Investors brace for ITT’s plan to survive new regulations

How bad is it going to get?

That’s the question investors will be asking when ITT Educational Services Inc. announces its third-quarter financial results Thursday.

The Carmel-based for-profit educator stands to suffer a bigger impact than its peers from new regulations proposed by the U.S. Department of Education. Those new rules have already forced the industry’s largest player to slash its forecasts.

Phoenix-based Apollo Group Inc., operator of the University of Phoenix, said last week that new-student enrollment will drop 40 percent next quarter as the school takes steps to adjust to the government’s proposed rules, which are designed to slow down the growth of for-profit schools and boost their graduation rates.

Apollo’s Oct. 13 announcement hammered for-profit education stocks, with shares of ITT falling more than 20 percent the following day. ITT’s stock has lost one-third of its value since the federal government proposed its new rules on July 23.

Apollo’s answer to the rules has been to stop paying its admissions personnel bonuses for signing up large numbers of students and by offering a free, three-week orientation program to see if students are good prospects for graduating. Those measures will certainly lead to fewer students enrolling, the company predicted.

ITT would need to take even more drastic actions than Apollo, it would seem. That’s because Apollo is much closer to meeting the government’s proposed requirement that at least 45 percent of former students be actively paying down their loans four years after leaving a school.

If schools’ former students fail to achieve that threshold, the government would not allow a for-profit education program to get student-loan funding to raise its enrollment levels. And if repayment rates fall below 35 percent, the government would cut off student-loan funding entirely for any new students.

The Department of Education believes the repayment rates are an indication of whether students at for-profit schools graduate at all and whether the degrees they earn lead to “gainful employment.”

Apollo’s repayment rate, according to data released by the government in August, is more than 40 percent. ITT’s repayment rate is just 31 percent.

“There has been a shot across the bow of the entire industry,” said Alex Paris Jr., a for-profit education analyst at Barrington Research in Chicago. “ESI,” he added, referring to ITT by its stock ticker, “is going to be one of the most affected by proposed gainful employment regulations.”

Paris does not expect ITT managers to detail their plans for answering the government’s new rules, because they want to wait until the rules are final, which could be as early as next month. The company will release its third-quarter results before the markets open Thursday, and then hold a conference call at 11 a.m.

However, Paris said there is a chance ITT might not have to take steps quite as drastic as Apollo did. Because Apollo is the industry behemoth—needing to recruit hundreds of thousands of students each year just to sustain its enrollment of 470,000—it faces pressures that a small company like ITT does not, Paris said.

ITT currently enrolls about 80,000 students.

Paris and other analysts do expect ITT to slash its tuition costs by 25 percent to 50 percent. It will need to do this in order to comply with another part of the proposed regulations.

That part would calculate graduates’ annual payments on their student loans, then divide that figure by the annual income that gets reported to the Social Security Administration.

If that ratio is higher than 8 percent, a for-profit degree program would be restricted from growing its enrollment. If that ratio is above 12 percent, new students in that program would be ineligible for federal student loans.

Deutsche Bank analyst Paul Ginnochio estimates that ITT’s bachelor’s degree graduates are paying roughly 16 percent of their starting salaries in loan payments. ITT’s associate’s degree graduates are paying just under 12 percent of their incomes to repay student loans.

It’s expensive to earn a degree at ITT—about $56,000 for a bachelor’s and about $30,000 for an associate’s. On average, federal student loans cover 80 percent of those costs for ITT students. Federal loans are often the only source of financing available to ITT students, who on average are 29 years old with annual incomes of $17,000 when they enroll.

ITT has seen phenomenal growth, especially during the recent recession, as out-of-work adults flocked to its campuses to pick up new skills. That growth put ITT on a pace this year to turn a profit of $380 million, a spike of 27 percent from last year.

Paris predicts that 2011 will be a year of painful transition for ITT and its peers, with stock prices holding fairly steady at their depressed levels. But as the schools adjust to the new rules, he still expects them to be highly profitable—if slower growing—companies.

“Slower growth but more predictable growth and potentially higher margin growth because those students who persist generate higher lifetime revenue to the institution,” he said.

More coverage on the proposed rules and their impact on ITT can be found here.

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