Apollo Group (NASDAQ:
APOL) is under pressure this morning after announcing its results and yet another SEC inquiry into its revenue recognition practices:
- Merrill Lynch/BAM is downgrading the stock to Neutral from Buy with a $73 target (unch)
- RBC Capital is downgrading APOL to Underperform from Sector Perform and lowering their target to $66 from $73.
- Morgan Stanley is downgrading APOL to Equal-Weight from Overweight.
The downgrades are what they are. I'm going to focus on the defenses and other comments:
- JP Morgan maintains their Overweight rating and $95 target noting that two most obvious areas of SEC review could be revenue impact of refunds and bad debt. In general, both of these areas use a relatively limited amount of "judgement", thus perhaps limiting the exposure. They acknowledge that Apollo's (and for-profit sector's) business model is highly attractive from the cash flow perspective, as majority of cash is paid upfront and then recognized over the appropriate periods. Importantly, APOL's cash flow from operations has consistently exceeded net income, (comprising 1.6x of net income in FY2009, for example), which also gives us some comfort on revenue recognition. Firm also notes that APOL's revenues are shorter cycle (based on 5-9 week courses) which leaves less room for timing differences across reporting periods.
While JPM's review of similar inquiries in the for-profit industry (COCO in 2005) and other industries found individual cases of SEC inquiries, the outcomes varied widely. For example, COCO was forced to restate its revenue recognition for certain diploma programs with a limited impact on financials.
Apollo stated that the Enforcement Division of the SEC has started an informal inquiry into the revenue recognition practices. Management has not been able to identify specific items under review, but feels comfortable with the existing policies. Importantly, APOL's auditors have signed off on the 10K without qualification. JPM's research of similar inquiries in this and other industries found a wide variance of the possible outcomes and that resolution could take more than a year
Taking a longer-term approach. Before a retrenchment today, shares of APOL trade at 13x firm's revised CY2010 estimate of $5.48 vs. the sector's average of 15x. They think that APOL is compelling given company's dominating market position, strong growth/margin balance, and more consistent execution.
