On Wednesday, January 27th, President Obama laid out several initiatives that he hoped would advance the cause for higher education in America. We note that two of the three mentioned are positive for the for-profit education sector. However, we view the most important initiative as a net negative for the sector.

The first was a proposed $10,000 tax credit for four years of college education. This should be viewed positively, as the tax credit will increase incremental demand in the for-profit sector. Schools which have a focus on Bachelor’s degrees would benefit more as a result. We would especially like to single out companies such as Strayer Education Inc. (NADSAQ: STRA) and DeVry Inc. (NYSE: DV) as beneficiaries.

The second proposal was an increase in Pell Grants. Pell Grants are targeted towards lower income students. Currently, Pell Grants provide a student with $5,350 per year in tuition assistance. Although it is not yet known how much of an increase will be proposed, this should also be viewed positively for the schools with a higher mix of lower income students. Companies that would benefit from this proposal include ITT Education Services (NYSE: ESI) and Corinthian Colleges Inc. (NASDAQ: COCO).

The third proposal was a 10 percent cap on student debt repayments. Under this proposal, a student would be required to allocate a maximum of 10 percent of their post graduate income towards tuition debt repayments. We view this as a negative for the sector. Longer term programs such as Bachelor’s and graduate programs will be more negatively affected, since students who enroll in those programs tend to graduate with higher levels of debt. Schools might be forced to be more selective when enrolling new students, thus slowing down growth rates. The schools might also be forced to lower tuition fees, as well as slow down tuition fee increases.

Currently, there are a lot of uncertainties regarding the proposed terms of the President’s program. While President Obama mentioned 10 percent as a threshold, Education Department regulators are floating the idea of an eight percent threshold on student loan payback limits. Ultimately, schools that are likely to be more hurt by this proposal are those whose student mix stems from a lower economic bracket, while schools with a “higher quality” of revenue mix will reap the rewards.

The US Government Accountability Office (GAO) released its study on proprietary schools on September 21st. Our analysis of the report indicates that the recommendations offered by the GAO are more favorable to postsecondary education companies than previously anticipated. Certain higher quality schools within the sector should benefit more than others as a result of the GAO recommendations.

The objective of the GAO study was to review how $16 billion in funding awarded to proprietary schools in the 2007-2008 academic year were used. Along with for-profit universities, the study also evaluated public universities as well as nonprofit private universities. Wall Street’s concerns in advance of the study included a combination of a lack of familiarity with the current administration’s stance on proprietary schools, as well as anxiety over how harsh the recommendations might be. There were specific concerns that profit margins would be a major focus of the study along with student enrollment standards.

After a thorough review of the report, we found that there was less scrutiny of the profitability of schools than previously anticipated. Instead the focus was on student outcomes. Good outcomes can be measured by high persistence rates among current students, or by student job prospects after graduation. If a student graduates and cannot find a job, he or she is at risk of defaulting on their federal loans. The cohort default rate (CDR) is the metric which indicates the percentage of students who default on their federal loans within two years after graduation. Using the most recent four year data, the CDR rates for proprietary schools stood at 8.6 percent. A school would lose funding if its CDR reaches 25 percent for three years in a row or 40 percent for one year.

The major reason cited by the GAO for the differences in performance between proprietary schools when compared to either public schools or private nonprofit schools is the differences in student population demographics and socioeconomic background. When these factors are taken into consideration, the higher CDRs and worse outcomes were not only unsurprising but also expected.

One concern raised by the report is the issue of quality control within the proprietary schools. The report mentioned cases where students who were not academically qualified for enrollment were allowed to enroll after taking an “ability-to-benefit” (ATB) exam. The exam tests basic Math and English skills. If the enrollment process receives further scrutiny, it is conceivable that a higher barrier will be erected for prospective students.

Among the for-profit companies that we currently cover, we believe the higher quality schools will benefit more from this report. Schools such as Apollo’s University of Phoenix (NASDAQ: APOL), DeVry (NYSE: DV), Strayer (NASDAQ: STRA) and Capella (NASDAQ: CPLA) will be the biggest beneficiaries. Among the schools that disclose post graduation metrics, DeVry graduates are shown to have the highest job placement rates as well as the highest salaries. Companies such as ITT Tech (NYSE: ESI), Career Education (NASDAQ: CECO) as well as Corinthian Colleges (NASDAQ: COCO) stand to benefit less than the aforementioned school in our opinion.

Google, the king of search, is often touted as Microsoft’s most potent challenger. Fueled by its meteoric rise through a competitive search market and shrouded in secrecy, Google is surrounded by a cloud of confusion. It has rolled out a series of products that compete with Microsoft’s dominant businesses, including GMail (competes with Hotmail and Exchange), Google Docs (competes with Microsoft Office), and Android (Smartphone and mobile device platform). None of Google’s newer products have achieved the penetration or dominance that it has in search, leaving many to question its ability to compete outside of its core business, or worse that it has lost focus.

Google’s Chrome products, a web browser and newly announced operating system, are designed to grow the market size for its core advertising business by stimulating interest in the internet infrastructure space. Chrome, Google’s web browser, brought a critical change to browser architecture: multi-process browsing. With traditional browser technology, errors or malfunctions in a tab cause the entire browser application to slow or fail. With multi-process browsing, failure in a single browser tab will be isolated to the tab. In the context of cloud computing, where data storage, chat, e-mail, word processing, and multimedia consumption reside in web browser tabs, stability of the browser becomes critical. Shortly after Chrome’s first beta was released, Microsoft and Firefox set out to mimic this crucial feature. Accordingly, while Google Chrome will never be a major player in the web browser market, the impact of its entry will help to pave the way for cloud computing.

Similarly, Chrome OS will succeed by inducing innovation in the OS market. Chrome OS will aim to strip out operating system size and complexity, and focus on a simple task: getting the user onto the web. This will have the added benefits of reduced power load, markedly easier security, and fewer crashes. Whether Google Chrome exceeds Apple OS X or Windows market share is irrelevant to the success of the venture, so long as Microsoft, Apple, and other technology players mimic Chrome’s key innovations.

While Google Docs might never replace or match the Microsoft Office franchise, it induces investment and innovation in the market for web based office productivity software. With Chrome OS and other products, Google is lowering the barriers to widespread adoption of the cloud computing model. The company will grow as the web is used to access and consume applications, data, media, and other services, by collecting demographic information and delivering targeted, relevant advertisements.

Welcome to the May 11, 2009 edition of the Festival of Stocks. Festival of Stocks is a blog carnival that highlights current financial related content. This week covers a variety of topics, including fundamental analysis, trading strategies, and personal finance.

Continue reading 140th Edition of the Festival of Stocks

Battle Road Blog is highlighted this week in the Festival of Stock, Edition 138.

Oracle (NASDAQ: ORCL) announced in a surprise move this morning that it would acquire Sun Microsystems (NASDAQ: JAVA) for $7.4 billion. With the move, Oracle now competes with nearly all of the largest technology companies, including Microsoft in middleware and server operating systems, SAP and Salesforce.com in business applications, IBM, Cisco, HP, and Dell in server hardware, and EMC for storage solutions. Larry Ellison, CEO of Oracle, cited Sun Microsystems Java platform and the Solaris operating system for servers to be the primary motivators behind the acquisition.

While Java is an important component of Oracle’s middleware platform and Solaris an important OS platform for its database servers, it is unclear how Oracle benefits from having either component in-house. Java is not a major revenue generator, and Solaris has been slowly losing relevance in the server market for years, as commodity hardware and operating systems (like Windows Server and Linux) displace UNIX. While recent steps to open source Solaris have slowed the process, I believe that the operating system will continue to be on the decline.

The unmentioned key to the acquisition is MySQL, the open source database that Sun Microsystems acquired in January 2008 for $1 billion. When acquired, MySQL annual revenue was in the range of $50 million and growing rapidly. MySQL is the king of open source databases, receiving the lion share of support and development effort. The software has a dual license, meaning that commercial entities must pay to use the database while individuals can use it for free.

Oracle is, first and foremost, a database company, and MySQL was undoubtedly a long term threat. Many of Oracle’s middleware and software products rely on the use of databases, and even Salesforce.com, a major disruptor and competitor in business software, relies on an Oracle database to run its platform. Many of Oracle’s software acquisitions allow it ensure the usage of Oracle databases, hence allowing it to add both revenue and earnings from the software AND additional database sales. With the acquisition of Sun Microsystems and MySQL, Oracle seeks to control this up-and-coming, open source database, and most importantly, its licensing for commercial use. Our suspicion is that MySQL’s revenue growth rate, while no longer disclosed, will slow precipitously following the integration of Sun Microsystems into Oracle.