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Debate Club: Education Stocks – Buy or Sell?

In the battle between the bulls and the bears, it’s often best to not take sides. So if two powerful yet diametrically opposed hedge fund managers disagree over, say, education stocks, there might be a better way to play the sector than buying or selling the companies in question.

This scenario played itself out just yesterday at the annual Ira Sohn Investment Research Conference in New York, as legendary short seller James Chanos of Kynikos Associates and Lone Pine Capital’s Steve Mandel debated the idea of investing in for-profit schools like Strayer or American Public Education.

While Mandel sees tremendous secular growth potential in this group, and a great entry point given these stocks’ recent pause, Chanos is worried about President Obama meddling in the sector the way he has in health care. Mandel sees working-adult post-secondary education as a cheaper, more attractive alternative to community colleges and state universities, but Chanos thinks the White House will view 27% operating margins – the industry average – as piggish.

Why? Because a significant chunk of for-profit schools’ revenues come from government-funded student grants and loans. They then spend 53% of those revenues on advertising. That may look to some people like Washington is subsidizing the ad campaigns that eventually generate big profits for these education firms. So if Obama trains his righteous sights on this sector, many companies could take a hit.

The long-term thesis behind the education stocks still works, though, Cramer said. Investors just have to find the right play. The group’s most recent IPO, Bridgepoint Education , might work. Bridgepoint just came public in April, so it missed the rally enjoyed by its peers. And the stock is up just $2 so far, leaving plenty of room for upside. Compare that with Grand Canyon Education, which added 70% to its share price in the two months following its IPO.

Bridgepoint is also growing faster than some of its biggest competitors, such as Apollo Group and the aforementioned Strayer. BPI expects its student body to increase by more than 50% this year alone. In 2010, the company should grow earnings in the high 20% range. This makes the stock, trading at just 14 times earnings, look cheap.

Another positive is Bridgepoint’s political cover. The company does earn much of its revenues via student loans and grants, but it charges less – 30% less, in fact. And in some cases tuition is 50% lower. Also, marketing costs are just 35% of revenues and not the 53% other companies seem to be spending. Lastly, operating margins here are just 15%, certainly not enough to draw the ire of Washington.

Given these positives, Cramer doesn’t see much worth debating. Investors should let Wall Street’s giants fight over other education stocks while they buy Bridgepoint.

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