All Hopes on Education IPO To Break Through Drought

NEW YORK (Reuters) – If Grand Canyon Education Inc. manages to get its planned $179 million initial public offering off the ground this week, it will break a nearly four-month drought in U.S. IPOs.

But whether that will happen is still an open question. Even more doubtful is whether even a successful deal by the online university operator will signal any kind of broader market reopening.

Still, while the markets remain turbulent in most sectors for established stocks, let alone IPOs, Phoenix-based Grand Canyon’s deal might get a warmer reception from investors seeking safety in an industry that typically thrives during an economic downturn.

A number of leading education companies have fared well so far this year. DeVry Inc (DV.N: Quote, Profile, Research, Stock Buzz), a technology-based business education company, has seen its stock rise almost 7 percent.

Apollo Group (APOL.O: Quote, Profile, Research, Stock Buzz), which focuses on education for working adults, is down about 3 percent, but has been rising since the company reported better-than-expected earnings two weeks ago, bringing other educations stocks up with it. By contrast, the S&P 500 .SPX is down nearly 40 percent so far in 2008.

“In a bad economy, people go back to school and learn a new trade,” said Jeffrey Silber, a senior analyst with BMO Capital Markets. “There is counter-cyclicality in this sector, and where you see it most is in post-secondary programs and companies that specialize in non-degree granting programs.”

The sector as a whole had been volatile earlier in 2008 because of fears about the availability of student loans. But after the Education Department increased lending limits on certain loans in May, investors were reassured, analysts said.

“The government has stepped up to close the funding gap,” Silber said.

Because investors want companies with a lot of cash and fast growth, education companies have proven popular.

“Students pay tuition upfront and companies recognize revenues over time, so that generates strong cash flows and high returns,” said Jennifer Childe, an analyst with Credit Suisse.

But Childe said the sector’s fortunes could change if the economy begins turning around and investors shift toward industries that move more closely with the economy.

EXCEPTIONS TO THE RULE

In contrast to almost all other IPOs since early 2007, the two IPOs by U.S. education companies have performed well.

Online post-secondary education provider American Public Education Inc (APEI.O: Quote, Profile, Research, Stock Buzz), which went public with a $94 million IPO about a year ago, posted better-than-expected earnings on Wednesday. The stock is up more than 100 percent from its offer price.

K12 (LRN.P: Quote, Profile, Research, Stock Buzz)’s shares are up 29 percent since the online education company’s $124 million debut last December.

In addition to Grand Canyon, the other education company in the IPO pipeline is Education Management Corp, which is gunning for a $500 million IPO, but has not yet scheduled a pricing.

Still, the climate remains difficult, with investors skittish and more inclined to trust known companies.

One of Grand Canyon’s challenges could be valuation. It has already reduced its target IPO price range once, to between $16 and $18, from $18 to $20.

Using the deal’s mid-range price of $17, Grand Canyon’s price-earnings ratio would be about 67, based on annualized earnings for the nine-month period that ended Sept. 30 — well above that of many of its competitors.

Online university operator Capella Education Co (CPLA.O: Quote, Profile, Research, Stock Buzz) boasts a multiple of 31 based on estimated 2008 earnings, while Apollo Group is trading at about 24 based on actual 2008 earnings.

While Grand Canyon’s growth — including 38 percent revenue growth in 2007 — might make it attractive, investors could be turned off by the fact that 75 percent of the deal’s proceeds will go to insiders, one analyst said.

“IPOs where existing investors are selling stocks have not gone well in 2008,” Scott Sweet, a senior managing director with advisory firm IPO Boutique said, adding that investors want IPO proceeds to go toward building a company.

While no one expects one deal to un-freeze the IPO market, a successful Grand Canyon IPO would help, he said, and possibly tempt others in the pipeline to test the waters.

“It would instill some minor amount of confidence that IPOs can come in in an environment as volatile as this,” Sweet said.

Still, so long as the economy stays mired in a slowdown, education stocks likely will remain popular.

“You have investors hiding in this sector,” BMO’s Silber said.

By Phil Wahba
(Editing by Matthew Lewis and Maureen Bavdek)