In review the other day, read all prior posts re ESI and in particular ESI cash flow. ESI numbers have always shown great free cash flow. Cap expenditures are nominal, so net income goes right to cash. Government student loans are prepaid, so ESI gets paid in advance on those tuition. On third party private financing, ESI also gets paid in advance! Nice. Going forward, ESI student tuition that are government student loan financed, ESI gets the $ up front still. Now, ESI students have no private financing (eg the SLM RSA 2007 the third party lender 2009 RSA, and the PEAKS program). These program are done with and there is no replacement. Now ESI offers students loans out of its own pocket, but on terms described in the 10Q.
"Cash flows from operating activities decreased $273.1 million to $18.8 million in the nine months ended September 30, 2012 compared to $291.8 million in the nine months ended September 30, 2011, primarily due to lower student enrollments and a decrease in the amount of funds received from private education loans made to our students by third-party lenders.
In 2011 and 2010, we received funds on behalf of our students from unaffiliated private education loan programs, which represented, in aggregate, approximately 7% of our cash receipts in 2011 and 12% of our cash receipts in 2010. As previously discussed, the two private education loan programs that provided the vast majority of private education loans to our students in 2011 and 2010 expired in 2011. As a result, in the first nine months of 2012, we increased the amount of internal student financing that we provided to our students. The internal student financing that we provide to our students consists of non-interest bearing, unsecured credit extended to our students and is included in Accounts receivable, net on our Condensed Consolidated Balance Sheets. Payment of the student’s account balance is generally due by the end of the student’s academic year (which is generally nine months) or at the end of enrollment, whichever occurs first. As of September 30, 2012, our accounts receivable less allowance for doubtful account increased $41.3 million, or 85.9%, to $89.4 million compared to $48.1 million as of December 31, 2011, primarily due to the increase in the amount of internal financing that we provided to our students in the first nine months of 2012."
ESI now lets a bunch of students attend school without putting up cash up front, but signing loans that indicate the student must pay at the "end of the student's academic year (9 months) or the end of enrollment (ie the student drops out)." What does this mean? It means that ESI records revenues from these students that haven't paid in advance and ESI records that revenue also in its accounts receivable account. This pretty much started in the September 2012 quarter. That should mean that after nine months, these accounts receivables will start to be collected and cash flow should be coming in. I am not sure if ESI will collect 100 cents on the dollar for these accounts receivable. Some students will walk from paying I suspect, but these are not some long term loans that no one knows will ever be paid off in the distant future. The nine month period basically terminates in March 2013 for the June 2012 student starts, and rolls forward for each following student group. That means the cash flow position should improve starting q1 2013, which is pretty soon. For the past 9 months ESI has been extending credit to students (not all students) and educating them without getting any cash from them. This has hurt the ESI free cash flow, but it does not mean that ESI will not get paid and generate cash flow for the education services it renders. ESI has moved from a 100% pay upfront model to a partial pay up front (government sponsored student loans) and a partial pay after 9 months model.
This seems to be a temporary issue as ESI changes models on the timing of how it gets paid. Nothing more. During the transition period, free cash flow looks weak when compared to a time when ESI got paid totally upfront. Comparing the new way to the old way is like comparing apples to oranges.
The self funding model that ESI has moved to is at the core of investor concerns. students have been notorious in defaulting on loans and now, under this model, ESi is directly on the hook for these defaults. I only expect the default rates for students to accelerate. At the least ESi just became a far riskier play by taking on the default risk. Any cash flow projections are now totally suspect as we cant say how the defaults will turn out.
IF the student default rates remain manageable then there might be a bounce up but why gamble now? One earnings report showing stable cash flows should give ample room to figure out new valuation metrics and then go long.
hadrian, Your post is one of the few that I have seen where the poster has attempted to think things through. Good job. Some added points of clarity, however. ESI has moved to a "partial" self funded model. The bulk of ESI's students are government guaranteed student loan business. The loans that ESI now gives directly to students is only part of their business. You are completely correct in saying that we do not know the default risk on the students that ESI offers short term loans to. ESI reserves for these up front, but who knows if they will have reserved enough. These loans are short term (9 months to 15 months) as I understand from the SEC filings, so we will know real soon regarding repayment rates. I would also say that ESI is probably not handing out its money to students with abandon. I believe that the parents usually cosign the loans or there is some other form of collateral. I think the concerns re bad debts on these new loans is overblown. That would be like Wells Fargo handing out no documentation mortgage loans to dead beats in 2012 after the 2009 mortgage/housing collapse. The important issue that needs to get cleared up is how the cash flow looks once these short term student loans mature, the overall demand for ESI's education services (ie new student enrollment), and the 2009 RSA and Peaks financing obligations. Looks to me like it is all priced in to the shares. I do not think that you will be able to buy ESI shares anywhere near the current price if the above issues resolve anywhere better than horrible, which is what Wall Street seems to be expecting. By the time you figure out that things are not as bad as originally thought and things are getting better, the shares will already be much much higher.
I was reviewing ESI's 2012 projections to see how badly they screwed up. Did you know that at the start of 2012 ESI was projecting earnings of $7 per share. Now, earnings for 2012 are slated to be $8.05 for 2012 (well ahead of estimates - excluding the recent one-time settlement charge to SLM). Beat the earnings estimates and your stock goes to less than 2 times earnings! It must be a first. I have never seen that before.