This report was originally published on September 15th, 2009.

Please note, the following is a letter PAA Research recently sent to Warren Buffet, Chairman and CEO of Berkshire  Hathaway, Inc.. We thought our readers might find the analysis of Washington Post and Kaplan in particular interesting.  As a reminder, Washington Post is on our list of short ideas in large part due to our concerns about regulatory compliance issues at Kaplan Higher Education and the lack of intrinsic value of the company’s other operating businesses relative to the current stock price.

Dear  Mr. Buffet:

We wanted to take the opportunity to introduce ourselves and offer our thoughts on one of Berkshire Hathaway (BRK.A 123250 ↓0.28%)’s longest standing investments, Washington Post Company (WPO453.49 ↑0.74%).  PAA Research is a recently formed independent research firm focused on identifying compelling investment opportunities through comprehensive fundamental analysis and rigorous primary research.  You can find all of our research at the following website: www.pleaseactaccordingly.com.

We thought you might be interested in learning more about our analysis of the Washington Post Company even though Berkshire Hathaway has owned a stake in Washington Post before some of the principals of PAA Research were born.  The company receives little attention from the broader investment community and to our knowledge there has been little written about WPO by traditional brokerage firms in the past few years.  Over the course of this letter we will make several inferences as to how you might think about a particular issue or investment (after all this has become a favorite past-time on Wall Street). In this case, we would postulate that the lack of attention from the broader investment community does not bother you in the least, but you would still welcome the perspectives of an unbiased third party on the state of the Washington Post Company.

The purpose of this correspondence is as follows:

1. To provide a thorough analysis of what we think the intrinsic value of the Washington Post Company currently is and which operating division is most important for shareholder value.
2. To illuminate what we think are significant regulatory compliance issues at Kaplan Higher Education and how they could critically impair the company’s earnings prospects over the next 3-5 years.
3. To establish the case that WPO shares could be MATERIALLY over-valued in a scenario where growth at Kaplan slows due to regulatory issues or a change in higher education enrollment trends

The Intrinsic Value of the Washington Post Company

We have analyzed each of WPO’soperating divisions on both a relative value and discounted cash flow basis.  We have read about your disdain for “relative value” analysis given its reliance on short term market dynamics. We think it serves some purpose, but is not the principal factor that drives our investment process.  We have always found discounted cash flow analysis troublesome given its reliance on long-terms assumptions about the growth prospects and competitive landscape for any given company.  This is particularly true for Washington Post’s media assets, where the outlook could not be more uncertain.  The purpose of our analysis is to determine if the sum of the intrinsic value of each of WPO”s operating divisions is greater than, equal to, or less than the current stock price.  Here are the primary assumptions we have used in our intrinsic value analysis:

• Cost of debt of 7.25% for all divisions, which is equal to the interest rate on WPO’s most recent bond offering
• A target debt to capital of 15%
• A base case weighted average cost of capital of 11.3%

The Newspaper Division

We have no intention of addressing all of the secular issues impacting the newspaper business today.  Donald Graham holds the view that the dissemination of news in the future will still come from traditional newsroom sources.  We are not as certain.  In the table below, we have compared WPO’s newspaper division to the New York Times and Gannett Co., Inc. along some basic fundamentals.  We view the New York Times and USA Today as the closest comparable to the Washington Post given their reach and brand awareness.  However, Washington Post is not nearly as levered as the New York Times, nor does it have the reach of the USA Today.  According to the current valuation of NYT and GCI on a price to revenue basis, WPO’snewspaper division could be worth as much as $340 million, or $35.86 per share.

We think this overstates the value of the newspaper division.  First, as we mentioned earlier the New York Times and USA Today are superior assets and are more likely to effectively navigate the secular decline in newspaper readership.  Second, NYT and GCI also own other media assets, which makes the comparison to WPO’s newspaper division less than perfect. One could make the argument that for relative valuation purposes, the combination of WPO’s newspaper, magazine, and broadcasting divisions would be the most appropriate comp to NYT and GCI.  Based on a price/revenue multiple, WPO’snewspaper, magazine and broadcasting divisions could be worth as much as $583 million or $61.41/share when compared to the current valuation of NYT and GCI.

In order to determine the intrinsic value of WPO’s newspaper division we have conducted a discounted cash flow analysis.  We have assumed that the company’s newspaper division witnesses a cyclical bounce in revenues in 2011, after which sales resume their secular decline at a rate of 5% per annum. We also forecast that the division will operate at 10-11% EBITDA margins from 2011-2019.  In a historical context this would appear to be very low for a newspaper company, but we anticipate this could prove to be optimistic in light of the secular challenges ahead for the Washington Post.  Based on our DCF analysis, we arrive at a value for the newspaper division of $170-$215 million or $17.80-$22.56/share, assuming a terminal value multiple of 10x free cash flow.

The Broadcasting Division

There are no pure play publicly traded comparables for WPO’s broadcasting division. Each of the six stations is located in a top 50 broadcasting market in the US.  Historically, the broadcasting business has been a steady cash generator, but the outlook going forward is increasingly uncertain given declining ad revenue share for the networks.  For the purposes of our DCF analysis, we have assumed that the broadcasting division witnesses a cyclical rebound in revenues from 2010-2012 of approximately 30%, after which we have assumed revenues begin to decline at 5% per annum.  Based on the rate at which the Internet continues to gain advertising market share, this could prove to be an optimistic assumption.  We also forecast that EBITDA margins will stabilize at approximately 40% over the course of the projection period.  Based on these assumptions and a 10x terminal value of free cash flow, we arrive at an intrinsic value for the broadcasting division of $550-$685 million or $57.64-$72.11/share.

Magazines Divison

There is one publicly traded company that generates a significant portion of its revenues from the publication of magazines, MeredithCorporation.  The focus of Meredith Corporation’s publication are parenthood/family, home/shelter, and women’s lifestyle, not exactly the same target demographic of Newsweek.  MDP generates approximately 65% of its revenues from its magazine franchises and trades at 0.9x revenue.  This would imply a valuation of WPO’s magazine division of approximately $207 million or $21.87/share.

Our 10-year DCF analysis indicates that the intrinsic value of the magazine division could be materially less.  We would argue that the case we have established below could be optimistic.  Either way, the magazine division is unlikely to be a meaningful contributor to shareholder value going forward.  We have assumed that revenues stabilize in 2010 and then remain flat over the projection period.  Based on the cost reduction actions taken thus far we think the magazine can operate at 8% EBITDA margins if revenues stabilize.  Based on our assumption of a 10x terminal value multiple of free cash flow, we arrive at a value of $67-87 million or $7.04-$8.55 for WPO’s magazine division.

Cable Divison

In the table below we compare CableOne to its three largest peers in the cable sector: Comcast, Time Warner and Cablevision.  As the table below demonstrates, CableOne is considerably smaller and has a lower penetration rate of digital, high speed data, and voice services.  This could make one bullish or bearish on the revenue growth prospects for CableOne.  From a bull’s perspective, all of the revenue upside from cross-selling digital, Internet and voice over services is on the come.  From a bear’s perspective, the company has squandered the opportunity to upsell its customer base and now CableOne will face intense pressure from non-cable companies.  In our opinion, the latter scenario appears to be more and more likely.  Assuming CableOne were to trade at a similar EV/EBITDA multiple as TWC, CMCSK, and CVC the division could be valued as much as $1.75-$2.0 billion.  An analysis of EV/RGU multiples suggests that CableOnecould be worth as much as $2.0-$2.0 billion.    We think this dramatically overstates the value of CableOne.  The company has a fragmented network and operates in second tier MSA’s such as Boise, ID and Biloxi, MS.  The lack of penetration of additional service offerings and high concentration of basic subscribers indicates that the company’s network is comprised of households from lower socio-economic backgrounds.  Unlike its peers, CableOne is not leveraged, which could make it a compelling acquisition candidate for a strategic buyer.

The cable industry is notorious for its capital intensity and now for its increased competitiveness. Our 10-year DCF analysis of CableOne implies a much lower intrinsic value for the division than would relative valuation.  We have assumed that CableOne can generate 3% revenue growth over the course of the next five-years after which we expect revenues to flatten out.  We anticipate the division will be able to sustain EBITDA margins of 35-38% over the course of the projection period, even in the face of increased competition.  We expect CAPEX to remain at 17.5% of revenues for CableOne over the next 10-years.  Our 10-year DCF analysis results in a value of $814-$1,029 million or $82.76-$104.46/share for CableOne assuming a terminal value multiple of 12.0x free cash flow.

Education Division (aka Kaplan)

There are many publicly traded for-profit education companies. We think the most appropriate comparables to Kaplan are: Career Education Corp., Corinthian Colleges, Inc., DeVry, Inc. based on Kaplan’s mix of businesses between test preparation and higher education, degree offerings, accreditation of its schools and mix of online students.  Overall, Kaplan’s higher education division accounts for approximately 63% of division revenues and 34% of company-wide revenues. From an EBITDA perspective, Kaplan Higher Education represents 81% of division profits (before  corporate overhead) and 67% of total company-wide EBITDA.  Many of the for-profit education companies trade at discounts to their historical valuation multiples due to a variety of issues including: concerns about self-funding student tuition, regulatory issues and counter-cyclical demand. CECO, COCO, and DV currently trades at 14.2x unlevered free cash flow, which would imply a valuation of $1.5 billion for the division.

For our DCF analysis we have assumed that relatively strong revenue growth continues in the higher education division for the next two years, while the test prep and professional divisions benefit from a cyclical recovery.  We anticipate Kaplan will be able to achieve 16-17% EBITDA margins as the rate of investment in Kaplan Higher Education slows and margins for Kaplan test prep and professional recover.  However, we expect working capital to become a significant drain on free cash flow for Kaplan Higher Education as a greater percentage of the company’s tuition revenue comes from its own balance sheet.  The spread between tuition levels and student loan limits continues to widen, which has substantially altered the free cash flow profile of operators in the for-profit education sector. We expect working capital to be a drain of $75-$100 million annually over the course of the projection period.  Overall, our 10-year DCF implies a value of $1.5-$1.9 billion for Kaplan assuming a 14x terminal multiple of free cash flow.  This equates to approximately of $156.89-$200.68 on a per share basis.

Intrinsic Value Summary – Equity Value of $395.24

The table below outlines the sum of our divisional intrinsic value analysis. Assuming a net debt position of $49 million and value of other investments (including Berkshire Hathaway stock), we arrive at an equity value per share of $395.24.

We hope this exercise illuminated the importance of Kaplan in the context of WPO’s intrinsic value.  If issues arose to impair profitability or growth prospects for Kaplan, the intrinsic value of WPO would be damaged significantly.  It is important to note that the analysis of the value of Kaplan does not include any change to the regulatory landscape or the company’s enrollment practices.

Kaplan Higher Education – Growth at What Cost

Through our intrinsic value of WPO’s various operating divisions we have established that the company’s education division is the primary source of shareholder value.  We find it strange that the company’s stock price tends to track that of newspaper companies, instead of some of the aforementioned for-profit postsecondary education companies.  In the table below, we outline the correlation of WPO’s stockprice to that of NYT, GCI, CECO, COCO and DV on a 1-month, 3-month, 6-month, 1-year, 3-year, 5-year, and 10-year basis.

Over the past 5-years, WPO shares have been almost perfectly correlated to those of NYT.  Strangely enough the stock has been NEGATIVELY correlated over a 5-year period to COCO and DV shares.  This data would suggest that established perceptions are difficult to change, but we also attribute it to a conscious choice by senior management at WPO to keep Kaplan out of the investor spotlight up until recently.  In general, WPO management is not highly visible from an investor relations perspective and Kaplan senior management even less so.

We recently had the opportunity to listen to the Washington Post Company annual shareholder meeting.  Donald E. Graham, Chairman and CEO made it abundantly clear that he continues to employ a “hands-off” approach to the management of the various operating divisions of the Washington Post Company.  His approach appears to be similar in spirit to the manner in which you have managed the investments of Berkshire Hathaway over the decades.  To borrow a phrase from Mr. Graham, Kaplan has been “run with an unusual degree of autonomy”.  From a pure financial perspective, it appears Mr. Graham’s “hands-off” approach with regard to Kaplan has worked wonderfully.  Under the stewardship of the former head of Kaplan, Jonathan Grayer, revenues doubled from 2004 to 2008 through a combination of organic revenue growth and acquisitions.  Mr. Graham has lauded Kaplan’s outstanding results and growth.  Everyone in WPO senior management appears to be satisfied with the results.  Here are a few comments from current CEO and Chairman, Andy Rosen about Kaplan Higher Education:

“We are focused on educational results…. helping students succeed in careers”

“Completion rates at our schools are 70%”

“Kaplan creates the kind of outcomes the federal government wants”

“We are obsessively focused on keeping within regulatory compliance”

From the sound of it, Kaplan Higher Education has achieved remarkable growth without sacrificing student outcomes (as measured by graduation/completion rates, job placement, or student loan cohort default rates).  Not so fast.  We have followed the for-profit education sector for almost a decade now, which in the context of the industry is a fairly long period of time.  It has been our experience that any company that experiences rapid growth through acquisition and appears to have ambitious, yet “hands-off” senior management should be watched with considerable caution.  From an outsiders perspective, it is very difficult to gain a full understanding of the student experience at any particular higher education institution.  There are a few things we analyze to determine if a company could be at risk of violating regulatory standards, they are: cohort default rates for the company’s schools, the level of litigation activity from former students or employees, the number of disciplinary actions from accrediting agencies, job placement rates and starting salaries and graduation rates.  These criteria provide a glimpse of whether or not a school or company has lax admissions standards and provides good educational outcomes for its students without untenable financial burden.  Based on our review of some of these metrics, Kaplan Higher Education does not score well, despite Mr. Rosen’s strong statements about providing the kind of outcomes the federal government wants.

A Quick Review of the Cohort Default Rate

The for-profit education sector has what we call an “agency problem”.  Enrollment counselors are incentivized to enroll students, campus managers are motivated to grow enrollment and senior management are compensated based on achieving specific financial benchmarks. Unfortunatley, in many cases this results in lax admissions standards, higher dropouts, lower completion rates and eventually higher student loan default rates.  The US tax payer bears the brunt of the financial damages for any school that enrolls a student that is not qualified to complete a program or becomes saddled with an untenable debt burden due to high tuition costs.  There is a recourse mechanic in the higher education system for institutions that consistently enroll unqualified students or deliver poor education outcomes, which is the measurement of cohort default rates. We have included a sequence of  reports we issued on the release of the FY07 cohort default rate data, which explain how the default rates are calculated.

Under the Higher Education Act a postsecondary institutioncan lose eligibility to participate in certain Title IV programs, if the rate at which their students default on their federal student loans exceed certain percentages. The rates are calculated per institutionand based on the number of students that default (not the dollar amount). An institutionwhose cohort default rate exceeds 25% for three consecutive years loses eligibility to participate in the vast majority of Title IV programs.  Loss of Title IV historically has been a “deathblow” to a for-profit institution, or at the very least leads to dramatically lower enrollments due to the lack of funding.

How the Cohort Default Rate Is Calculated

It is critically important to understand the methodology used to calculate the cohort default rate, which in general has been proven to understate credit risk for a particular group of student loans. The data is calculated based on a fiscal year that begins October 1st and ends September 30th. The cohort is based on the number of students that enter the repayment period in a particular fiscal year. The repayment period typically begins 6-months after a student graduates or withdraws from a postsecondary institution. Student loan defaults are then calculated through the following fiscal year to determine the numerator in the cohort default rate calculation.

For example, if a student began repayment in October 2006 and defaulted on their student loan in August 2008, they would be captured in the cohort default data for 2007. However, if that student were to default two months later, in October 2008 they would not be captured in the cohort default rate. In short, any student that defaults 24-months after the initial repayment period WILL NOT be captured in the cohort default data. In addition, a lender can not make a claim for a defaulted loan with a guaranty agency until it is more than 270 days delinquent. A loan is not considered in default until a claim has been PAID by a guaranty agency. For example, a student that graduates in October 2006, enters repayment in March 2007, makes payments on his student for 12-months and then never makes another loan payment will actually never be captured in the cohort default rate data (as of the end of the measurement period, 9/30/08 his loan was only 180 days delinquent). The cohort default rate is not a good indicator of overall student loan outcomes, in fact during a period of rising unemployment it will likely massively understate the level of defaults associated with a particular cohort.

Changes Made During the Reauthorization of the Higher Education Act in 2008 (the Higher Education Opportunity Act)

Starting with the 2009 cohort, the maximum default rate to determine institutional eligibility to receive Title IV funds will be increased to 30%. However, as a trade off, the amount of time used to measure defaults will be extended from two years to three years. This will likely result in SUBSTANTIALLY higher cohort default rates for all industry participants.

• Until three consecutive years (FY2012) of cohort default rates (CDRs) are calculated using the three-year default period, CDRswillcontinueto be calculated and penalties assessed using the two-year default period. Here are a few other changes beginning with FY2012 (which begins 10/01/11), the new law:
• Allows schools with a CDR of less than 15% (currently less than 10%) to qualify for multiple delivery and delayed delivery exemptions
• Requires any institution whose CDR is equal to or above 30% to establish a default prevention task force and prepare a plan to submit to ED for review

The Evidence of Potential Regulatory Issues and Aggressive Practices at Kaplan Higher Education

There are a few factors that lead us to believe that Kaplan Higher Education could face substantial regulatory issues in the coming years and perhaps has achieved a level of growth that is unsustainable if the company is compelled to improve its compliance.  These factors are: 1) the company has the highest cohort default rates among publicly traded companies, 2) there are several oustanding qui tams against the company, and 3) Completion rates are well below the 70% level stated by management.

Kaplan Higher Education Has the Highest Cohort Default Rates Among Publicly Traded Companies

Based on Mr. Rosen’s fairly strong statements about the level of focus on regulatory compliance at Kaplan Higher Education one would think that the company would have some of the lowest cohort default rates in the industry.  In fact, based on the FY07 data, the oppposite is true: the school’s owned by Kaplan Higher Eduaction have the highest cohort default rates among publicly traded for-profit education companies.  In the table below we compare the cohort default rates of many of the leading publicly traded for-profit postsecondary education providers.

It should become abundantly clear that Kaplan has more schools that are already bordering on the edge of regulatory compliance with cohort default rate standards.  Additionally, four schools owned by Kaplan had a cohort default rate in excess of 25%. None of the other publicly traded companies own a single school whose cohort default rate eclipsed 25% for FY07.  In the table below we provide an outline of the timing of key dates for the cohort default rate calculation. Note the line “Student delinquent as of”, which is the cut off date for being captured in the default data.

Based on these measurement periods and current employment trends it appears highly likely that the default rate for most, if not all schools will increase in FY08 and then again in FY09.  This could imply that the four schools owned by Kaplan whose default rate exceeded 25% in FY07 could be at risk of losing access to Title IV funds in the near future.  Based on data from the National Center for Education Statistics, these four schools had approximately 6,200 students enrolled in the Fall of 2008, this represents approximately 6% of Kaplan’s student population.  We would argue that any school’s whose cohort default rate exceeded 20% in FY07, a period during which the unemployment rate was still below 5%, is at high risk of having 25%+ cohort default rates for at least the next two years.  There are 10 schools owned by Kaplan that exceeded a cohort default rate of 20% in FY07.  Total enrollments at these schools in  Fall 2008 was 10,200, or 10% of Kaplan’s current student population.

Kaplan Higher Education Is Currently Subject to Three Qui Tam Actions

In the for-profit postsecondary education sector, litigation is a cost of doing business. It is not uncommon for a former student to file claim against an insittution.  Additionally, in recent years lawsuits surrounding alleged “incentive compensation” violations have been very common.  Under the Higher Education Act, for-profit education companies are prohibited from compensating enrollment counselors based off the number of students they enroll.  This begs the question as to how compensation should be determined for enrollment counselors. It is a difficult and controversial issue.  Kaplan Higher Education is currently subject to three qui tam lawsuits under the False Claims Act based in part on alleged violations of incentive compensation provisions.  In general, we would not view that as a huge cause for concern. As far as we know, almost every publicly traded for-profit higher education provider has been sued on these grounds in the past five years.  However, one of the qui tam actions was brought by two former instructors of the company.  They both worked at a Kaplan Career Institute for more than five years.  In addition to allegeations about incentive compensation, the complaint included allegations about inflation of job placement statistics, grade falsification and manipulation of attendance records.  We cannot speak to the veracity of the allegations, but we consider them serious.  This qui tam only outlines alleged improprieties at one school, but it does cause concern when it occurs at a company who has adopted a “hands-off” approach to management, completed a number of acquisitions in a short time frame, and has achieved relatively rapid growth.

Completion Rates (aka graduation rates) at Schools Owned by Kaplan Higher Education Are Much Lower Than 70%

We are not sure what Mr. Rosen was referring to when he indicated that completion rates exceed 70%. According to our analysis of the most recently available data from the Department of Education, only 5 (out of 34 for Dept. of Ed purposes) of the company’s schools had a graduation rate in excess of 70%.  Perhaps, Mr. Rosen was referring to retention rate.  In this case 50% of the company’s schools had a retention rate in excess of 70% based on the most recently available data from the Department of Education.  We cannot be certain what Mr. Rosen was referring to in his statements at WPO’s shareholder day, but it appears that the statistics from the Department of Education tell a different story.

The Transition to a 3-Year Cohort Default Rate Calculation Could Potentially Impair Enrollment Prospects for Many of Kaplan’s Schools

As we mentioned earlier, the calculation of the cohort default rate will increase from a 2-year measurement period to a 3-year measurement period.  We think this will have substantial implications for many companies in the for-profit education sector, including Kaplan.  The U.S. Government Accountability Office (GAO) recently issued a report entitled “Stronger Department of Education Oversight Needed to Help Ensure Only Eligible Students Receive Financial Aid“.  Among other things the report included a review of how the transition from a 2-year to a 3-year calculation of cohort default rate might impact the number of defaults.  As the table below demonstrates, the expanded measurement period has the affect of almost doubling the number of defaults that are captured for for-profit institutions (proprietary).

As we noted earlier, the threshold for regulatory compliance was increased from 25% to 30% for cohort default rates in conjunction with the move to a 3-year calculation. Simply stated: if the data from FY04 were to be extrapolated, any school’s whose cohort default rate eclipsed 15% in FY07 could be at significant risk of violating the 30% threshold when the 3-year measurement period is implemented.  In the case of Kaplan, this represents a total of 23 schools whose enrollment eclipsed 28,000 in Fall 2008 according to the Department of Education.  Additonally, default rates at Kaplan University have been increasing at a rapid clip. In  FY07, the cohort default rate at Kaplan University was 13.3%, dangerously close to the levels that indicate the school could have difficulty keeping its cohort default rate below 30% under a 3-year calculation.  We think the company needs to take action TODAY to address these issues or run the risk of having a number of it schools lose access to Title IV.  From a much higher level perspective, we pose the questions: Is this a good use of tax payer dollars?  As a country we are committed to expanding access to higher education, as is the Administration.  We wonder if public perception of Title IV will start to change based on the realization that there are some schools in the system that generate significant profits for their shareholders, but have more than 30% (possibly close to 40%) actually default on their student loans.  In an environment where there is greater transparency into the actual level of student loan defaults (vs. the current cohort default rate construct) we anticipate the scrutiny on schools with high default rates will intensify.

Remedies and Potential Outcomes for Kaplan Higher Education

You might read our analysis and think that we want to villify Kaplan or WPO senior management.  Nothing could be further from the truth.  We wonder if Mr. Graham is aware of some of these issues, we are almost certain that Mr. Rosen is.   The issues at Kaplan Higher Education are fixable, although they will take time.  In our view, the situation at Kaplan Higher Education today resembes that at Career Education in 2004.  CECO had experienced a number of years of rapid growth.  The company completed a large number of acquisitions over a short period of time, while building out a new online higher education platform (AIU in the case of CECO).  Senior management at that time at CECO had somewhat of a “hands-off” approach to the management of the schools.  Does this sound familiar?  Growth came at a cost, and the company eventually became subject to greater  regulatory scrutiny and was effectively forced into changing a number of established practices.  The company’s operating results suffered as a result of these changes for 3-4 years, but we think the alternative would have been far worse  In the case of Kaplan Higher Education, we think these are some of the actions we think the company should take:

1. Increase collections efforts. It is notoriously difficult to get a student that drops out to pay off his loan.  The return on this investment might not be as high as some of the other remedies, but every little bit will help lower the company’s cohort default rates.
2. Enhance student retention programs.  A student that drops out is more than  twice as likely to default.
3. Increase admission standards.  WPO does not disclose the number of “ability to benefit” students (those that did not graduate high school) it enrolls, but we think the company should seriously consider raising its admissions standards in order to ensure that the students enrolled are capable of completing the program and can service the debt upon graduation
4. Lower tuition.  Tuition price increases are viewed as sacrosanct in the higher education sector.  In many cases , the cost of some of Kaplan’s degree programs have exceeded the student’s ability to pay even if a favorable outcome is obtained (job placement).  Tuition price increases have more than doubled the rate of inflation over the past 10-years. Student debt burdens increasingly resemble average mortgage payments at the peak of the housing bubble.  This is unsustainable.

These remedies will likely reduce regulatory risk for Kaplan and lead to a much more stabile growth profile for the  company over the longer term.  However, in the short term these steps would lead to a lower level of growth, if not an outright decline in enrollments.  The alternative is to continue on the current path and deal with the ramifications in a few years, which we think could lead to as much as 25-30% of the company’s enrollment base becoming subject to the potential loss of Title IV funding.  In a scenario in which some of the regulatory issues are not addressed we anticipate the intrinsic of value of Kaplan could be impaired by as much as 30-40%, which would imply WPO shares would be worth as little as $275-$300.  Conversely, we anticipate the remedies we proposed above would reduce the growth profile of Kaplan for 3-5 years, but perhaps only impair the intrinsic value of the company by 10-20%.  Stated another way, should these regulatory issues go unchecked we estimate peak cycle earnings for WPO of $18-20 per share, assuming earnings recover for the company’s newspaper, magazine and broadcasting divisions.  The stakes are incredibly high for WPO shareholders.

Thank you for your time and consideration. Please do not hesitate to contact us if you would like to speak about our analysis of WPO or Kaplan Higher Education in more detail.

PAA Research