College Investors Bank On Gainful Employment Rule Easing

Stocks of for-profit college operators have soared in the past two months as concerns about the federal government implementing harsh regulations on the sector begin to ebb.

Whether that sense of relief is merited, however, is up for debate.

Recent comments from members of Congress, and even from the Department of Education itself, are giving investors hope that the government may soften its proposal to penalize schools whose students graduate with large loans and low- paying jobs. The issue comes under the guise of "gainful employment," which fundamentally questions how well schools prepare their students to get jobs that can cover their educational debt.

The stocks of companies such as Bridgepoint Education Inc. (BPI), Career Education Corp. (CECO) and Corinthian Colleges Inc. (COCO) initially dipped after the proposal was announced in late January. It recommended that programs whose graduates have a debt-to-income ratio above 8%, or who don’t meet certain other criteria, lose access to Title IV federal financial aid – the main revenue source for the for-profit schools. Opponents say the rule could force schools to lower their prices.

The schools’ stocks started rising in mid-February as short-sellers, believing no more negative news would come for months, started covering their positions. The Education Department likely will release an official proposal in June, open for public comment, and a final rule in November. Any changes won’t go into effect until July 2011.

Shares have been on a tear since. Bridgepoint is up 63.8% since the rule was proposed, while Career Education has gained 42.3% and Corinthian is up 41.1%. American Public Education Inc. (APEI), Grand Canyon Education Inc. (LOPE) and others have also outpaced the market. The Russell 2000 Index is up 12.1% in that time.

Some saw a boost when Education Secretary Arne Duncan testified in front of the House Education and Labor Committee March 3 that the department is "by no means wedded to any one direction" on the rule. "We don’t want to be overly heavy-handed," he said.

Four committee members, including two Democrats, expressed concerns about the proposal during the question-and-answer period.

On March 11, the Congressional Black Caucus circulated a letter for members to sign and send to Duncan noting their distaste for the rule.

But congressional disappointment might not have much impact.

"While certainly a positive step, a letter is only a letter," said Ariel Sokol, an analyst with Wedbush Securities, regarding the Congressional Black Caucus’s missive. "This is not a legislative process," he added, as Congress ultimately has no say in what rule the department adopts.

Congress does have a say on the upcoming reauthorization of the Elementary and Secondary Education Act, though, which some believe could put Duncan in a tight- enough spot to make concessions to ensure passage of that bill.

"The department easing up would be a small price to pay to accommodate everyone," said Trace Urdan, a research analyst and managing director at Signal Hill Capital Group.

Harris Miller, head of the Career College Association, an industry trade group, says he has had talks with the department about the gainful-employment language. "I know from various conversations that the Department is increasingly aware of these concerns," he wrote in an email. "But whether this increased attention will divert them from their path remains to be seen."

Jeffrey M. Silber, managing director at BMO Capital Markets, agrees. He wrote in a note to investors Wednesday, "We believe nobody outside of the Department of Education has true insight into how the language has changed." He expects that the initial proposal will be watered down "a bit," but some type of debt ceiling will still be implemented.

An Education Department official said the office is working on the language and couldn’t comment further.

Even if the ultimate rule is softened, some fear the schools most affected – those whose students default on their debt or who graduate into low-paying jobs – may not disclose the potential impact on their bottom line early enough. That could force the industry into another cloud of uncertainty like the one under which it hovered for much of last year as investors waited for the government to introduce the list of regulations it would seek to revise in the first place.

"Investors would be ill-informed to think that we’re out of the woods, by a long shot," Sokol said.

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