This report was originally published on 10/20/09.

Corinthian Colleges (COCO 17.39 ↓0.57%), Inc. announced it has reached an agreement to acquire Heald Capital, the owner of Heald Colleges for a total consideration of $395 million.  This is the company’s largest acquisition ever based on total purchase price.  The company expects the transaction to be accretive immediately upon closing.

Heald College Profile

Heald College has eleven campuses spread across California, Oregon and Hawaii.  As of 9/30/09 Heald Colleges had approximately 12,300 students enrolled.  More than 85% of the company’s students are enrolled in degree programs.  Heald College offers associate’s degree programs in allied health, business, criminal justice and IT.

Heald college looks very similar to other for-profit education providers that focus in those four program areas.  COCO management has argued that the school significantly expands the company’s geographic reach.  Seven of Heald’s nine campuses are located in California, where COCO already has 16 schools.  In the table below we have put together a brief profile of each of Heald’s 9 campuses.

Source: Department of Education, PAA Research

Let’s compare the profile of Heald College to that of COCO’s existing Everest and Wyotech schools in California.  The acquisition does expand COCO’s presence in northern California.    As you can see the Heald College locations are generally larger than the typical COCO school and have lower default rates. However, from a funding perspective the Heald College schools rely heavily on Title IV funds. From a “90/10″ perspective, 80-85% of Heald College’s revenues come from Title IV funds, which might limit COCO’s ability to increase tuition meaningfully going forward even though current tuition levels are well below those for Everest or Wyotech.

Source: Department of Education

Financial Implications

According to COCO management, Heald College is expect to generate $180-$185 million in revenues and $38.5 million in EBITDA for calendar 2009.  This implies a purchase price multiple of approximately 10.3x EBITDA.  COCO will receive an additional tax benefit over the next 15-years for cash purposes of $120 million, which has a net present value of $70 million assuming a 7% discount rate.  Overall, management expects the transaction to be accretive to earnings almost immediately.  In the table below we have provided summary results of our accretion/dilution analysis based on two variables: annual depreciation and amortization for Heald and the interest rate on the company’s bank debt. In our base case we have assumed COCO will draw down approximately $250 million on its revolver to fund the deal.  This would imply an incremental cash outlay of $145 million compared to $160 million in cash on hand as of 6/30/09.  Management has indicated that it expects the transaction to be $0.15-$0.20 accretive to FY11 EPS.  As the table below demonstrates, given the low cost of debt, management’s guidance for the transaction appears more than reasonable.

Source: PAA Research

Strategic Benefits – Regional Accreditation Platform, Less Reliance on ATB, but 90/10 Remains an Issue – Does the Acquisition Really Say Anything About the Regulatory Environment?

The acquisition of Heald College increase COCO’s presence in the degree granting market.  Pro forma for the acquisition 50% of the company’s student population will be enrolled in degree programs vs. 36% currently.  Heald College also provides COCO with a regional accreditation platform.  Heald College has been approved to offer online degree programs.  Starting in 2010, the company will begin to offer online degree programs. That space has become increasingly crowded, so it will be interesting to see if Heald can gain any traction in the marketplace.  More than anything it should be clear that COCO’s enrollment, revenue and EPS prospects are increasingly tied to higher education demand in the state of California.  Pro forma for the acquisition, we estimate approximately 22-23% of the company’s student population will reside in the state of California.

On the surface it appears that Heald College relies less on “ability to benefit” (ATB) students than does COCO.  It has become increasingly clear that the Department of Education and other regulatory bodies have started to scrutinize the manner in which colleges are enrolling ATB students. The acquisition reduces COCO’s reliance on that market, which currently comprises more than 25% of the company’s student population.  From a negative perspective, the acquisition does little to reduce COCO’s 90/10 issues (the percentage of revenues each school gets from federal financial aid).  Based on our review of publicly available data for Heald College, the schools are just as reliant on Title IV funds as are existing COCO schools.

Finally, we noticed that shares of ESI (108.44 ↓0.96%) and EDMC rallied sharply today, which we can only presume is the market’s interpretation that there is a “bid” out there for companies offering associate’s degree programs.  We wouldn’t draw too many inferences from today’s announcement from COCO. First, COCO management and that of Heald College have a unique and long-standing relationship.  Nolan Miura, the CEO of Heald College spent eight years working at COCO in a variety of roles.  We know first hand he was an integral part of COCO’s acquisition team.  COCO’s intimate knowledge of Heald College from a management and geographic location perspective makes this a unique situation in our view. We find it hard to believe there is another strategic buyer out there that has the financial capability to take on an acquisition of EDMC or ESI.  APOL (63.47 ↑0.17%) might be the only one, but it appears they are more focused on international expansion than growing market share in the US through acquisition.  Finally, COCO has yet to receive final approval for the deal from the Department of Education.  We would not equate approval of this transaction asvalidation of COCO’s regulatory compliance.  Historically, there have been multiple examples of companies that have received acquisition approval only to fall under greater regulatory scrutiny within a 6-12 month period.

We continue to see substantial risks to COCO’s earnings prospects due to the company’s reliance on ATB students and business risk associated with the transition to a 3-year calculation for cohort default rates.   The acquisition of Heald will help reduce those risks somewhat and provide an earnings tailwind for FY11, but it should be acknowledged that the company has chosen to pay a higher multiple to diversify away from its current program offerings rather than repurchase its own stock at a lower multiple.

As always, please act accordingly…