For-profit education companies have had a strong run in the past decade. They have tripled both enrollment, to about 1.4 million students, and revenue, to $26 billion. They have done this by recruiting low-income students and active military personnel. These educators are now taking advantage of a loophole in government regulation that allows them to acquire struggling, traditional, nonprofit and religious schools. By doing so, they can gain these schools’ coveted accreditation. Accreditation is a formal recognition that the school or program meets certain standards and provides quality education. It essentially gives assurance that a student will attain the same education as he or she would in a traditional school. It also entitles students to financial aid, an important contributor to sales for many for- profit educators.
The current accreditation system wasn’t designed to evaluate for-profit takeovers. As a result, many for-profit education companies have purchased poorly performing schools and transformed them into taxpayer-funded giants by adding online-only programs, which drastically increase enrollment. Many of the students at these schools receive federally backed financial aid, which is only available to accredited schools. Student aid can provide more than 80% of revenue for some of the for profits.
In short, for-profit educators are basically buying accreditation. Most of them have been accredited by less prestigious national organizations. But by gaining regional accreditation, these online and trade schools gain a credential typically associated with traditional schools. It generally takes five years or more, as well as evaluations by outside professors, to gain accreditation. For-profits don’t want to wait five years; they typically want to double enrollment and revenues within a couple of years.
As an example, ITT Educational Services (ESI) paid nearly $21 million last year for Daniel Webster College, a school with only 1,200 students and a significant amount of debt. The main reason for the acquisition was the school’s regional accreditation status, which allowed ITT to immediately benefit from federal student aid. This was ITT’s first regionally accredited campus. Corinthian Colleges (COCO) also made an acquisition last year, Heald Capital for $395 million, despite Corinthian’s past difficulties with California state regulators regarding its misrepresentation of graduates’ job placement rates and salaries.
Regional accreditors typically rely on academic volunteers, and they don’t provide much scrutiny of a buyer’s background when an acquisition is being reviewed. The question is whether a purchase should be considered a change of ownership or a completely new school that should be required to earn certification from scratch. There have been very few instances where accreditors refused to continue accreditation of a recently purchased college. Regional accreditation has been valued at $10 million for a for-profit acquirer. This is how much it would cost to start a regionally accredited school, which can take years and likely has only a 50% chance to succeed.
The Obama administration has questioned whether the current accreditation system has been effective in protecting academic standards. It believes these decisions lack transparency and take too long. It also wants to determine if these types of purchases are circumventing a federal law that requires a two-year wait before new for-profit schools can qualify for assistance. There have been some updates to the rules in recent months. The Higher Learning Commission, which certifies over 1,000 colleges in the Midwest, recently toughened its rules for ownership last year. Acquirers must wait from one to four years to reapply for accreditation if the school it buys doesn’t maintain the same basic mission. A $10,000 fee for ownership changes is now being charged to help pay for more extensive research, and acquirers must now be approved by its board instead of lower-level staff.
Some believe that it is in the public’s best interest to have smaller, accredited schools with financial difficulties bought out by larger for-profits, since the acquirer typically has the resources to invest in the school and retain qualified staff. However, there are others who view the process with suspicion. Regarding ITT, shortly after it acquired Daniel Webster College, it laid off 20 employees. It also restricted the faculty’s role in issues regarding curriculum and governance, which would seem to violate policies that were instituted to prevent a change in the mission of the school. Many think ITT simply wanted Daniel Webster’s accreditation, despite management’s insistence that it wouldn’t change the fundamental operation of the school. What is known for sure is that ITT is now expanding Daniel’s online offerings, opening more campuses, and introducing more academic programs, all in an effort to expand enrollment and revenues.
Based on the furor over the accreditation issue, it is highly likely that there will be additional changes to the process over the coming months. If the changes to the accreditation process are especially stringent, the for-profit educators may find a valuable avenue for growth stymied. This would likely put a damper on the shares of these stocks. If the changes are strict, but not onerous, we think ITT, Corinthian Colleges, and several other, well-funded educators will continue to make acquisitions in order to gain schools with regional accreditation. It may be more difficult, and take a little longer, but the benefits of higher enrollment, along with increased sales and profits, make the decision to purchase these schools an easy one for these companies.