Sunday, October 29, 2006

Quick Valuation - Apollo Group (APOL)

Apollo Group runs the University of Phoenix and other for-profit higher education institutions. It recently reported 12% lower net income due to higher costs in marketing expenses and retention program costs. The earnings miss, poor retention rates, higher capex, and an options backdating probe has brought these shares down 25% from last month's prices. Is this best-of-breed business worth buying? I'm not 100% sold on the business, but the valuation seems cheap.

I played with a 3-stage DCF valuation to see how bad the growth has to be for the shares to be fairly valued around $35 a share. Using my customary 11% discount rate for companies of this size and the current FCF of $435 million dollars, the company would have to only grow 5% for the next five years and 3% in perpetuity to be worth $35 per share. To put this into perspective, the annual growth rate of the company over the last 5 years has been about 17%. A worst-case scenario of 7%, 5%, 3% staged growth results in the shares being worth $41. A more likely scenario is that the company can grow 10%, 7%, 3%, resulting in an intrinsic value of $49 a share. At current prices, APOL is trading with a 27% margin of safety. There doesn't seem to be much more down-side, but I am wary of the headwinds against the for-profit education establishments.

If the price gets even cheaper from here, I will take a closer look at the company. There are just too many unknowns and risks.

22 Comments:

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Can you show a posting on your DCF methods? I have seen a few DCF models around and was interested in your formula.

I have one based on morningstar's books, and also one based from the motely fools.

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Blogger wcsinvestor said...

The DCF that I'm using is a variant of the DCF used by the Motley Fool folks at Inside Value. I can post details within the next two weeks. I have two posts on the backburner and will do a DCF description post after those two.

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