Citron Comments on Apollo Part 2 – Revenge of the Analysts

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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. http://www.insidehighered.com/news/2008/05/21/default

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
http://finance.yahoo.com/q/bc?s=EVCI.PK&t=my&l=on&z=m&q=l&c

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.”

http://www.ifap.ed.gov/drmaterials/doc0101_bodyoftext.htm

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.

http://frwebgate.access.gpo.gov/cgi-bin/get-cfr.cgi?TITLE=34&PART=668&SECTION=22&TYPE=TEXT

“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?

Conclusion:
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?