ITT Educational Services Inc. (NYSE:ESI) offers postsecondary education in the form a masters, bachelors and associate degree programs. It provides flexible educational solutions for students in information technology, drafting and design, business, and criminal justice, and nursing and health sciences. ESI has an annual enrollment of about 55,000 students on 147 campuses in the United States.
We feel that ESI has done a good job wading through its prior problems. They currently have a Wells notice and an SEC investigation. We feel that both of these investigations will be dropped because ESI has proven, or will prove themselves in the near future. ESI is worth only about 20% of what it was under a year ago due to these factors. Once ESI is past these issues they will be valued based on fundamentals and return a share price that is competitive with comparable companies in the industry.
$100 Million Loan From Cerberus
On December 4, 2014 ESI entered into a financing agreement with Cerberus Business finance for $100 million dollars. This loan is to be used as collateral for the $89.2 million for letters of credit that remain outstanding. This loan has been seen by the market as a large display of faith in ESI by a large player in the market. ESI has also raised its cash and cash equivalents from $100 million to $150 million.
Wells notice will be dropped
On September 19, 2014 ESI was issued a Wells notice. ESI was required to submit a letter of credit of $79.7 million. The new financing through Cerberus will easily allow ESI to put up this line of credit and eliminate the Wells notice. Upon the announcement of the elimination of the Wells notice ESI will prove to investors that they are on their way out of trouble. When the Wells notice is rescinded, ESI will show a rapid share price increase, as its announcement almost cut share price in half.
SEC will cease investigation
ESI has been under investigation from the SEC for missing mandated SEC filings. In the past few months ESI has restated their financials and brought everything up to date. With the recent hire of Deloitte, statements will be current in the near future. The SEC will drop their investigation. This will remove yet another drag on ESI’s share price. In general, many of the major catalysts for ESI involve getting back to business as usual.
The Department of Education will not shut ESI down
In our opinion, the Department of Education has no intentions of shutting down ESI, and would prefer to give them a clean bill of health. ESI has over 50,000 students that would be without an institute of learning if it were shut down. To compound the issue many of ESI’s job specific course credits would not be transferable to more traditional universities.
The last thing the Department of education wants is more bad press after the mishandling of Corinthian Colleges (NASDAQ:COCO). With the closing of Corinthian Colleges the Department of Education left over 50,000 students with student debt. These students are not able to easily find programs to accept their credits from COCO. This is not only putting an undue burden on a person trying to better themselves, but also government loan programs. Because the students were not able to graduate and generate income from higher education, they cannot afford to pay back their student loans. Therefore, the government is on the hook for many of these loans. The Department of Education does not want this fiasco to occur again.
We believe that it is in the DoE’s best interest to keep ESI running. ESI has made the right changes to appease the DoE, and now the DoE could use ESI as an asset. With a proper plan, ESI could take over some of COCO’s programs and accept the credits of students that have been put out. This is helpful for the DoE and the 50,000 students that took on student debt but could not obtain a degree before the DoE shut down COCO.
Set up for major short squeeze
Shares have been shorted at an astounding rate since the announcement of the aforementioned investigations. As of November 28, 2014 over 60% of ESI’s shares outstanding are sold short. The announcement that any investigations will cease should cause many of the shorts to cover their positions. Short covering forcing the buying of shares of ESI should cause a massive spike in share price. There are about 11 million shares shorted right now. At current volume it would take the shorts almost a month to cover their positions.
We used three exceptionally comparable for-profit post-secondary educational institutions to value ESI. The Apollo Group (NASDAQ:APOL), DeVry (NYSE:DV), and Strayer (NASDAQ:STRA) all compete in the same for-profit education market that ESI operates in. ESI is currently the smallest of these companies by market cap but less than one year ago it was larger than Strayer by market cap.
Compared to its three closest competitors ESI is heavily undervalued. We feel that ESI has been heavily over discounted due to the Wells notice and SEC inquiry. When pricing it at a fair value to its peers ESI is worth about $33.91 per share. We feel that this price is attainable but over the coming months there may be some fluctuation in the price to move past the investigations. With new management in place we feel that in 12 months ESI will be priced approximately half of what it is actually worth or about $17 per share.
We feel that ESI provides a huge opportunity for brave long term investors. This position does not come without risk as the share price has been fluctuating as much as 10% on a daily basis. The biggest catalyst for ESI is the wrap up of detrimental investigations. These investigations will cease in the near future because ESI has met the burdens set forth by the regulators. In the coming months we feel that ESI will revert back to industry average metrics as it comes out of its problems. ESI is currently valued at approximately 25% of comparable companies, and has much room to grow. This is a long term value play that will come to fruition in under 12 months.
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