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Capella No Longer Shines

 August 31, 2011 10:04 AM

Capella Education (CPLA) is an online education company that offers undergraduate and graduate degree programs. The stock trades near its five-year lows, but the company's earnings per share are three to four times higher now than they were last time the stock traded at this price!

Capella trades with a P/E of 8, and carries a ton of cash against no debt. Subtracting the cash from the company's market cap gives the stock a P/E of just 5. It has all this cash despite the fact that the company has paid out more than 10% of its current market cap in the form of share buybacks in the first six months of this year.

Unfortunately, it's not just current market turmoil that has dragged down this company's stock price. Many of its industry peers are in the same boat, as a result of a serious issue with respect to student loans.

The government provides certain loan guarantees for students who seek higher education. As is always the case when loans are backstopped by a 3rd party, abuses have run rampant. Many schools took on students and gave them "training" which did little to improve their employment prospects. As a result, many loans have gone bad, leaving the government with the bill.

As a result, the government has implemented new eligibility requirements for loans that will likely hurt the revenues of the schools. What the effect might be is hard to say at this point, as the rules only recently came into effect. Furthermore, it's not clear whether additional regulations are on the way.

For its part, the company does appear confident it will make it through the regulatory scrutiny unscathed. It continues to deploy cash towards acquisitions and share buybacks, and stated recently that "(w)e believe our programs will meet the requirements under the new gainful employment regulations." At the same time, however, it should be noted that Capella expects that new enrollments will decline by 30% year-over-year in the coming quarter!

Investing in unpopular industries can be very profitable. But investors shouldn't go in blindly. A thorough understanding of how these new regulations will affect business for these companies is required.

Disclosure: None

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