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Big Short Eisman Vies With Goldman Over For-Profits

Portfolio Manager Steve Eisman
Steve Eisman, senior portfolio manager with FrontPoint Financial Services. Photographer: Daniel Acker/Bloomberg

U.S. higher-education stocks fell 48 percent from April to October last year as the federal government proposed tighter regulation and short sellers led by hedge-fund manager Steve Eisman targeted for-profit colleges.

Eisman, whose early bet against the housing market was chronicled in Michael Lewis’s 2010 book “The Big Short,” lobbied Department of Education officials and Senate staffers, according to documents obtained through a Freedom of Information Act request. He publicly called for-profit schools “as socially destructive as the subprime-mortgage industry.”

Now, value investors are buying the stocks, saying the worst is probably over. Maverick Capital Ltd. and Goldman Sachs Group Inc. have seen their investments rebound as the Bloomberg index of 13 for-profit colleges has rallied 17 percent since its 2010 low on Oct. 15, compared with the 9.1 percent gain by the Standard & Poor’s 500 Index.

“There is a lot of fear-mongering, which is actually great because it causes the stocks to probably overshoot on the downside, giving us the opportunity to look at them,” said Jason Subotky, vice president at Yacktman Asset Management Co. in Austin, Texas, which has $6.7 billion under management.

“We are glad the short sellers came along to amplify the uncertainty,” Subotky, whose firm owned 1.67 million shares of Apollo Group Inc. as of Sept. 30, said in an interview. The firm has increased its stake since, he said.

University of Phoenix

Apollo is the operator of University of Phoenix, the biggest for-profit college by enrollment. On Jan. 10, after the close of regular U.S. trading, the Phoenix-based company reported a higher-than-expected profit for the first quarter ended Nov. 30. The stock rose 13 percent the next day, and has gained an additional 3.95 percent since, while the S&P 500 is little changed.

The $33 billion for-profit college industry tripled enrollment to 1.8 million in the past decade while some of the biggest companies -- among them Apollo Group, Education Management Corp. and Washington Post Co.’s Kaplan Education unit -- received 80 percent to 90 percent of their annual revenue from federal student aid, according to company filings. The industry stock index more than doubled from 2006 through its 2010 peak on April 21. The S&P 500 fell 3.4 percent in the same period.

Beginning last year, the Government Accountability Office and Congressional Democrats, including Senator Tom Harkin of Iowa, have raised questions about the industry’s recruiting practices and record on educating students.

Limiting Loans

Secretary of Education Arne Duncan said in September that a new rule, known as “gainful employment,” will be published early this year that would limit the industry’s access to federal student aid by linking for-profit colleges’ eligibility for government grants and loans to former students’ incomes and loan-repayment rates.

Industry trade groups and company executives have been lobbying against the rule. They helped generate 90,000 letters and e-mails in response to the proposal last year, leading Duncan to delay implementation.

Donald Graham, chief executive officer of Washington Post, criticized proposed regulations Jan. 14 in an op-ed article in the Wall Street Journal, writing “their result will be less access for our nation’s most needy students.”

Eisman’s bets against bonds backed by subprime mortgages helped double the size of his portfolio at FrontPoint Partners LLC, the Greenwich, Connecticut-based hedge fund where he is a managing director, according to Lewis’s book. In May, at the Ira Sohn Investment Research Conference in New York, he predicted that higher-education stocks could fall as much as 50 percent if the government tightened student-loan rules.

‘Morally Bankrupt’

“Until recently, I thought that there would never again be an opportunity to be involved with an industry as socially destructive and morally bankrupt as the subprime-mortgage industry,” he said. “I was wrong. The for-profit education industry has proven equal to the task.”

Vijai Mohan, a hedge-fund manager at Hyphen Fund Management LLC in San Francisco, who had a stake in Washington Post, decided to sell after Eisman spoke at the conference.

“He’s such a high-profile investor, people listen to him and he was quoted widely, and congressmen started scratching their heads and decided they needed to do something,” Mohan, who declined to disclose how many Washington Post shares his fund held, said in an interview.

Attractive Valuations

Eisman’s comments helped accelerate a selloff that has left companies in the higher-education index trading at an average of nine times last year’s profit. That’s 43 percent less than the price-earnings ratio of 15.8 for the S&P 500, according to data compiled by Bloomberg. Santa Ana-based Corinthian Colleges Inc. trades for 3 times earnings. No stock in the S&P 500 is that cheap.

The decline has attracted value investors, who buy stocks they consider inexpensive based on financial measures like earnings.

Many value investors “stayed away from the group for two years as they were put off from the regulatory overhang,” said Trace Urdan, an analyst with investment bank Signal Hill Capital Group LLC in San Francisco. They now “seem sufficiently confident that the regulatory environment is going to resolve itself, at least no worse than it’s been seen so far, and are stepping in.”

‘Significant Opportunity’

David Perkins, an analyst at Wallace R. Weitz & Co. in Omaha, Nebraska, said, “Often times the most opportune time to purchase a stock is when people believe the story the least.”

The investment firm oversees $3.7 billion, including shares of Phoenix-based Grand Canyon Education Inc., Strayer Education Inc. of Arlington, Virginia, and Washington Post, where the Kaplan unit generates two-thirds of the Washington-based company’s revenue.

“As longer-term value investors, we’re not playing the headlines or trying to find investments that will necessarily reward us in the near term,” Perkins said in a telephone interview. “We believe there’s still a significant opportunity to educate working adults in this country and that the for-profit model, when applied in the best interest of its students, is an economically compelling means of providing a necessary public good.”

For-profit college investors include hedge funds Maverick Capital, New York-based Tiger Global Management LLC, Lone Pine Capital LLC of Greenwich, Connecticut, and San Francisco-based Blum Capital Partners LP. Goldman Sachs, the New York-based investment bank, has a 39 percent stake in Pittsburgh-based Education Management. Warren Buffett’s Berkshire Hathaway Inc. of Omaha owns 24 percent of Washington Post.

Maverick’s Ainslie

Lee Ainslie, the New York-based founder of Maverick, invested in Apollo in the third quarter of 2008 and has added to his position. In the third quarter of 2010, he bought 190,692 shares, for a total of 7.7 million shares valued at about $330 million. Maverick owns 5.4 percent of Apollo, making it the company’s second-largest shareholder after John Sperling, its founder, according to data compiled by Bloomberg. Apollo fell 35 percent last year, the third-worst performer on the S&P 500.

At the Value Investing Congress in New York in October, Ainslie defended for-profit schools. “They serve minority communities that are underserved,” he said. “For-profit colleges deliver better results than community colleges.”

Ainslie declined to comment.

On some companies, the bears have pulled back. Shares of Apollo sold short represented 6.9 percent of stock available for trading, or float, as of Dec. 31, down from 9.6 percent in September, according to exchange data compiled by Bloomberg. The figure for Hoffman Estates, Illinois-based Career Education Corp. declined to 9 percent from 17 percent in July.

Shorts Haven’t Disappeared

Others are still under pressure. Short selling in Corinthian Colleges amounted to 30 percent of float on Dec. 31. That compared with the average of 3.9 percent for the Standard & Poor’s 500 Index, the benchmark measure of U.S. shares.

In a short sale, traders sell borrowed stock, wagering they will be able to repurchase it later at a lower price and pocket the difference. If the stock goes down, it will benefit the shorts.

Jim Chanos, president of hedge fund Kynikos Associates Ltd., has been betting against for-profit stocks for more than two years. In a speech to investors in May 2009, he warned of numerous instances of recruiting and lending violations at higher-education companies. Chanos, who is based in New York, declined to comment.

Eisman’s Role

“It’s kind of a religious argument at this point,” Jarrel Price, an analyst with investment-analysis firm Height Analytics LLC in Washington, said in a telephone interview. “On the one hand these companies print a lot of cash, and on the other hand their enrollment strategies are vulnerable right now.”

Eisman, 48, has voiced his opinions regarding pending regulation to government officials and Congressional Democrats.

On April 16, Eisman met with Education Department officials, including acting deputy assistant education secretary David Bergeron, according to Justin Hamilton, a department spokesman. He sent multiple e-mails to a number of Education Department officials, including Duncan, on May 28, two days after airing his views at the Sohn conference in New York. He warned against the watering down of gainful employment, according to the documents obtained through a Freedom of Information Act request.

Harkin Hearing

“I have been hearing that the Dept. of Ed. is considering adjusting the gainful employment metrics in response to the industry backlash against the proposal,” Eisman wrote in one of the e-mails. “I cannot stress enough how critically important choosing the right metrics are to enact the intended outcomes.”

Eisman also had an April 15 telephone conference with staffers from Harkin’s Health, Education, Labor and Pensions Committee, and met with Harkin staff in May, according to Justine Sessions, a spokeswoman for the senator.

The committee, chaired by Harkin, held a June 24 hearing that was critical of for-profit colleges for misleading applicants and graduating students with higher debt loads than traditional colleges and poor job prospects. Eisman, a witness, repeated his comments comparing for-profit schools to subprime lenders.

Eisman informed the Education Department and Harkin’s staff that he had a short position, he said in a telephone conversation. In an e-mailed statement, Eisman said there was nothing wrong with his contact with the Education Department.

“I have never had communications with the DOE of any kind with respect to any existing or pending regulations,” Eisman wrote, declining to disclose his current short position or comment further.

PowerPoint Presentation

“He shared a PowerPoint that he intended to use for a speech he was planning to give in May,” Bergeron, the acting deputy assistant education secretary, said in a telephone interview. “It would have been inappropriate for us not to meet with someone that indicated that he had done serious research on the industry.”

On Jan. 21, Eisman said in a separate statement that he was considering starting his own hedge fund and leaving FrontPoint, the firm Morgan Stanley plans to spin out by the end of March, to give himself “greater operational flexibility and control over my own business.”

Eisman’s main FrontPoint Financial Services fund fell 8.3 percent in 2010, while his Financial Horizons Fund lost 7.7 percent, according to a person with knowledge of the results, which were reported earlier today by the New York Post.

Apollo Group Donations

For-profit colleges have spent millions of dollars on campaign contributions and lobbying. In the 2010 U.S. midterm elections, for-profit colleges made up half of the top 10 universities and educational institutions whose employees donated the most money to federal candidates, parties and committees, according to data compiled by the Center for Responsive Politics, a Washington-based group that tracks money in politics.

Employees at Apollo Group gave $300,292 to political parties, the fourth-largest donation, after University of California, Harvard University and Stanford University. According to the center, 9 of the 13 largest for-profit colleges spent more than $4 million on lobbying in 2010.

“What we’ve seen is a significant increase in for-profit college spending on lobbying,” said Dave Levinthal, a spokesman for the center. “For-profits are honing in on issues that have a direct impact on their profitability.”

As for Mohan in San Francisco, he’s not looking to invest in for-profit schools.

“This sector is in the crosshairs of regulation and we’re broadly in a pro-regulatory environment,” he said. “That’s the kind of situation I’d try to avoid.”

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