GRAND CANYON EDUCATION, INC. 
By 
First, let’s note that the future financial performance of Grand Canyon will without a doubt be nothing like its past performance. The company went through a significant transformation in 2018, so the financial statement’s history is of little interest in understanding its business or outlook.
In the past, Grand Canyon owned and operated the eponymous university in Phoenix, Arizona: this institution is a heavy-weight on the US higher education map since it’s the largest Christian university in the world. Fortunately, its religious vocation hasn’t diverted him from more practical considerations - such as, for example, the taste for profit.Indeed, following some major difficulties in the early 2000s, the university was bought by two bold entrepreneurs - the brothers Chris and Brent Richardson - and immediately adopted the status of an organization authorized to make a profit. This may seem insignificant but this kind of change was rather shocking back then because Grand Canyon was the first among Christian universities to assume a full corporate roll.
A couple of years later, the company was listed on the stock exchange and the Richardson brothers appointed Brian Mueller as the head of the company. Mr. Mueller is a caricature of the American success story himself: father of four children and an interim philosophy teacher paid $5 000 per term, his estate consisted of an old beat up car. He decided to retrain himself and joined the University of Phoenix - not to be confused with Grand Canyon University, even though both are in the same city - as a recruitment officer for new students.
The least we can say is that he worked his magic there: in twenty years, he gradually rose through the ranks and became president of the university, where he was particularly quick to seize new opportunities that were merging in online programs and profession reconversions (“adult education”).
In 2008, he became head of the Grand Canyon University, reviewing all its programs and putting its various departments in order to accelerate the university’s recruitment. And with success! The number of students on the campus multiplied by eighteen in ten years, while the turnover multiplied by five (from $200 million to almost a billion) and the profit broke records year after year.
Everything, however, wasn’t perfect. First of all, the maintenance of the university’s gigantic infrastructure - spread over nearly 100 hectares - consumed the majority of cash flows. Secondly, the private education industry in the United States has been blamed for its many excesses for several years; new legislation is under consideration and the years of euphoria are probably over. Finally, innovative programmes - such as MOOCs and other online training systems - distinguish themselves by much more affordable prices than traditional university courses.
With regard to the excesses mentioned just now: the American press comments on them almost daily, without failing to highlight the parallels with those that led to the last major financial crisis; indeed, universities have used and abused attractive credit offers to recruit their students, sometimes in defiance of common sense - many loans are thus classified as “subprime”, and therefore at risk of default.
With their accounting, which is sometimes more like that of a bank than a school - because they earn money on credit rather with than tuition fees - private education companies are walking on thin ice… With some of them - recognizable by their extremely low graduation rates - simply ending up in a scam.
In short, like other industries where latent inefficiency and high tariffs have favored the emergence of a new ultra-aggressive competition, the private education sector is undergoing a famous “disruption”. A redistribution of cards seems inevitable in the short to medium term, but Mr. Mueller, as we have seen, is not the type to wait and see what happens: Grand Canyon was thus completely reconfigured in 2018.
In other words, Grand Canyon University bought its independence from Grand Canyon Education for $870 million; the payment was made by means of a 6% per annum bond that matures in 2025. In parallel, the university - which is returning to its status as a “not-for-profit organization” - and the company have signed a 15-year service contract, under which the former subcontracts its academic, commercial and administrative management to the latter in exchange for 60% of its income.
The deal seems ideal: Grand Canyon Education outsources a large part of the operational and financial risk, while its new activity focused on services should prove much more profitable than the previous one, which was too capital intensive and under competitive pressure due to lack of pricing power - only superb franchises like Harvard or Yale can really afford to increase their prices, even if they are already prohibitive!
However, Grand Canyon University remains Grand Canyon Education’s only client. It is therefore vital that the company diversifies its portfolio: given the nature of the activity and the resources required to manage an institution, the signing of one or two new contracts could double or even triple the turnover. In passing, we should mention the recent acquisition of a specialist in nursing training - a promising segment - which announces further external growth operations in complementary segments.
Naturally, it is difficult to project the earnings capacity of the new version of Grand Canyon Education, but the company’s management is advancing an EBITDA of $274 million in 2018. The latter could grow significantly in the coming years, as Grand Canyon University expands into Oklahoma and aims to have 30 000 students on its campuses (vs. 19 000 today) by 2025, in addition to 100 000 enrolled in its online programs (vs. 60 0000). Naturally, these ambitions are only binding for those who formulate them.
As the activity is now not very capital intensive - excluding acquisitions - and the interest expense is zero - the balance sheet is an absolute fortress, with a liability of $110 million covered by the cash alone - the EBITDA here presents a possibly fairly accurate reflection of profit before taxes. Roughly speaking, we can, therefore, expect an after-tax and investments profit (“free cash flow”) of about $200 million for 2019.
Analysts who follow the company - and who we suppose are better informed - are a little more confident and regularly raise their forecasts. However, let us retain our assumption of $200 million: with a market capitalization of $5.5 billion, Grand Canyon trades at 27 times its by the author projected profit, a valuation that a priori is optimistic.
However, and this is exactly why this case is interesting, if a new management contract were to be signed - we know that discussions have reached an advanced stage with at least two institutions - it is not unreasonable to imagine a clear increase in profits. The contract may not be as juicy or extensive as the one with Grand Canyon University, but it would probably add several tens of millions in the bottom line in the first three years.
This is the scenario on which investors who enter at the current share price are betting: without predicting its chances of success - which nevertheless seem real - let us acknowledge that they have in the person of Brian Mueller the ideal leader to make such a vision a reality.
Aside from the inevitable operational risks - common to all companies experimenting with a new strategy - and cyclical risks, it should be pointed out that the market addressed by the company could turn out to be more limited than expected, as secular universities may have some qualms about entrusting their management to a third party as “militant” as the Grand Canyon.
Grand Canyon Education is a position in the MarketScreener USA Portfolio.
(The author is not a shareholder.)
