programs, 3) less dependent on Title IV students than average, 4) relatively high margin, as an indication of competitive cost structure, and 5) growing faster than average. The companies that fit these criteria are American Public Education, Capella, Strayer, DeVry, Grand Canyon and Bridgepoint. We also see K-12 online curriculum and LMS software as fundamentally attractive. K12 and Archipelago play in the first category, while Blackboard Inc. and Skillsoft play in the second.


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