Leading School Chain Rolls Back To Market Amid Political Debate

• Amy Reeves
• On 6:07 pm EDT, Monday September 28, 2009

Education Management Corp.

Pittsburgh, Pa.

(412) 562-0900

edmc.com

Lead underwriters:

Goldman Sachs, JPMorgan, Banc of America, Barclays Capital, Credit Suisse, Morgan Stanley and Piper Jaffray

Offering price: $18-$20

Expected date: week of Sept. 28

Ticker: EDMC

THE BUZZ

Things are getting interesting for the for-profit education industry. On Sept. 21, the Government Accountability Office found that students attending these schools have a higher default rate than students at conventional colleges, prompting the House Education Committee to plan hearings on the findings.

Nonetheless, school stocks went up after the report's release. Like so many things on Wall Street, it was an expectations game: Investors had feared the GAO would call for stricter regulations than it did.

"Our take on the GAO report is that nothing too dramatic or too detrimental to these companies came out," said Todd Young, who covers the industry for Morningstar. "We expect that will be the same going forward."

Meanwhile, Education Management CEO Todd Nelson was on the road promoting his company's upcoming IPO. He said he "welcomed" greater scrutiny by the feds.

Education Management has its reasons to feel secure. It's one of the biggest and best-known players in the field, not some fly-by-night diploma mill. Before its private equity buyout in 2006, it was one of the Street's star stocks. In February 2006, just before the buyout, IBD gave it a Composite Rating of 97.

On the roadshow, Nelson told investors that the firm went private because it wanted to invest in expansion, which would temporarily dock its margins. But the buyout was also a symptom of its age. Private equity was rolling in dough and eating up promising companies. Initially, the partners didn't plan to be in as long as they were.

The company first filed to go public in December 2007. The bear market intruded, but after the successful offerings of Grand Canyon Education (NasdaqGM:LOPE - News) and Bridgepoint Education (NYSE:BPI - News), the owners are probably feeling more confident.

THE COMPANY

Education Management's flagship school brand is the Art Institutes, a 44-campus chain offering degrees in subjects such as graphic design, interior decorating, film and media arts, fashion design and cooking. In 2000, it launched an online division. In 2001, the company decided to branch out by buying Argosy University, bringing in departments of health sciences, psychology, law and business.

In 2003, the firm bought South University, another set of schools with a heavy health sciences focus and a handful of campuses around the Southeast. The next year, it acquired Brown Mackie Colleges, a Midwestern group that offers a range of nondegree diploma programs in health sciences, business, law and information technology.

After the 2006 buyout by Goldman Sachs and Providence Equity Partners, Education Management stopped the merger binge but expanded its existing programs. According to the prospectus, it opened 20 new campuses, acquired two schools and developed 36 new academic programs.

Education Management now owns 92 campuses in 28 U.S. states and in Canada, with more than 110,000 students. About a quarter of them are online, a fivefold increase from the 2006 figure. The Art Institutes still account for more than 60% of enrollment. Some 64% of all students are enrolled in degree programs, mostly undergraduate. The firm says that between 1998 and 2008, enrollment growth averaged 18% a year, 12% at schools open a year or longer.

RISKS/CHALLENGES

After all this expansion, Education Management has a whopping $1.7 billion in consolidated debt. The proceeds from the IPO will pay only about $320 million of that.

The initial offering of 20 million shares will be a fairly modest chunk of the company, and the partners will still own 65%. Public shareholders will have limited control.

Whatever Congress decides to do, for-profit schools are already subject to extensive regulation. Education Management relies on Title IV funds for much of its income, and the Department of Education scrutinizes its practices in return for the loans.

As an example of what can happen, Bridgepoint Education shares shed 15% this month after it said it would be fined for failing to meet certain requirements.

The schools also have to meet various national and regional accreditation requirements to keep their reputations.

Last year, the company launched its own Education Finance Loan program for students who couldn't get government loans. That means the company will also take on the default risks.

THE RESULTS

In fiscal 2009, which ended June 30, net revenue rose 19.4% to $2.01 billion. Net income jumped 58% to $104.4 million.

USE OF PROCEEDS

Education Management expects to raise about $353 million from the sale of 20 million shares.

THE MANAGEMENT

Todd Nelson

Chief executive and director

Joined in 2007. From 1987 to 2006, he worked at Apollo Group (NasdaqGS:APOL - News), the last five years as CEO. He was also on the faculty of the University of Las Vegas from 1983 to 1984.

Edward West

President and chief financial officer

Became CFO in 2006 and president in December 2008. From 2002 to 2006 he was chief executive of ICG Commerce. From 2000 to 2002 he held executive positions at Internet Capital Group (NasdaqGM:ICGE - News). Before that he was CFO of Delta Air Lines (NYSE:DAL - News).

Robert Carroll

Senior vice president and chief information officer

Joined in 2007. He previously spent eight years as CIO of Apollo Group.

Buzz up!