After years of on-again-off-again controversy, the for-profit education industry is experiencing an explosion of negative publicity and government scrutiny—and investors have noticed.
Once the darlings of Wall Street, for-profit education companies have seen their market value plunge to the lowest level in 52 weeks, leaving investors to wonder if the industry would be able to survive in its current form. An index of nine for-profit education companies, the S&P 1500 Education Services Index is down nearly 30 percent for the year.
ABCs of The Business
Serving mostly non-traditional students, for-profit schools offer a wide range of programs: from technical and vocational training, to four-year liberal arts degrees, and even PhDs.
Over the last decade, enrollment in these colleges surged by 300 percent 1.5 million—ten times the rate of all post-secondary programs. Their coffers also grew quickly. During the past 10 years, the industry’s revenue has ballooned from $9 billion to $29.2 billion, according to BMO Capital Markets.
Much of this spectacular growth, however, has been funded by taxpayers.
For-profit schools are private businesses, but finance their operations primarily with public dollars coming by way of federal student aid.
While these schools enroll roughly 10 percent of all higher education students, they receive 24 percent of public funds. In 2009, that amounted to more than $24 billion.
Moreover, the schools benefit from other forms of government aid— including money from Department of Defense, Department of Veterans Affairs and various state programs. In the last four years, combined VA and DoD education benefits received by for-profit education companies increased 683 percent to $521 million.
At many for-profits schools, like , part of the Apollo Group,, federal loans and grants now account for almost 90 percent of revenue.
The business model built around taxpayer subsidies has allowed not only for impressive growth of for-profit education companies, but also for impressive compensation for their executives, critics argue.
Last year, Strayer Education paid its Chairman and CEO Robert Silberman $41.9 million, according to the company's proxy statement. That is 24 times more than the compensation of the highest-paid president of a traditional school, according to data from executive compensation research firm Equilar.
Most of Silberman's compensation comes from a $40 million stock grant that vests over ten years and is tied to company's academic, operational, and financial performance. His base salary in 2009 was $665,000. The second highest paid CEO in the industry was Andrew Clark of Bridgepoint Education. The company, which has $913 million in market cap, paid Clark $20.5 million last year.
Return of Subprime?
While the taxpayer investment in the industry is enormous and starkly evident, the return on investment is much harder to assess.
A combination of low graduation rates and high loan default rates, along with questionable job placement numbers has raised concerns that the schools are abusing the system, merely collecting government funds, and delivering little in the way of a usable education.
A recent report from Education Trust, an influential Washington think tank, equated for-profit colleges to subprime lenders and accused the industry of "peddling access to the American dream but delivering little more than crippling debt."
Earlier this year, hedge fund manager Steve Eisman made waves with a similar comparison. Eisman tied the industry's success to a Bush administration that loosened regulations and increased the private sector's access to public money.
"The government, the students, and the taxpayer bear all the risk, and the for-profit industry reaps all the rewards," said Eisman in a speech at the Ira Sohn Investment Research Conference last May. "This is similar to the subprime mortgage sector in that the subprime originators bore far less risk than the investors in their mortgage paper."
Not surprisingly, the industry disagrees with the argument. Harris Miller, President of the Career College Association, called the comparison "absurd".
Regulatory Change In The Wings
The parallels, though simplistic, are striking, raising important questions.
For example, take student loan defaults. True, the rates are rising across the board, but graduates of for-profit schools default at three times the rate of those at private nonprofit institutions. Last year, students at for-profit colleges represented 26 percent of the borrowers and 43 percent of all defaulters, according to the Education Department.
Over the past two years, defaults have swollen to $50 billion from $36.6 billion. As of the end of September, the government collected $10.2 billion of that money.
Industry representatives argue that rising default numbers reflect the poor economy. They also note that for-profit schools enroll large numbers of low-income students, who are likely to default no matter what institution they graduate from.
But like the subprime mortgage industry, are for-profit schools saddling people with debt they cannot afford?
Not Just a “Few Bad Apples”?
Government reports and Congressional hearings paint a picture of an industry with serious systemic problems and a questionable business model.
Florida's Attorney General Bill McCollum is investigating practices of five colleges run by Education Management , Corinthian Colleges , Washington Post and Apollo Group.
A separate probe by the Government Accountability Office found that enrollment counselors at 15 for-profit colleges had lied or misrepresented programs, and encouraged applicants to make false statements on financial-aid applications. Critics say the industry functions as a giant marketing machine that targets unsophisticated consumers and poses a real danger.
In a report this month, Senator Tom Harkin, Chairman of the Health, Education, Labor and Pension Committee voiced concerns about the share of military education funds going to for-profit schools with questionable outcomes.
“This report raises serious questions about whether some for-profit education companies view providing education to our service members and veterans as incidental to ensuring a robust profit for their company and their shareholders,” said Harkin.
The Obama administration has been raising pressure on for-profit education providers. The Education Department wants to tie distribution of federal student aid to school's ability to demonstrate that it prepares students for "gainful employment", which is a somewhat abstract measure of graduate's ability to repay student loans.
The final proposal, which is expected to restrict the flow of taxpayer dollars to for-profits whose results do not meet certain metrics, is expected early next year.
For now, the schools are fighting tooth and nail to water it down. But they also realize that things will have to change.
Many for-profit education companies, including Apollo and the Washington Post’s Kaplan Education, are already making adjustments to their business model and concede that the changes will eat into their profits, at least in the near term.
Here to Stay
There is still a lot of uncertainty surrounding the industry. But some things are clear.
For-profit colleges are here to stay. The demand for higher education continues to grow, and traditional schools cannot meet it alone.
"In the United States of America, where fewer than 30 percent of adults have bachelors degrees, I can't envision a way to ensure that those who were left behind by the traditional institutions, have an opportunity to realize the American Dream other than through programs like ours," President of Strayer University, a subsidiary of Strayer Education , Sondra Stallard told CNBC.
Education Secretary Arne Duncan, who is critical of the industry, has said that for-profits are important to President Obama's goal of increasing college graduation rates in the United States by 2020.
So as more money is expected to flow into the higher education and to for-profit schools, questions about quality and accountability remain critical. Thus far, the industry has not been eager to answer them.
Watch the premiere of "Price of Admission: America's College Debt Crisis," Tuesday, December 21 at 9pm ET on CNBC.