Back To Earth For Apollo Group?

High marketing costs could slow growth for the University of Phoenix parent

Last fall, when Apollo Group paid a big fine to the U.S. Education Dept. to close an investigation of aggressive recruiting practices by its University of Phoenix subsidiary, many investors feared the fast-growth company was about to hit the wall. By November, the stock had plunged 36%, to $62.55 -- an abrupt reversal of the previous 4 1/2 years, when Apollo's price rose from $9 to $98.

Since then, Apollo Group Inc. (APOL ) CEO Todd S. Nelson has worked feverishly to reassure investors that the scandal was nothing more than a hiccup. In mid-December, the Phoenix-based company reported that net income and sales surged 30% in the quarter ended Nov. 30, the first since the scandal broke. Nelson insists he sees plenty of room for expansion, including plans to charge overseas and to enter the market to serve younger college students. "The next five to 10 years look very, very promising," he says.

But Apollo will have to fill acres of classroom seats to keep up its pace -- and it is paying an ever-increasing cost to do so. The company already has 268,000 students. Some 90% of those are enrolled at the University of Phoenix, making it by far the nation's largest private university. Apollo also runs separate schools for financial planning and professional development and Western International, a small university. Given that size, it had to add nearly 57,000 students -- the equivalent of another University of Texas at Austin -- in the past 12 months just to make its growth target.

And Apollo spent $383 million on marketing last year -- a staggering amount, considering that few universities spend even $10 million. Marketing costs surged 48% in the first quarter, to 22.5% of revenues, up from just 15.8% in 2000. True, Apollo's earnings last year grew an impressive 36%, to $336 million, before special charges, on 34% higher revenues of $1.8 billion -- vaulting it to the No. 48 spot on the BusinessWeek 50 ranking of top-performing companies. But Barmak Nassirian, associate executive director of the American Association of Collegiate Registrars & Admissions Officers, warns: "This rate of growth may not be sustainable." His group represents traditional colleges, many of which are critical of Apollo. But even Nelson expects revenues to grow at a slower 27% pace this year.

BOILER ROOM

Until recently, Apollo had the wind at its back. John G. Sperling, who founded Apollo in 1976, was a visionary who saw a huge untapped market in working adults who needed degrees to get ahead at work but couldn't fit into the rigid schedules at many colleges. Phoenix caters to them by offering courses at convenient times and locations. In the early 1990s, Phoenix made it even easier when it became one of the first universities to offer full degree programs online. With many employers willing to foot all or part of the $10,000 yearly tuition tab, enrollment has grown ninefold over the past decade.

But Apollo's reputation was sullied in September with the release of the Education Dept. report. The authors depicted a high-pressure sales culture that resembled a telemarketing boiler room more than a university admissions office. "Phoenix recruiters soon find out that UOP bases their salaries solely on the number of students they recruit," the report charged. That's prohibited by federal law. One recruiter who started at $28,000, for instance, was bumped to $85,000 after recruiting 151 students in six months. But another who started at the same level got just a $4,000 raise after signing up 79 students.

Ultimately, such violations could have led the government to bar Phoenix from the federal student loan program, crippling the university. Nelson calls the report "very misleading and full of inaccuracies." But he says he decided to settle rather than wage a protracted fight. Apollo agreed to change its compensation system and pay a $9.8 million fine without admitting guilt. Still, Apollo's defenders note that the point of the law is to prevent for-profits from luring unqualified students. If Phoenix is doing that, it hasn't showed up in student-loan default rates, which remain a low 6%.

FOREIGN EXPANSION

With the regulators off its back, Apollo is once again focusing on growth. The online program, with 133,000 students, is far from saturated. And for the first time Apollo is targeting high school graduates, who are expected to hit a record later this decade. Similarly, Apollo has barely begun to scratch the international market, where experts see huge demand for U.S.-style education. Phoenix plans to open its first Mexican campus this year, and Nelson also has big hopes for China, where Apollo's Western International University now has just 50 students.

But future growth won't come as easily as it has in the past. Phoenix was once one of the only players online. Now it faces a lot more competition from public universities and other for-profits, warns Sean R. Gallagher, senior analyst at Eduventures Inc., a Boston-based researcher. Most worrisome, though, are the rising marketing costs. "The big question now is whether that means the economics of this business are changing," says Gregory W. Cappelli, an analyst at Credit Suisse First Boston (CSR ).

Until that's answered, even Cappelli, who calls Apollo "a fantastic company," is urging a "neutral" attitude toward its stock, now at $82. This onetime star is teaching a new course in caution.

By William C. Symonds in Boston

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