We reduced our holding in Strayer Education from 14.1 percent of the portfolio at the end of the third quarter to 5 percent at the end of the year. We believe Strayer has lower growth prospects and as a result trades at a fair valuation. It therefore represented too high a percentage of the portfolio at 14.1 percent. We believe it is more prudent to remain on the sidelines and wait to see if growth begins to materialize before committing a larger percentage of our portfolio to this position.
We also do not see any short-term catalysts on the horizon. We examined job growth prospects in the markets where Strayer’s students are located such as Washington, D.C. and Virginia, and saw no dramatic near term job growth that would drive prospective student enrollment within the most common degree plans at Strayer.
We have also become increasingly concerned that the employee culture is exhibiting signs of decline as the leadership continues to emphasize cutting costs instead of growing the business. This is placing pressure on existing employees as many are being asked to take on more work. For example, full-time faculty members are being asked to teach more classes. Also, many support positions have been eliminated which we believe may have an effect on service quality. We believe layoffs can profoundly affect the culture of the business, spreading fear among the remaining employees in the organization. This fear causes companies to contract rather than expand.
Is Strayer a mistake?
As many of you know I have been a champion of Strayer for many years, writing at length in past quarterly letters about the strength of the investment. My investment thesis was based on the fact that Strayer was the best run for-profit education institution and it avoided the bad practices of other for-profit colleges, such as recruiting students with false promises and loading them up with debt they could not pay back. I felt many of Strayer’s problems were industry related and that its stock price would recover as investors discovered Strayer did not engage in the same practices as other for-profit schools.
Then employment growth in the United States began to decline and this along with other factors caused new student enrollments to decline by double digits. This had the effect of shrinking Strayer’s total enrollment from 60,000 students at the end of 2010 to 42,200 students as of the most recent quarter. I had underestimated how quickly enrollments would decline but did not want to react too quickly to the negative news and sell the position. As new student enrollment stabilized in the last year, this gave me further confidence to continue holding our position. We also gave Strayer credit for proactively seeking new avenues of growth such as their deal with Fiat Chrysler and the new Jack Welch Executive MBA program. Fiat Chrysler is paying 100 percent of the tuition for dealership employees and Jack Welch Executive MBA enrollments are growing at a double digit rate, both creating more value. In other words, we thought that their positive steps were balancing the stagnant enrollment environment.
I believe in some respects this investment has been a mistake. First, I succumbed to the dreaded enemy of all investors – the confirmation bias. This is the bias which causes investors to stick to their existing beliefs. I found myself in a position where I was defending this investment, instead of making a detached evaluation. As we invested in higher quality faster growing businesses my comparisons changed and therefore our decision to reduce our position became clearer.
I continue to have some conviction in Strayer but believe the negative attributes may outweigh the positive attributes. This is why I reduced the position size. Strayer continues to trade at a double digit free cash flow yield and has an even stronger balance sheet now that it has repaid all of its debt which protects our downside.
This post has been excerpted from a letter to partners of Compound Money Fund, LP.
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