DeVry Inc: Strategic Financial Analysis - Essay Example

DEVRY INC. DeVry Inc: Strategic Financial Analysis SCHOOL DeVry Inc. (DeVry), one of the largest private, degree-granting, regionally accredited higher education systems in North America, owns and operates DeVry University, Ross University, Deaconess College of Nursing and Becker Professional Review. This paper evaluates DeVry's proposal to obtain financing from venture capital fund for its latest endeavor towards the further diversification of its program offerings. The proposition is assessed in light of the firm's financial performance and strategy as well as its growth potential. In view of the company's lackluster performance in the past five years and the competitive pressures from cheaper alternatives, the author as a venture capitalist opts to forego the company's proposal Company Background DeVry Inc. (DeVry), founded in 1931 in Illinois, owns and operates academic institutions including DeVry University, Ross University, Deaconess College of Nursing and Becker Professional Review. DeVry University engages in the provision of undergraduate programs in technology and business. This segment also operates the Keller Graduate School of Management that offers graduate programs in management. DeVry's medical and healthcare segment includes Ross University, which operates Ross University School of Medicine and Ross University School of Veterinary Medicine located in Dominica and St. Kitts/Nevis; and Deaconess College of Nursing, which offers associate and bachelor's degree program in nursing. ("Yahoo Finance," 2005) Under DeVry's professional and training segment, Becker Professional Review prepares candidates for the Certified Public Accountant, Certified Management Accountant and Chartered Financial Analyst professional certification examinations. ("Yahoo Finance," 2005) From the operation of DeVry University, the company has pursued its strategic expansion into the said segments since 2003. This enabled the firm to offer more diversified course programs. In line with the company's growth plan, DeVry is currently seeking various sources of funding to finance its expansion binge. The following sections would discuss and evaluate the company's credit standing based on its historical financial performance vis--vis the industry average of the education and training services group. Situational Analysis Table 1: 5-Year Financial Performance ("DeVry Inc. Annual Report", 2002-2005) 2005 2004 2003 2002 2001 Income Statement (in millions) Revenue Tuition $737.13 $737.55 $628.33 $600.40 $524.00 Other Educational 45.53 47.17 50.81 47.18 43.01 Interest 0.64 0.17 0.44 0.55 1.18 Total Revenue 781.30 784.89 679.58 648.13 568.19 Less: Cost of Educ. Services 437.35 420.11 366.08 347.99 304.53 Operating Income 343.95 364.78 313.50 300.14 263.66 Less: Other Expenses 309.22 283.42 227.05 189.52 167.73 Income Before Taxes 34.73 81.36 86.45 110.62 95.93 Less: Income Tax Provision Add: Change in Accounting 8.01 1.81 23.30 25.31 43.57 38.14 Net Income 28.53 58.06 61.14 67.05 57.79 Earnings Per Share $0.40 $0.82 $0.87 $0.96 $0.83 Balance Sheet (in millions) Assets Current Assets $242.34 $208.88 $169.69 $117.83 $88.63 Land, Building & Equipment 286.77 286.89 285.35 257.63 207.47 Other Assets 380.93 388.37 401.60 92.17 95.58 Total Assets 910.04 884.14 856.64 467.63 391.68 Liabilities Current Liabilities 186.72 156.65 138.51 103.69 94.38 Other Liabilities 215.39 249.23 302.47 10.39 12.62 Total Liabilities 402.11 405.88 440.98 114.08 107.00 Total Shareholders' Equity 507.92 478.26 415.67 353.55 284.67 Total Liabilities & SH Equity 910.04 884.14 856.64 467.63 391.68 Table 2: Financial Ratios ("Money Central MSN", 2005) 2005 2004 2003 2002 2001 Profitability Ratio Net Profit Margin 3.65% 7.40% 9.00% 10.35% 10.17% 5-Year Ave. Net Profit Margin 8.11% Industry Average 9.40% Variance -1.29% Asset Utilization Asset Turnover Ratio 0.86 0.89 0.79 1.39 1.45 5-Year Ave. Asset Turnover 0.84 Industry Average 1.20 Variance -0.36 Liquidity Ratio Current Ratio 1.30 1.33 1.23 1.14 0.94 5-Year Ave. Current Ratio 1.04 Industry Average 1.50 Variance -0.46 Debt Utilization Debt-Equity Ratio 0.34 0.45 0.66 - - Industry Average 0.10 Variance -0.24 Table 3: Financial Market Position 2005 Market Capitalization ("Money Central MSN", 2005) $1.535 B Ownership ("Corporate Information", 2005) Institutional 84% Insider 16% Total Share Outstanding 70.53 M Table 4: Compound Annual Growth Rate 2005 2004 2003 2002 2001 Assuming: $20k initial investment of Venture Capital Fund in 2001 $32,224 $30,602 $27,299 $23,800 $20,000 Return on Equity ("Money Central MSN", 2005) 5.3% 12.1% 14.7% 19.0% - Compound Annual Growth Rate 10.1% Industry Average 15.5% Variance -5.4% Financial Strengths and Weaknesses Strengths Based on DeVry's annual reports, the company is able to generate a steady revenue stream from payments for student tuition, books, educational supplies and other fees. This is because the company, with its diversified service offerings, is able to address the educational and training needs of the knowledge-based economy. Furthermore, DeVry is able to provide services that better equip students to contend with the technological changes and skills requirement in the workplace. The company foresees the growth potential of its program offerings particularly in its medical and healthcare, and professional and training segments. Apart from this, the company also has a reputation as a reliable academic institution which provides high quality education. With this, DeVry has sufficient cash reserves and credit line to fund its operations and settle the current portion of its long-term debt. Moreover, the company may be able to undertake opportunistic acquisitions to further expand its educational services line as well as embark on facility improvement including facility renovation, expansion of existing campuses, opening of new campuses and formation of DeVry University Centers. ("DeVry Inc. Annual Report", 2005) Weaknesses Although DeVry is able to generate stable income stream, the company's profitability is apparently declining as evidenced by the net profit margin it posted in the past five years. For 2005, the reduction in earnings is attributed to the decrease in total undergraduate student enrollments particularly at DeVry University. The company's competitive edge is also waning due to the growing competitive pressure from local community colleges and state universities that provide educational alternatives for those whose primary consideration is lower tuition cost. Furthermore, DeVry cited that some educational institutions, which the company directly competes with, form partnership with local businesses for the expansion of their educational reach. Aside from its profitability, the firm is also highly leveraged. The company's five-year debt-equity trend is significantly higher than the industry average. DeVry's strategic expansion binge from 2003 to 2005 is mainly debt financed. Albeit debt-financing facilitates the company's expansion plans, this may have an adverse effect to investors' perception with regard to DeVry's financial health. Critical Issues One of the vital issues in this financial analysis is DeVry's growth rate. According to Money Central MSN (2005), in the past twelve months, the company posted sales growth of 4.5%, which is way below the industry average of 22.4%. Moreover, $22.9M income generated by DeVry is less than the $36.2M industry average of the education and training services group. This weak performance is primarily ascribed to the declining enrollment specifically in the full-time undergraduate performance. In the same way, the firm's compound annual growth rate (CAGR) indicates the same dreary result. The CAGR derived using the assumption of $20,000 as the initial investment in DeVry was only 10.01%, substantially lower than the industry average estimated at 15.5%. In relation to the above, significant issue to be considered, aside from the company's shrinking profitability, is its leveraging. Note that DeVry is highly leveraged relative to the other companies in the industry. Its debt equity ratio for 2005 is estimated at 0.34, higher by 0.24 to the industry average of only 0.10. Moreover, the firm's ability to service current obligations may be at risk since its current ratio of 1.30, which indicates its liquidity, sinks below the industry average of 1.50. These issues are discussed relative to the myriad risks that DeVry potentially confront the firm as well as its expected return to shareholders, financial strategy and controls. Business Leverage Operating Leverage The operating leverage indicates the degree to which costs are fixed. As such, a firm with high fixed cost is deemed to have high operating leverage. Operating leverage is measured by the percentage change in profits given a 1% change in sales. (Brealey, Myers & Marcus, 1995) In the case of DeVry, the degree of operating leverage in the past 4 years is as follows: Table 4: Degree of Operating Leverage 2005 2004 2003 2002 2001 Degree of Operating Leverage 110.57 0.32 1.81 1.14 - Industry Average 0.86 Variance -109.71 Given these figures, it can be inferred that DeVry has a relatively higher operating leverage compared to other companies in the educational and training services group. In this regard, the company's earnings affected particularly during periods of slump since a deficit in sales would have a magnified effect on profits. (Brealey, Myers & Marcus, 1995) Financial Leverage Financial leverage is defined as the increase in the variability of shareholder return that comes from the use of debt (Brealey, Myers & Marcus, 1995). As seen in the section on Situational Analysis, DeVry is more highly leveraged as indicated by the debt-equity ratio that is substantially higher than the industry average. The company's capital expenditure and working capital requirement from 2003 to 2005 are primarily debt-financed through revolving credit agreements with a group of banks and senior notes held by a group of insurance company lenders ("DeVry Inc. Annual Report", 2005). In view of its capital structure, the firm is committed to service a series of fixed payments such as interest arising from its debt. With this, the rate of return on equity increases since debt holders have first claim on DeVry's revenues and assets. Only after the company's debt has been settled can the shareholders' partake in its earnings. (Brealey, Myers & Marcus, 1995) Opportunity and Risk of Business Leverage Debt-financing enables the company to undertake its expansion strategy and diversify its educational program offerings. As such, this helps enhance the firm's earnings in light of the changes in students' preferred educational programs. However, such capital mix produces high operation and financial leverage for DeVry. With loan financing, additional debt interest, a form of fixed cost, is incurred and magnifies the variability of profits after interest. (Brealey, Myers & Marcus, 1995) Business Risk Assessment The potential risks that may have substantial impact on DeVry's operating income are generally related to the enrollment size and educational mandates. For instance, DeVry identified the shift in applicant career away from the focus of its undergraduate programs in selected areas of technology, healthcare and business that the firm does not amply respond to may adversely affect its operating income since this would result to plummeting enrollment size. Similarly, reductions in tuition pricing by other educational institutions may affect DeVry's current competitive position and its ability to regulate tuition rates in the future would have significant effect on the firm's operating income level. ("DeVry Inc. Annual Report", 2005) As evidenced by DeVry's financial trend, the company attributed the decline in earnings to these risk factors. The decrease in undergraduate enrollment in DeVry University brought about by the shift in program preference and presence of cheaper alternatives resulted in lower operating income for 2005. To address this, DeVry has undertaken several workforce streamlining to better match human resources to the changing demands of the business ("DeVry Inc. Annual Report", 2005). This is done in order to reduce the company's fixed cost in the form of faculty salary and wages. Moreover, to sustain demand for its product and services, DeVry commenced with offering online courses and resources like e-books. This undertaking is critical for the firm's expansion plans due to the advent of e-learning which fuels the demand for these types of educational services and products particularly by adult learners. To date, earnings from this segment proves to be promising, thus, the company intends to further invest in growing their online course offerings. In addition, DeVry has appointed an additional general manager to oversee all the aspects of its growing online operations ("DeVry Inc. Annual Report", 2005). Other risks that may affect the firm's operating income include loss or limitations in accreditations and licensing approvals; changes to regulations that may affect the company's current operations or future growth opportunity; and failure to hire and retain a competitive faculty. ("DeVry Inc. Annual Report", 2005) Cost of Capital DeVry's cost of capital is the expected rate of return required by investors in the company. Since DeVry utilizes both debt and equity to finance capital expenditure, the firm's cost of capital is the weighted average of the returns demanded by debt and equity investors (Brealey, Myers & Marcus, 1995). Given this, DeVry's weighted average cost of capital, based on 2005 figures, is derived as follows: Long Term Debt: Revolving Loan $50.00M Senior Debt 125.00M Total Long Term Debt 172.00M Equity: Common Stock $0.71M Additional Paid-in Capital 73.37M Retained Earnings 507.93M Total Value of Business = $682.93M Weighted Average Cost of Capital (WACC) = [(175/682.93) x 4.44% (i)] + [(507.93/682.93) x 5.7% (ii)] = 5.37% Notes: (i) Interest rate on DeVry's senior notes as at end-June 2005 (ii) Money Central's calculated return on equity as at end-October 2005 The weighted average cost of capital is 5.37%. This means that investors in the company would require 5.37% return on its investment in DeVry. In the same way, this is DeVry's minimum required return or marginal cost of capital when investing in new projects which have material effect on the company's finances. Return to Shareholders Dividend Policy and Historic Dividend Declaration As per the company's dividend policy, DeVry has not paid any dividends on its common stocks. The firm asserts that, being a holding company, it is dependent on the earnings of its subsidiaries. In this regard, it expects to retain all earnings from operations to be plowed back into business. Moreover, its cash flow may be restricted by law and the stipulations of its debt agreements. The Board of Directors, however, will periodically review DeVry's dividend policy. For its historic dividend declaration, DeVry declared a one common stock purchase rate for each outstanding share of DeVry's common stock in 2004. This was distributed on December 2004 to shareholders of record. The said right entitles the holder to purchase one one-thousandth of a share of DeVry's common stock at an exercise price of $75 subject to adjustment. However, following the acquisition of 15% or more of DeVry's common stock by a person or group, those entitled with the rights (other than the purchasing person or group) would be eligible to buy the firm's commons stock at 50% of the market price. ("DeVry Inc. Annual Report", 2005) Instead of a dividend in the form of cash or repurchase of its own stock, DeVry opted to offer rights to its shareholders that would entitle them to purchase the firm's common stock at a discounted price. Although the company is able to reinvest its earnings back to the firm, not declaring dividends may send negative signals to investors. Investors often perceive that a company which regularly pays dividend is "putting its money where its mouth is" (Brealey, Myers & Marcus, 1995, p.424). In this regard, investors prefer firms with established dividend records and tend to value the information content or signaling effect of dividends on the company's profitability. Generally, investors would refuse to believe a firm's reported earnings announcements unless they were accompanied by a suitable dividend policy. (Brealey, Myers & Marcus, 1995) Given the trend in the company's financials, it would be difficult for the firm to declare dividends in the coming years. Since it is currently undertaking its growth strategy, earnings are allotted for opportunistic acquisitions and servicing of interest and other current obligations. Expected Capital Expression According to the estimates of professional analysts, DeVry's stocks, which is currently priced at $21.76, is projected to further slide to $21.47 for fiscal year 2006. Their confidence in DeVry's stocks remains low and they recommend investors to hold their DeVry shares ("Money Central MSN", 2005). Albeit DeVry's current price has not sunk below its first support or floor price of $19.33, the stock price has not risen above the overhead resistance of $24.48 (52-week high) which would signal its rebound. With this, analysts do not expect the stock price to appreciate until 2007. ("Money Central MSN", 2005) Company Strategy Business Mission and Objectives DeVry's mission is to provide high quality education while at the same time maximizing returns for its shareholders. In light of this mission, the company aims to continuously improve the competitiveness of its undergraduate programs. In addition, DeVry intends to expand DeVry University Online and DeVry University Centers to capture a greater share in the market for on-site and online programs. For its professional and training, and medical and healthcare segments, DeVry aspires to keep up with the latest developments and incorporate these into its program offerings as well as improve and expand facilities and operations. Financial Strategy According to DeVry's 2005 annual report, beginning 2003, DeVry commenced its expansion strategy as it entered into an $85M revolving loan agreement with a group of banks and senior notes. With this debt-financing under DeVry Inc and its international subsidiary Global Education International, the firm acquired Ross University to establish its medical and healthcare segment. Following the acquisition, DeVry terminated this revolving loan agreement and issued senior notes. The company then entered into two new loan agreements wherein the loan maturity is extended to July 2009 and the interest rate on outstanding borrowings is reduced by 0.25% subject to the achievement of certain financial performance ratios. Under the terms of the agreement, interest rate is set in accordance with the prime rate or Eurodollar LIBOR rate plus 0.75% to 1.5%. To control its increasing interest rate cost, DeVry entered into several agreements to set interest rate cap for its $100M current borrowings. This was undertaken in order to hedge the company from sharp increases in short-term interest rates. DeVry continuously evaluates the need for future interest rate protection in view of the projected changes in the prevailing interest rate regime and its borrowing level. Moreover, the company utilizes derivative financial instruments to manage its exposure to increases in interest rate. ("DeVry Inc. Annual Report", 2005) In 2005, DeVry invested about $129M for the improvement of its facilities, school laboratory and teaching and administrative equipment. The firm also continued with its programmatic diversification with the introduction of more business and healthcare programs. DeVry has expanded its existing programs to new location and opened seven new DeVry University Centers. In addition, the firm completed the acquisition of Deaconess College of Nursing to fortify its presence in the field of healthcare. DeVry intends to reinvest its cash reserves and subsequent earnings to settle the company's current debt. Given the growth potential of its medical and healthcare segment, the company plans to enhance and expand the facilities and operations of the Ross Schools. Moreover, the firm will constantly be on the lookout for future opportunistic endeavors outside the United States. In line with its financial plan, the company believes that its cash reserves, and revolving loan facility if need be, will be ample to finance its current operations as well as its growth strategy as the top management remains "focused on solid execution" of its growth plan (Duhn, 2005). However, as the DeVry is able to execute its growth plans through loan financing, the firm should be cautious with its financial leverage. In the aspect of leverage, the firm somehow lacks the financial prudence considering its declining profitability. As mentioned, a high degree of leverage may send negative signals to investors since high debt levels entail commitment to servicing fixed costs. Shareholders may only partake in the residual earnings of the company only after these obligations have been settled. As such, a higher fixed cost such as interest expense to be settled puts a downward pressure on the earnings allocated for shareholders. This may quench investors' appetite in investing in the company due to the financial risk involved. Financial Controls As part of its financial control, DeVry's management regularly evaluates its interest rate exposure due to the company's highly leveraged standing. If it deems that the company is at risk of rising interest rates for its short-term borrowings, DeVry will promptly negotiate its loan terms with creditors. Aside from this, the management also provides reasonable assurance for prevention and timely detection of unauthorized acquisition, utilization or disposition of company's assets that could have material effect on company's financial health. This is undertaken by adhering to the internal control on financial reporting in accordance with the standards set by the Committee of Sponsoring Organizations of the Treadway Commission. ("DeVry Inc. Annual Report", 2005) DeVry also contracts qualified external auditors to review the financial and accounting aspects of the business to ensure that DeVry's practices are in line with the law and generally accepted accounting principles. Potential Risks and Responses As mentioned in the previous section, DeVry is facing potential risks and uncertainties which include the increased competition in recruiting new students and retaining students already enrolled ("DeVry Inc. Annual Report", 2005). To address this issue on improvement, the company is continuously increasing its focus on local marketing and outreach. DeVry will further strengthen its marketing programs in order to more effectively communicate the quality of the firm's degree programs. In line with this, the firm has forged new relationships with several marketing and advertising agencies as well as other academic institutions. Relative to this, the company is also undertaking market assessments in order to evaluate the preferred programs of students. For instance, as the company deemed that existing universities could not adequately accommodate the rising enrollment in medical-related courses, DeVry strategically acquired Ross University and Deaconess College of Nursing. The increasing revenues from this segment would help augment the reduction in DeVry's earnings on its traditional program offerings. To mitigate the risk of competition, DeVry is also maintaining its competitive tuition and fees by keeping increases at moderate levels. Although its undergraduate tuition rates are below average tuition of four-year independent institutions, the firm's rates are higher than the average four-year publicly supported institutions. Apart from this risk, DeVry is also confronted with the potential risk of losing accreditations and licensing approvals. The firm recognizes the fact that accreditation and approval signify achievement of level of quality that boosts public confidence towards the education community. In this regard, DeVry will ensure that its schools are able to qualify for accreditation status by thoroughly evaluating the quality of its course offerings, enhancing the facilities and hiring as well as retaining highly competitive faculty Resources Required In view of the company's response to these risks, the cost of educational services is projected to exhibit an upward trend in the coming years to reflect the company's plans to continuously enhance its facilities and equipment and ensure the quality of its program offerings. Furthermore, DeVry will also incur additional marketing-related cost so as to improve its promotions and recruitment. Aside from primarily using debt financing to fund its expansion plans and enhance the quality of the services it renders, DeVry may opt to issue shares and offer it to the market. This option would apparently be subject to the approval of the company's Board of Directors and existing shareholders if pre-emptive rights are granted since this may result in dilution of shares. The firm may also consider a global offering to raise additional capital. However, this may not be practical since the firm, to date, operates only within a limited market and geographic coverage in the US. Recommendation In view of the above discussion, DeVry's proposal to obtain financing by utilizing the venture capital fund should not be pursued at this time due to the reasons as follows: The company is already highly leveraged and committed to service fixed interest payments in the near term. As such, there is a high probability of default since its earnings are already constrained by its existing obligations; DeVry's lackluster performance, indicated by the financial ratios it posted, makes the firm financial health questionable. The company falls short of the industry average in terms of profitability, asset utilization, liquidity and even on equity returns; Although the actions undertaken in 2005 were deemed to have a favorable impact on fiscal year 2006 results ("Business Wire", 2005), it would take some time for the company to fully recover and improve its financial standing. Given the overall economic slump, trend in the academic sector is towards the enrollment in institutions offering quality programs at lower tuition cost. With this, DeVry will face critical competitive pressure from local community colleges and state universities; and There are more viable options in other field with better growth potential and meet our investment criteria that can be considered. For your information and concurrence please. References Brealey, R., Myers, S.C. & Marcus, A.J. (1995). Fundamentals of Corporate Finance. McGraw-Hill, Inc. Business Wire. (2005). Accessed: 29 October at http://yahoo.brand.edgar-online.com Corporate Information. (2005). Accessed: 29 October at http://www.devryinc.com/corporate_information/history.jsp# DeVry Inc. Annual Report 2005. (2005). Accessed: 29 October at http://www.shareholder.com/devry/edgar.cfmDoctype=Annuals&year= DeVry Inc. Annual Report 2002. (2002). Accessed: 29 October at http://www.shareholder.com/devry/edgar.cfmDoctype=Annuals&year= Duhn, B. (2005). Briefing.com. Accessed: 29 October at http://moneycentral.msn.com Money Central MSN. (2005). Accessed: 29 October 2005 at http://moneycentral.msn.com Read More