SEC Creates the Bargain of the Year

Francisco Bermea's picture

Tuesday, November 24, 2009 - 2:54pm

by Francisco Bermea

Unemployment hit 10.2% in October. That's only the second time that figure has ventured into double-digit territory since World War II.

And it may get worse.

Many economists predict the unemployment rate won't peak until mid-2010 at 11%.

That's bad news for most sectors in the economy. People without jobs tend to not spend money. Many of them do, however, return to school to strengthen their resume or learn a new trade.

As a result, revenues and earnings in the for-profit sector have been on a tear since 2007. While most stocks were slammed during the downturn, shares of these for-profit educators shot up.

One of the best performers was Apollo Group (Nasdaq: APOL). From January 2007 to January 2009, Apollo's shares gained +101% while the S&P 500 index fell -36%. Its shares peaked at $90 in the beginning of 2009, not long before the S&P bottomed in early March. And through it all, Apollo's earnings have continued to rise.

  2009 Earnings 2008 Earnings 2007 Earnings
Apollo Group (Nasdaq: APOL) $598M $476M $408M

Then came October 27. That's when Apollo said the SEC was launching an informal inquiry into its accounting. Apollo's shares fell -15.1% on the news, accounting for the lion's share of a -28% loss year to date.

There is limited information on SEC's inquiry, only that it relates to Apollo's revenue recognition practices. Apollo said that its accounting policies are appropriate and in accordance with generally accepted accounting principles (GAAP). Apollo's last informal inquiry in 2006 related to stock-option grants and did not lead to any enforcement action by the SEC.

While it's possible that historical earnings will be restated as a result of the inquiry, the SEC's action is unlikely to affect Apollo's future ability to generate revenue, thanks, ironically, to another government agency -- the U.S. Department of Education.

One of the main investor fears associated with the SEC inquiry was that the University of Phoenix, Apollo's main source of revenue, would not be recertified. The Department of Education alleviated those concerns when it recertified the university on November 16. This guarantees that University of Phoenix students will continue to receive federal grants and loans from the government until at least December 31, 2012, when the school will again be eligible for recertification.

This is a hugely favorable development for Apollo, since 86% of its revenue comes from government aid given to students. It also suggests that the University of Phoenix is in compliance with the Department of Education's regulations and that the SEC's inquiry probably won't affect future cash flow, whatirer else the outcome.

And the cash keeps flowing. Apollo is one of the world's largest education providers and has been in business for more than 30 years. The University of Phoenix is the largest university in North America. With a current enrollment of about 500,000 students, the student body at the University of Phoenix is 10 times larger than that at The Ohio State University, the biggest public university in the United States. Enrollment at the University of Phoenix at the end of fiscal 2009 August 31 was 23.5% higher than a year earlier.

  12-Month Trailing P/E 5-Year Average P/E Forward P/E
Apollo Group (Nasdaq: APOL) 13.0 23.3 10.4

The recent sell-off has Apollo's shares trading at a -44% discount to their 5-year average earnings multiple. That's a steep discount considering the S&P 500 index is trading at a +29% premium to its 5-year average earnings multiple. Investors should be cautious regarding the SEC inquiry, but going forward Apollo is a market leader that continues to expand its revenue base - that's nothing but good news for its share price going forward.

Francisco Bermea does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.