Wall Street PhD: for-profit education can be good for business - and for education - includes related article on school voucher systems - Back to School

National Review, Sept 30, 1996 by Michael P. Garber, Fritz Steiger

For-profit education can be good for business -- and for education.

THE "education industry" was born as a news story in the New York Times this January. Few of the companies that make up the industry are yet household names -- Sylvan Learning Systems, DeVry, ITT Educational Services, KinderCare -- but they're now officially on the map.

This spring, two major investment houses -- Lehman Brothers and Smith Barney -- hosted conferences to introduce institutional investors and investment bankers to the leaders of roughly thirty for-profit education companies looking to raise capital in the equity markets. Their interest in education should be warmly welcomed.

John McLaughlin, editor of The Education Industry Report (based in St. Cloud, Minn.), has developed an index to rate the performance of 25 publicly traded education stocks. Last year, the Education Industry Index climbed a whopping 65.5 per cent (the Dow Jones Industrials were up 37 per cent). During the first eight months of this year the index rose another 38 per cent.

Why has Wall Street taken a sudden interest in education companies? For the same reason Wall Street is interested in any industry. America spends roughly $600 billion per year on education, or roughly 10 per cent of our gross national product. That's second only to health care (14 per cent) and more than twice as much as we spend on national defense (4 per cent). As media mogul turned education entrepreneur Chris Whittle reminds us, one point of market share in the elementary - secondary market alone equals $3 billon.

Analysts compare education today to the health-care industry twenty years ago. Until the 1970s, health care was inefficiently managed and dominated by the public sector and non-profit entities that had little direct competition and little incentive for innovation. Costs rose markedly without corresponding improvements in the quality of care. Doctors and boards of directors of non-profit hospitals were the "gatekeepers" in those days, much as local school boards and unionized teachers have a lock on service delivery in education. Then along came HMOs, and a multibillion-dollar industry was born.

It is no coincidence that investment banks have created the notion of "Education Management Organizations" (EMOs) in their investment literature as one of several sectors of the education industry. Companies like the Edison Project and Education Alternatives, Inc., have been the big players in the K - 12 arena, but the sector also includes management companies in pre-school and higher education. The biggest performer in the latter sector is the Phoenix-based Apollo Group.

Apollo operates the University of Phoenix, a chain of stand-alone for-profit universities, and it also contracts with smaller universities to provide students with specific degree offerings. Catering to the schedules of working people, most of the schools operate from 8 A.M. to 8 P.M. An on-line component is also offered, either as a stand-alone means of earning a degree or to augment campus-based offerings. Apollo's stock was offered for $11 per share when the company went public two years ago (with adjusted current value of about $2.40 after a secondary offering and four stock splits). Today, it trades in the mid-20s. When asked if the University of Phoenix has to spend time on "fundraising," founder John Sperling replied, "We don't need an endowment. We have Wall Street."

In addition to education-management groups, the education industry includes sectors such as educational services (learning centers, test-preparation companies) and educational products (textbooks, software).

Sylvan Learning Systems is one of the fastest-growing companies in the educational-services sector. In addition to offering tutorial services (focused on reading, math, and school readiness), Sylvan is now also operating remedial-education programs for 9,000 students in 62 school systems around the country. The company is also expanding into the growing area of testing.

For the market to exist, there have to be buyers. Who's buying and why? First among reasons for private-industry success is widespread dissatisfaction with the current systems, both at the K - 12 and the post-secondary levels.

But there are other forces at work as well. Companies like Apollo and Sylvan are taking advantage of a trend concomitant with the rise of the knowledge economy: while the premium paid for intellectual capital is at an all-time high (ask Bill Gates), many are questioning the value of formal academic credentials (again, ask Bill Gates).

Michael Prowse, writing for the Financial Times in November 20, 1995, argues that "Higher degrees serve a function akin to that of the exotic plumage of birds: they are primarily a means of attracting attention, of signaling that you deserve special attention." In today's world, as Sylvan Learning Systems knows well, "simple tests of cognitive ability can be administered in less than 30 minutes. Such tests, which can be tailored to the needs of particular companies, are a better guide to job performance than academic degrees."