Citron Comments on Apollo Part 2 – Revenge of the Analysts


Citron is fascinated by the analysts’ quick responses to its Apollo report, which focused on the business risk revealed in the recent lawsuit by a group of students who withdrew from the University of Phoenix shortly after enrolling (read earlier story). The analyst community once again is shallow in thought and so hasty in discounting the information while rushing to defend the name, that they miss the point. For that reason, Citron offers this clarifying commentary.

Managing Cohort Default Rates by paying back student loans is not a new concept. It was employed by EVCI Career Colleges as discussed in this 2008 article.

Citron finds it chilling that EVCI engaged in precisely the same “policy” with regard to students withdrawing during their first semester that the suit against Apollo now alleges.

“According to the department, the company “then attempted to collect the loan amounts from its students by entering into repayment plans” beginning 150 days after the end of their last semester at TCI. Of five students randomly examined by the inspector general’s office, none had made payments to the company, and the college marked their accounts as delinquent and turned them over to collection agencies.”

As a result of the audit:

“The inspector general urges department officials to consider punishing the institute with the ultimate sanction: limiting, suspending or terminating its participation in federal student aid programs.”

As an aside ….take a look at the chart on EVCI

We do not suggest that APOL is on its way to penny stock status, but we are pointing out that this policy aligns their corporate behavior with a now defunct penny stock company. This practice is clearly addressed in the Higher Education Act:

  • Pursuant to Section 435(m)(2)(B) of the HEA, “A loan on which a payment is made by the school, such school’s owner, agent, contractor, employee, or any other entity or individual affiliated with such school, in order to avoid default by the borrower, is considered as in default for purposes of this subsection.”
  • Pursuant to 34 C.F.R. § 668.183(c)(1)(iii), “[A] borrower in a cohort for a fiscal year is considered to be in default if . . . [b]efore the end of the following fiscal year, you or your owner, agent, contractor, employee, or any other affiliated entity or individual make a payment to prevent a borrower’s default on a loan that is used to include the borrower in that cohort.”

We note in particular that as part of the audit report on TCI, the school was explicitly required by the auditor to restate Cohort Default Rates for prior years.

Yet, instead of assessing possible risks, this is how the analysts comment:

From Bank of America Securities:

“The suit claims that after the students dropped out of school, UOP returned too much Title IV federal loan funds to the government and required the students to pay the earned revenue directly to Apollo (as opposed to the students owing the amount of the loan to the federal government). The suit suggests that in doing so, Apollo violated the Higher Education Act in order to manage its cohort default rates (CDR).”

Fact: The suit claims that the Apollo returned all the loan funds due the student, not “too much”, as though there was a minor miscalculation of an amount due. This is clearly a matter of company policy, not a calculation rounding error. While the suit complaint suggests that Apollo is managing its cohort default rates, Citron stated explicitly that the real reason for this policy, and the full statistical impact of how such students are booked and reported, is unknown.

From Morgan Stanley:
“Lawsuits are a cost of doing business in this industry, and Apollo is a target given its strong cash position.”

Fact: Money doesn’t buy immunity from the law. The amount of money Apollo is liable for in the case is not the material point of concern — Apollo’s standing as the country’s largest recipient of Title IV funds is the point.

Apollo has, for the last 18 months, in fact been on a month-to-month basis with regard to its Title IV accreditation renewal. Legal filings indicate DOE employees have assessed the likelihood of a lawsuit in Apollo’s demand for discovery documents.

“According to the company, there has been absolutely no change to its “return to lender” policy, which has always been conservative and is consistently applied. “

Fact: “Conservative” is a value judgment. Apollo’s actions, which apparently violate HEA law by depriving students of legally obtained loan benefits (loan which the company has explicitly facilitated and arranged), may be interpreted as “conservative” from the perspective of a corporate balance sheet, but do not appear “conservative” with regard to the law and the explicit reporting requirements of its Title IV accreditation.

“In our view, given that CDR [Cohort Default Ratio] ‘s are calculated two years in arrears (the most recent data covers 2006 graduates) CDR’s would be difficult to manipulate.”

Fact: If Apollo’s unilateral reclassification of this class of student withdrawals is deemed by regulators to be unlawful, the reporting of Cohort Default Ratios would have to be restated for an unknown number of years. Clearly this outcome would impact Apollo’s Title IV accreditation status, the effects of which are unknown.

From Credit Suisse:
“Don’t feel the lawsuit carries significant merit and if it proves to be successful should have little impact on the company that has a $13B market cap. The largest fine APOL was assessed in the past was $10MM, nothing given their size.”

Question: Is this analyst qualified to render legal opinions?
Fact: The outstanding qui tam suit against Apollo for incentive compensation for recruitment counselors has a potential economic impact of over $500 million per year, plus substantial penalties.

In contrast, the recent suit against Apollo regarding return of students’ Title IV loan funds obviously does not appear to be financially material in proportion to the company’s assets – financial liability was not the reason Citron suggests it is material.

It is material because the way Apollo reclassifies these early withdrawals impacts a variety of reporting, both for the government and the financial community, including cohort default rates, enrollment growth rates, program completion rates, and churn (currently unreported). Citron’s question remains: What is the implied business risk when the company unilaterally changes status of early-withdrawing students, even though the policy is clearly financially disadvantageous to the company?

Citron wants to make one thing clear. We have nothing but respect for John Sperling — he is a true American success story. Furthermore, although many might discredit the education UOP provides, it can be valuable to the right person.

We’re not saying that Apollo is legally or financially comparable to the Madoff Ponzi scheme, but there is one chilling parallel. In the Madoff matter, everyone is now asking “Why didn’t anyone know?” The truth is, a lot of people knew, they just all assumed he was cheating the system in a way that benefited them. (The prevailing theory about how Madoff was making his money was by frontrunning orders.)

Considering Apollo, analysts seem to assume that manipulating student withdrawal and default reporting (and recruiter incentive compensation, for that matter) is OK, as long as benefits the bottom line. But there’s a deeper concern with these issues, one that goes to the root of Apollo’s entire revenue stream. Citron thinks these risks are not being properly priced by the market. It’s the type of risk that results in harsh re-evaluations when the consequences finally manifest. Has the “heat” in Phoenix been turned up?

Citron Releases the Document that The Apollo Group (NASDAQ:APOL) Does Not Want You or the US Government to See.


Last week, The Apollo Group reported what appeared to be strong quarterly operating profits in their for-profit education business, which is primarily derived from operating the for-profit University of Phoenix (UOP below).  But before investors get too excited, Citron recommends people read the 10-Q details, which indicate the growth is more of a one-time bump than a sustainable trend.  More importantly, the company discloses a lawsuit with some troubling implications for the near future.

It seems like just another piece of every day litigation.  According to the Q:

On December 9, 2008, three former University of Phoenix students filed a complaint against Apollo Group, Inc. and The University of Phoenix, Inc. in the United States District Court for the Eastern District of Arkansas. The complaint alleges that with regard to students who dropped from their courses shortly after enrolling, University of Phoenix improperly returned the entire amount of the students’ federal loan funds to the lender. The students purport to be bringing the complaint on behalf of themselves and a proposed class of similarly-situated student loan borrowers.”


Apollo Class Action (PDF)

What seems to be merely a lawsuit against the institution by some disgruntled students is actually MUCH MORE MATERIAL and cannot be overlooked.   Here’s why:
Before discussing, it is important to note that Title IV loans are the backbone of the revenue stream for the entire for-profit education industry.  Apollo derives over 77% of their revenue from these loans, and is the largest single recipient of student loan funds in the country.

As such, institutions receiving Title IV funding are required to meet a variety of regulations, including a cap on the ratio of government loan funds to cash revenue (the “90% – 10% rule”), limits on defaulted loans extended to their students (the so-called Cohort Default Rate), and other regulatory requirements on financial status and academic standards.  Institutions that violate these requirements risk losing their Title IV accreditation, which for a company like Apollo, could be devastating by their own admission.

This class action represents a group of students who withdrew shortly after enrolling at The University of Phoenix.  Each student was enrolled long enough to incur pro-rata tuition and costs that UOP should have been paid from the student’s already-approved federal student loan.  In each case, although UOP had already received the student’s loan proceeds, they refunded 100% of it to the government, and opted instead for the far less lucrative path of trying to collect directly from the student, employing such tactics as collection agents and credit report dunning, while pressing for accelerated terms far more onerous than the terms of the student’s government-backed loan had been.

So here’s the question:  why would the UOP surrender cash in hand that is rightfully theirs, in exchange for a hard-to-collect receivable, plus collection costs and risks?  Why would UOP intervene in a lender/borrower relationship that they actually helped facilitate? 

Lets get this straight – the action UOP chooses here is financially worse for the company, worse for their students, and better for the US Government … in stark contrast to all the prior lawsuits and consumer complaints, you could at least see the company was acting in its own interests to increase its profits. 

Has anyone ever heard of a company voluntarily giving up money in hand for a questionable receivable?

This lawsuit lays out a rationale that describes how in the actions in question, UOP is not only trying to deceive their clients, but more importantly, the Department of Education and investors through manipulation of their reported numbers.  By removing these early-withdrawing students from their loan rolls, this lawsuit suggests understatement of Cohort Default Rates, plus other impacts on enrollments, retentions, and revenue ratios are implied.  As stated in the lawsuit

“By returning the money to the government, they are effectively prohibiting that person from being factored in their cohort default rate.  This manipulation is a clear violation of the mandates of HEA.”

Now we don’t know the full explanation of the company’s motives for this clearly illegal policy.  Nor is Citron suggesting that APOL is at immediate risk of losing their Title IV eligibility (an event which would cause devastating changes to the company’s business model.)  We can speak from experience in saying that when a business forgoes profits, it is time for investors to pay attention.

Citron also notes that according to its most recent 10-K, APOL’s current Title IV eligibility status is on a month-to-month basis, with review pending for the last year and a half.  As far as we can verify, none of their competition in the for profit education space is on the same month to month basis.

“University of Phoenix was recertified in June 2003 and its current certification for the Title IV programs expired in June 2007. However, in March 2007, University of Phoenix submitted its Title IV program participation recertification application to the Department of Education. We have been collaborating with the Department of Education regarding the University of Phoenix recertification application. Although we have submitted our application for renewal, we are continuing to supply additional follow-up information based on requests from the Department of Education. Our eligibility continues on a month-to-month basis until the Department of Education issues its decision on the application”

A third possible reason for the manipulation of numbers is the current qui tam lawsuit where the US Government accuses Apollo of false claims that costs taxpayers $500 million a year. For those who think the suit is old news and done with, we refer you to a November 10, 2008 court document which shows the government has requested that discovery demands Apollo made under the Freedom of Information Act, be denied as litigation has become a real possibility

Apollo Nov 10 (PDF)

The third, and in the opinion of Citron, most probable reason for the potential of manipulation of numbers is the fear of a new administration.  During the past 8 years under the Bush administration, Wall St. and corporate America has been able to set the regulatory agenda at the current expense of the taxpayers.  This includes private education — it is no secret to insiders that the Bush era education team has been favorable to for-profit education.  In fact, the Assistant Secretary for Post Secondary Education, the highest ranking official overseeing private for-profit schools, has been Sally Stroup, an 8 year lobbyist for the University of Phoenix. 

Count on the Obama administration to take a fresh, critical look — as the largest single recipient of Student loans in this country is a for-profit institution whose insiders have sold hundreds of millions of dollars of stock while collecting over 75% of their revenue from government guaranteed loan funds, while delivering an education of questionable value amid a history of unsavory business practices.

We’re In the Money

Thorough analysis of the company’s revenue mix and trends is a topic for a future report.  For now, we’ll just identify that the “one time bump” comes from the event described in the 10-Q:

“in May 2008, the Act increased the annual loan limits on federal unsubsidized student loans by $2,000 for undergraduate students, and also increased the aggregate loan limits on total federal student loans.”

This was a bonanza for Apollo, both in terms of revenue per student (they increased tuition immediately following the government action) as well as allowing them to increase enrollment among even more financially marginal students allowed under the higher aggregate loan limits.  Back out these effects, and “organic growth” shrinks to a fraction of the reported numbers.  The sustainability of this growth is topic one for the rest of this report.


It is the goal of Corporate America to deliver profits.  While it’s intriguing to speculate about the various theories that explain the company’s acts, the bottom line isn’t their motives, but their actions.  As fun as it might to be speculate as to why they might be employing this policy is irrelevant.  When it comes to the law, it is the action not the explanation that investors should turn their focus. When a company opts to leave easy money on the table, especially when executing company policy that’s explicitly in violation of the laws it operates under, Citron suggests that it might be prudent to look under the table.

Cautious investing to all.