Comparative financial analysis of Devry Education Group Inc. and the Apollo Education Group Inc.
T.J. Wetmore
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The purpose of this paper is to discriminate a short-sell and a buy between the two competing for-profit education firms, Devry and The Apollo Group. The comparison between
Devry and the Apollo Group presents the challenge of two companies in decline. That being said, there is reason to believe that a profit can be made from a mispriced security in relation to future income. This paper argues that the Apollo Group is an undervalued asset and ought to be
“long”, and that the Devry is an overvalued asset and ought to be “short”.
This paper proceeds as follows. First, there is an examination of past financial statements for both companies, addressing the strengths and the weaknesses of each. Utilizing past financial statements as a basis for an evaluation of market price, this paper looks into key ratios related to price and earnings. Then, this paper transitions to future projections. To project future income, the correlation of the unemployment rate and enrollment is used to predict future enrollment rates, as well as looking into the efficiency of operations and the cash turnover per student.
Having established projected income, future trading prices are established. From projected prices, discounted cash flows can occur for the time periods 2014 and 2015. With the knowledge of discounted cash flows and the rates of return, a strong argument can be made for short-selling
Devry and longing Apollo.
Financials
Looking at past financial statements, both the Apollo Group and Devry Inc. have a shared weakness of a strong decline in sales and revenue. Apollo’s income was $248 million in 2013,
43% of the return from just 2 years ago when the income was $572 million. Devry netted $106 million in 2013, 32% of the return of $330 million they earned 2 years.
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The specific strength of the Apollo group is their capacity to produce a lot of revenue in comparison to their asset base. Apollo sold $3,681,310,000 in 2012, with a return on equity of
22.4% and an asset turnover of 170%. Apollo’s major weakness is the extent to which they have borrowed. Their leverage ratio is 1.9, meaning they have almost twice as much assets as they do equity. However, they have managed to have a debt burden of 2% of EBIT (or $9 million per year). So although they are leveraged, they have managed it well. In sum, Apollo has the propensity to do a lot with the assets they have, although much of those assets are borrowed.
The specific strength of Devry is that it is simply a well run company. The past three years have seen consistent numbers in assets and equity, with the decline in income almost directly proportional to the decline in sales. The weaknesses of Devry is its inability to capitalize on the assets they do have. The total asset turnover is 53%, with a Return on Equity of 7%. This may be a product of their high amount of shareholder’s equity, amounting to $1.4 billion dollars.
Their profit margin is a substantial 16.82%, indicating their low ROE is due to a large equity base rather than inefficiency in operations. They are at little risk to default, with leverage ratio is a modest 1.3, with a debt burden of 2.1% (or 3.6 million a year). In sum, Devry is well-run company, with an extensive amount of shareholder’s equity, little chance of default, and a high profit margin.
Key Statistics 2013
Shareholder’s Equity
Revenue
Income
ROE
Asset Turnover
Leverage Ratio
Apollo Group
$1,117,598,000
3,681,310,000
248,526,000
22.24%
171.25%
192.35%
Devry
$1,397,156,000
1,002,152,000
106,786,000
7.64%
53.97%
135.84%
On the Market
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The markets have rewarded Devry’s transparency and efficiency. Their current price of
$35.50 reflects a Price to Earnings ratio of 20.71. Their growth rate is a miniscule 5.4%, and when placed in a Perpetual Dividend Discount Model with a capitalization rate of 18.92%, the implied dividend of Devry is $4.76. Their dividend for the past year was $0.52, leading the reader to believe that perhaps this security is overpriced. However, this low growth rate is the product of a high level of shareholder’s equity, so a different approach to evaluation may be necessary. Finally, with a beta of 0.88, the CAPM model would state that Devry is less volatile than the market as a whole, but should return less than market aggregate. Thus, Devry appears to be an overpriced stock, as their P/E is high and the price of their stock, taken with their capitalization and growth rate implies a dividend of $4.76.
The markets have not been kind to the Apollo Group, with good reason. The Apollo
Group has yet to pay a dividend, and a sinking ship that has yet to pay a divided has the potential to never pay a dividend. That being said, there is an argument to make that the Apollo Group meets the criteria of a “value stock”, currently trading at $26.29. This translates to an appetizing
P/E ratio of 11.93. In the perpetual growth DDM, their market capitalization rate is less than their growth rate, rendering the DDM untenable. However, their earnings per share was $2.21 in
2012, which means they could issue a dividend equivalent to Devry’s. Their beta for the years of
2010 through 2012 was 0.77, which the CAPM theory would state the Apollo group is less volatile than the market as whole, but should return less as well. In summary, Apollo may be an undervalued stock at their current P/E ratio of 11.93, however, not paying a dividend and the qualitative risks mentioned above righteously draws investors away.
Key Statistics
Price
Growth rate
β
Apollo Group
$26.29
0.2224
0.77
Devry
$35.50
.0539
0.88
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Price / Earnings
Book / Market
11.93
2.61
Future Projections
23.29
1.57
In order to project future income, it is necessary to dissect income into its causal parts.
Income is the difference between sales and expenses. Revenues, for theses two companies, come from enrollment. Each student enrolled produces some quantifiable amount of income, and as a result, enrollment numbers multiplied by a sales-per-student coefficient can project sales. The expenses amount to a percentage of total sales, and are relatively fixed as universities cannot close wings, fire teachers, or shut down operations quickly. Solving for enrollment, sales-tostudent, and expenses should result in projected income. Each variable will have a specific likelihood of occurrence, and as a result, a weighted average from all possible outcomes will produce the expected return.
To project future enrollment, the relationship between enrollment and the national unemployment rate is used. Logically, unemployment rates and enrollment increase proportionally. The data suggests a causal relationship, as enrollment peaks for both Devry and
Apollo in 2010, as does the unemployment rate. Running a linear regression with unemployment rates as the independent variable and enrollment as the dependent variable, a numerical relationship is defined. It is found that for Devry: Enrollment = (10593)*(Unemployment Rate)
+ 16866, and for Apollo: Enrollment = (23476)*(Unemployment Rate) + 201913. With these equations in hand, it is possible to project enrollment based upon unemployment rates.
The Federal Reserve projects future unemployment, from which future enrollment can be calculated. The Federal Reserve projects unemployment rates to be 6.2 to 6.9 for the year of
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2014
1
; however, the Federal Reserve tends to have a bias towards inflated numbers. Utilizing the equations found above and plugging in specific unemployment rates, it is estimated that Devry has a 5% probability of having 92,076 students next year at 7.1% unemployment, 20% probability of having 90,487 students at 6.9% to 7% unemployment, 50% probability of having
87,309 students at 6.5% to 6.8% unemployment, 20% probability of having 84141 students at
6.3% to 6.4% unemployment, and a 5% probability of having 82,542 students at 6.2% unemployment. Apollo has a 5% likelihood of 368,592 students at 7.1% unemployment, 20% likelihood of 365,071 students at 6.9% to 7% unemployment, 50% likelihood of 358,028 students at an unemployment rate of 6.5% to 6.8% unemployment, 20% likelihood of 350,985 students at 6.3% to 6.4% unemployment, and a 5% likelihood of 347,464 students with an unemployment rate of 6.2%. Thus, the projected enrollment numbers and their respective probabilities are found.
Unemployment
Rate
Probability Devry Enrollment Apollo
Enrollment
1 Federal Reserve Bank,
‘Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents,
September 2013’
, 18 September 2013, Federal Reserve, Web, http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20130918.pdf, 18 October 2013
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7.1%
6.9 - 7
6.5-6.8
6.3-6.4
6.2
10%
15%
50%
15%
10%
92076.3
90487.35
87309.45
84131.55
82542.6
368592.6
365071.20
358028.4
350985.6
347464.2
Having established the projected enrollment numbers, it is necessary to examine the sales multiplier, which will translate enrollment numbers into dollars. To do so, the past relationships of total sales divided by total students are examined. Over the past three years, Devry first increases and then decreases with $9,682 dollars per student in 2010, $10,109 dollars per student in 2011, and $8,808 dollars per student in 2012. Apollo has seen a climb in sales per student, as they sold $10,006 in 2010, $11,169 in 2011, and $11,224 in 2012. From past data, future projections can be estimated.
Future projections are based upon the opinion that Devry will most likely bounce back to a little less than its former efficiency. There is a 25% probability that it will continue its slide in efficiency with $8,000 per student, and a 25% probability that it will exceed expectations at
$9,500 per student. There is a 40% probability that Devry will turnover $9,000 per student, and a 5% probability for both a $10,500 and a 5% likelihood they will produce $7,000 per studnet.
Apollo has a modest projected growth in sales per student. There is a 40% likelihood to have a
$11,500 turnover, a 25% likelihood to produce $12,000, a 25% likelihood $10,500, a 5% likelihood to produce a high $12,750 per student, and a 5% likelihood they will produce $10,000 per student. Thus, the sales multipliers, and the corresponding probabilities have been calculated.
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Sales / Student Probability
Highly Optimistic 5%
Optimistic 25%
Neutral 40%
Pessimistic 25%
Highly Pessimistic 5%
Devry
10500
9500
9000
8000
7000
Probability
5%
25%
40%
25%
5%
Apollo
12750
12000
11500
10500
10000
It is necessary to project the future expenses of the companies. Expenses can be found by subtracting income from sales. In this method of projection, the percentage of sales that is lost to expenses is sought, and as a result, the difference between sales and income is divided by sales.
Multiplying that coefficient by projected sales will compute expenses. The equation is:
( 𝑠𝑎𝑙𝑒𝑠 − 𝑖𝑛𝑐𝑜𝑚𝑒 𝑠𝑎𝑙𝑒𝑠
) (𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑠𝑎𝑙𝑒𝑠) = 𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠
Again, the method is to extrapolate future projections from past data. In 2011, Devry saw expenses accounted for 73% of sales, 87% in 2012, and 89% in 2013. The projected ratios for
2014 are 85% at 5% probability, 89% at 25% probability, 91% at 40% probability, 92.5% at 25% probability, and 94% at 5% probability. For Apollo, 2011 saw expenses account for 87.8 percent of sales, 89.6% in 2012, and 93.2% in 2013. The projected ratios are 90% at 5% probability,
92% at 25% probability, 94% at 40% probability, 95% at 25% probability, and 96% at 5%. Thus, the ratio of expenses to sales and the corresponding probability has been calculated.
Highly Optimistic
Optimistic
Neutral
Pessimistic
Probability
5%
25%
40%
25%
5%
Devry
.85
.89
.91
.925
.94
Probability
5%
25%
40%
25%
5%
Apollo
.90
.92
.94
.95
.96
Highly Pessimistic
Having established projections and probabilities for sales and expenses, it is possible to find an expected return. The expected return is the sum of all possible incomes weighted by their respective probability. As there are five possibilities for future enrollment, five possibilities for
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sales multiplier, and five possibilities for earnings coefficient were calculated, there are a total of
125 possible incomes. Each of those 125 possible incomes is weighted by multiplying the probability of their respective components
2
. The equations used for expected income is:
((enrollement − to − sales multiplier)(enrollment))– ((revenue diverted to expenses multipier) ∗ (E − to − S multiplier)(enrollment))
= projected income
(probability of e − to − s multipler) ∗ (probability of enrollment) ∗ (probability revenues diverted to expenes multiplier)
= projected probability of income
∑ (𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑝𝑟𝑜𝑏𝑎𝑏𝑖𝑙𝑖𝑡𝑦 𝑜𝑓 𝑖𝑛𝑐𝑜𝑚𝑒 𝑓𝑜𝑢𝑛𝑑) ∗ (𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒) = 𝑡𝑜𝑡𝑎𝑙 𝑝𝑟𝑜𝑗𝑒𝑐𝑡𝑒𝑑 𝑖𝑛𝑐𝑜𝑚𝑒
The results are an expected income for Apollo at $257,648,079, while Devry produces
$72,255,022. Looking the income trends for Apollo demonstrates a “leveling off” of their fall in income, after producing $442,678,000 in 2012 to $248,526,000 in 2013. Devry continues its trajectory downward, as seen with an income of $141,564,000 in 2012 and $106,786,000 in
2013.
The same procedure was utilized to project for the year of 2015. Adjusting only the numbers above for the Federal Reserve’s projected unemployment rate, it was found that the expected income for Apollo and Devry for 2015 will total $ 248,720,209 and $ 72,158,596, respectively. Meaning, Apollo's income continues to fall as in previous years, while Devry's numbers seem to level out, decreasing only marginally.
Apollo 2014 Devry 2014 Apollo 2015
Expected Income
SD
$257,648,079 $72,255,022 $248,720,209
47,799,505.44
13,476,900.21
42,718,221.24
Shares Outstanding 112,803,000 60,000,000
Earnings Per Share 2.2841
1.2043
112,803,000
2.2049
Projecting Prices
2 See Appendix 2
Devry 2015
$72,158,596
12,503,414.97
58,000,000
1.2441
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Having projected future income for both Devry and Apollo, it is necessary estimate the effect of this income on the price of their securities. The projection of price is, of course, challenging and uncertain.
An earnings report of $75,255,002 will certainly send Devry’s stock price downward.
The extent to which the market will punish Devry when they release their earnings for 2013-
2014 can be estimated by previous punishments for poor earnings. On July 4 th
, 2011when Devry released their earnings report for 2010-2011, Devry was trading at $62.50. By August 15 th , 2011,
Devry was trading at $39.50, a 36.8% drop. Similarly, on July 2, 2012 when Devry released their earnings report for 2011-2012, Devry was trading at $31.50. By July 30 th
, 2012, Devry was trading at $18.50, a 41.2% drop. However, when the earnings report was released in 2013, no significant drop occurred. The average percentage drop of these three years is 26%. As a result, an educated guess of the price of Devry one month after the release of their income statement should be between $26 and $28.
Apollo, on the other hand, recently beat investor’s expectations for earnings. Their stock jumped from $20.94 on October 22 nd
, 2013 to $26.29 on November 26 th
, 2013, amounting to a
25.5% increase in price. As the projected income for Apollo is 3.67% increase from the earnings report of 2012-2013, a similar price jump is not anticipated. At the same time, two years of consistent earnings report should quell fears of a perpetual downward slide, and the low P/E ratio of 11.5 should make Apollo an appetizing stock to investors. An honest estimate for the price of
Apollo is between $29 and $31 dollars.
It is the belief of the writers that Apollo is falling into the category of a value stock , and should be picked up by smart money managers. For, “value stocks -defined by low P/E ratio, high book-to-market ratio, or depressed prices relative to historic levels – seem to have provided
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higher average returns than ‘glamour’ or growth stocks.” 3
Apollo has a low P/E ratio of 11.5, and their current price of $26.29 is a depressed price in comparison to its high of $93.49 in May
2004. If Apollo does meet the category of a value stock, one should expect Apollo to beat the returns of growth stocks. As smart money managers will add it to their portfolios, the price will continue to be driven up.
Present Value
Having projected future prices, in a next step the fundamental value of these firms can be calculated. The required numbers for discounting the cash flows are the betas for each company, the risk-free rate, the market returns, and projected cash flows. From the treasury department, the 1-year risk free rate is 0.13% and 0.28% for the two- year
4
. Goldman Sachs’ David Koshin projects the S&P to end 2014 at 1,900 and end 2015 at 21,000
5
, representing a market return from the current level of 18,005 of 5.5% and 10.5%, respectively. The beta of Apollo and Devry as represented by the NASDAQ composite were 0.77 and 0.88 for the years of 2011 -2013, respectively. That gives a required rate of return of 4.29 % for Apollo and 4.85% for Devry in
2014, and 8.17% for Apollo and 8.37% for Devry in 2015.
The projected dividend for Devry in 2014 is $0.36 with their current plowback ratio.
However, the plowback ratio for Devry has been decreasing from 0.95 in 2010 to 0.87 in 2011 to
0.70 in 2012. In order to maintain the dollar amount of dividends issued in 2013, Devry must cut their plowback ratio to 0.56 with their current amount of shares-outstanding. The outstanding shares have declined from 68,420,000 in 2010 to 64,120,000 in 2011 to 62,300,000 in 2012. As
3
Zvi Bodie, Alex Kane, Alan Marcus, Investments, McGraw-Hill/Irwin Series in Finance, Insurance and Real Estate, Ninth (9th)
Edition, Chapter 11, page 367,
4 U.S. Department of the Treasury, Resource Center, Interest Statistics, http://www.treasury.gov/resource-center/data-chartcenter/interest-rates/Pages/TextView.aspx?data=yield, 26 November 2013
5 Nick Taborek,
‘Goldman Sees S&P 500 Falling 10% Next Year Before Rally to 1,900’
, 26 November 2013, Bloomberg, Web, http://www.bloomberg.com/news/2013-11-26/goldman-sees-s-p-500-falling-10-next-year-before-rally-to-1-900.html, 27
November 2013
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a result, a projected outstanding shares number of 60 million results in a dividend of $0.54 at the plowback ratio of 0.56. This number assumes that Devry will attempt to keep their dividends at their current level. On the other hand, Apollo pays no dividend. All their earnings will be based upon projected stock prices.
To project stock prices for 2015, the growth rate of the market was discounted by the beta coefficient. Meaning, if the market is expected to increase 6.5% in 2015, and Devry has a beta of 0.77, the price of Devry is expected to increase 5%. The reasoning assumes that there is a direct trade off in returns for volatility.
To solve for present value, future cash flows were discounted at the rates found above.
The equations for the cash flows are:
𝐴𝑝𝑜𝑙𝑙𝑜 𝑃𝑉
2014
30
=
(1 + .0429)
= $28.77
𝐴𝑝𝑜𝑙𝑙𝑜 𝑃𝑉
2015
32.43
=
(1 + .0817) 2
= $27.72
𝐷𝑒𝑣𝑟𝑦 𝑃𝑉
2014
=
0.53 + 27.00
(1 + 0.0439)
= $26.39
𝐷𝑒𝑣𝑟𝑦 𝑃𝑉
2015
0.53
=
(1 + 0.0437)
+
29.50 + 0.56
(1 + 0.0837) 2
= $27.17
The present value of the Apollo stock is $28.77 for 2014, and $28.54 for 2015. At its current trading price of $26.40, this equates to yield of 9.42% for 2014 and a yield of 5.44% yield for
2015. For Devry, the present value is $26.39 in 2014 and $27.17 in 2015, resulting in a yield of negative 25.65% in 2014 and negative 23.47% in 2015. As a result, it is concluded that longing
Apollo and shorting Devry is the optimal position.
S&P Present / Projected
S&P rate of return
2013
18005
2014 2015
19000 21000
5.53% 10.53%
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Beta Devry
Beta Apollo
Risk-free rate
Apollo Required rate of return
Devry Required rate of Return
Projected Growth Rate Apollo
Projected Growth Rate Devry
Projected dividend Apollo
Projected dividend Devry
Current Price Apollo
Current Price Devry
Projected Price Apollo
Projected Price Devry
Present value Apollo
Present value Devry
YTM Apollo
YTM Devry
0.88
0.77
0.13%
$0.00
$0.53
$26.29
$35.50
0.88
0.77
0.26%
4.29%
4.39%
8.17%
8.37%
23.05% 22.25%
2.90% 2.84%
$0.00
$0.56
$30.00 $32.43
$27.00 $29.50
28.77
26.39
27.72
27.17
9.42% 5.44%
-25.65% -23.47%
Conclusion
In this paper, it was found that a wise investor should short Devry and long the Apollo group. The reasoning is that the Apollo Group is an underpriced security, most notably seen in their P/E ratio of 11.93 to Devry’s P/E of 20.71. When income projections were made, it was found that both groups face decreasing enrollment as a result of declining unemployment rates.
However, the efficiency of the Apollo group to turn enrollment into sales exceeded that of the
Devry Group. As a result, the Apollo group looks to increase sales by 19 million and the Devry
Group will decrease sales by 34.5 million. This change in income will result in a major slip in prices for Devry, and an increase in prices for the Apollo Group. When future cash flows are projected, an investment in Apollo will result in a 9.42% yield in the first year, and a 5.44% yield in two years.
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