See our presentation given at the Value Investing Seminar in Italy held in July 2011.

1. U.S. For-Profit Education Stocks:
A “Magic Formula” Approach
Oliver Mihaljevic
The Manual of Ideas
www.manualofideas.com
Value Investing Seminar Italy
July 13, 2011

2. “Magic Formula”
—
A Brief Review

3. Selected Value-oriented Idea Generation
Approaches (That We Like)
• “Magic Formula“ • “Net-Nets” (and other
• Advocated by Joel Greenblatt balance sheet plays)
• “Good” and “cheap” stocks • Advocated by Ben Graham
• Earnings-based • (Current assets minus total
liabilities) > market value
• Asset-based
• Sum-of-the-parts
• A staple approach of “activists”
• Investment case often rests on • Other Approaches
monetizing non-core and/or
excess assets • Equity “stubs”
• Earnings- and/or asset-based • Turnarounds
• Spinoffs
• “Jockey” stocks
3

4. Magic Formula: What Is It?
• Stock-screening methodology
• Popularized by Joel Greenblatt in The Little Book That Beats
The Market (2005)
• Ranks companies based on two factors (equal-weight):
• “Cheap”: Trailing EBIT / EV
• “Good”: Trailing EBIT / Capital employed
Goal: Pay a low price for companies likely to
reinvest capital at high rates of return.
4

5. Magic Formula: Why We Like It?
• It works:
• Performance vs. S&P 500 Index, 1999-2011*
(performance in %) '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 YTD
Magic Formula 16 9 36 -21 52 28 22 13 15 -36 43 13 15
S&P 500 Index 15 -9 -12 -22 29 11 5 16 6 -37 30 15 8
• Advocated by Joel Greenblatt
• Makes Sense
• Simple
• Will Continue to Work (institutional imperatives, emotional
bias)
* Data from 1999-2008 reflects the net performance of the Formula Investing Model Portfolio. 1999 data is from October 1, 1999
through December 31, 1999. Data since 2009 reflects the Formula Investing U.S. Value Direct Composite returns (net) of actual
accounts. 2009 data is from May 1, 2009 through December 31, 2009. Data from January 1, 2009 through April 30, 2009 is not
available. However, it appears the “magic formula” outperformed in that four-month period, as the Model Portfolio was up 46%
while the S&P 500 Index was up 19% from January 1, 2009 through September 30, 2009. Year-to-date 2011 performance
numbers are for the period from January 1, 2011 through May 31, 2011. Source: Formula Investing, www.formulainvesting.com
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6. Magic Formula: Recent Selections
Top 30 companies with $500+ million of market value
(based on July 1, 2011 share prices, sorted by company name)*
Market Most Market Most
Com pany Value Recent Com pany Value Recent
(in alphabetical order) Ticker ($ m illions) Filing Date (in alphabetical order) Tick er ($ m illions) Filing Date
Aeropostale ARO 1,418 Apr-30 Lam Research LRCX 5,615 Mar-31
Amedisys AMED 805 Mar-31 Lender Processing Services LPS 1,852 Mar-31
Apollo Group APOL 6,400 May-31 Microsoft MSFT 219,375 Mar-31
H&R Block HRB 4,981 Apr-30 Oshkosh OSK 3,001 Mar-31
Capella Education CPLA 686 Mar-31 PDL BioPharma PDLI 824 Mar-31
Career Education CECO 1,681 Mar-31 Par Pharmaceutical PRX 1,207 Mar-31
Comtech Telecommunications CMTL 741 Apr-30 Pow er-One PWER 850 Mar-31
Dell DELL 32,245 Apr-30 SanDisk SNDK 10,200 Mar-31
Deluxe DLX 1,295 Mar-31 TeleNav TNAV 736 Mar-31
Forest Laboratories FRX 11,493 Mar-31 Teradyne TER 2,812 Mar-31
GT Solar International SOLR 2,034 Mar-31 Tessera Technologies TSRA 883 Mar-31
ITT Educational Services ESI 2,270 Mar-31 Unisys UIS 1,130 Mar-31
Impax Laboratories IPXL 1,423 Mar-31 United Online UNTD 549 Mar-31
InterDigital IDCC 2,125 Mar-31 Veeco Instruments VECO 1,980 Mar-31
Kulicke and Soffa Industries KLIC 819 Mar-31 ViroPharma VPHM 1,472 Mar-31
* Source: www.magicformulainvesting.com
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7. Magic Formula: Evaluating the Selections
Key questions:
• Are high returns on capital sustainable?  “Moat”
Some issues to address: cyclicality, technological change,
customer value proposition, fads, threats to key revenue
source/business model (e.g. regulatory-driven)
• Does the business operate in a growing industry?
 High return reinvestment opportunities
7

8. Evaluating the Selections:
For-Profit Education
• Are high returns on capital sustainable?
• Questionable due to regulatory risk: most companies derive
80%+ of revenue from Title IV* federal student financial aid
(threat to key revenue source!).
• Growing industry?
• Yes, but regulatory changes could impede growth (“gainful
employment” rule; regulations related to recruitment, marketing
and other business practices).
For-profit education stocks are easy to
dismiss…
* Title IV of the Higher Education Act of 1965 covers the administration of federal aid to students.
8

9. Evaluating the Selections:
Other Companies
• Amedisys: 80+% of revenue from Medicare – regulatory threats
• Comtech: losing ~50% of revenue as U.S. Army contracts expire
• Deluxe: paper check provider – rise of payment cards, e-banking
• Forest Labs: branded pharma – 2012 patent expiry, “Obamacare”
• SanDisk: tech obsolescence, pricing pressure in data storage
• Microsoft: software model under attack from “cloud” computing
• Dell: desktop PCs, laptops under attack from netbooks, tablets
• H&R Block: paper filings in decline, share gains by Intuit, Internet
…other companies are also easy to dismiss.
9

10. (Unlikely) Winners from Past
Magic Formula Screens
• McGraw-Hill (MHP; $13 billion market value)
• Shares traded at $24 when featured in the September 2009 “Magic
Formula” issue of The Manual of Ideas; Einhorn’s Greenlight shorted
MHP due to regulatory risks at Standard & Poor’s; recent price: $42.
• Metropolitan Health Networks (MDF; $190 million market
value)
• Shares traded at ~$2.20 when featured in the September 2009 “Magic
Formula” issue of The Manual of Ideas; Metropolitan’s revenue is
dependent on Medicare Advantage funding; recent price: ~$4.50.
• Travelzoo (TZOO; $1.3 billion market value)
• Shares traded at $5 when featured in the November 2008 “Magic
Formula” issue of The Manual of Ideas; the online travel-related
company faced declining demand due to economic weakness; recent
price: $70.
10
All three would have been easy to dismiss.

11. Magic Formula: Conclusions
• It works.
• For-profit education stocks score highly…
• …but are easy to dismiss as investments.
• Other Magic Formula stocks are also “easily dismissed.”
• Past “winners” would have also been easy to dismiss.
11

12. U.S. For-Profit Education Stocks
—
“Value Traps” or
Typical “Magic Formula” Candidates?

13. Dismissed by the Market,
But not by the “Magic Formula”
Example: Corinthian Colleges (COCO): May 2009 – July 2011
(selected events and share price reaction)
13

14. U.S. For-Profit Education: Recent Valuation
Market Enterprise EV / EV / MV / MV / EV / TTM1
Price Value Value TTM 1 TTM 1 TTM1 2012E 2 Student FCF
Company Ticker 7/8/2011 ($mn) ($mn) Revenue EBIT Net Income Net Income ($) Yield
3
Apollo APOL $48.88 $6,921 $6,086 1.2x 4.4x 17.7x 15.0x $15,000 13%
Bridgepoint BPI 27.25 1,440 1,075 1.4x 4.3x 9.5x 10.6x 12,200 13%
Capella CPLA 44.40 698 513 1.2x 5.5x 11.4x 13.7x 12,900 8%
Career Ed. 3 CECO 22.72 1,763 1,365 0.6x 4.0x 9.6x 10.2x 11,500 8%
3
Corinthian COCO 4.52 382 546 0.3x 3.1x -4.7x 18.8x 5,300 -19%
DeVry DV 62.59 4,306 3,712 1.7x 7.7x 13.2x 13.1x 28,600 6%
Grand Cany on LOPE 14.46 649 644 1.6x 8.8x 14.7x 11.8x 15,100 -1%
ITT ESI 88.77 2,492 2,301 1.4x 3.8x 6.7x 11.4x 27,400 22%
Lincoln LINC 19.43 439 439 0.7x 3.8x 6.6x 13.0x 16,400 16%
Stray er STRA 137.48 1,683 1,692 2.6x 7.9x 12.8x 15.9x 29,400 7%
Average: 1.3x 5.3x 9.8x 13.3x $17,380 7%
Median: 1.3x 4.4x 10.5x 13.1x $15,050 8%
EV-to-trailing EBIT of less than 5x for selected companies
implies an undemanding valuation even if
“normalized” EBIT is 50% lower than trailing EBIT
1 Trailing twelve months refers to the twelve months ended March 31, 2011, except for Apollo (ended February 28, 2011).
2 Based on P/E ratios implied by the average of analyst EPS estimates as of July 8, 2011. All EPS estimates are for calendar
2012, except for Apollo (FY ended August 2012), Corinthian (FY ended June 2012), and DeVry (FY ended June 2012).
14
3 Trailing EBIT excludes impairment of goodwill/intangibles (and, at Apollo only, estimated litigation losses).

15. U.S. For-Profit Education: The ”Bear” Case*
“Classic Value Trap” (Jim Chanos, Kynikos):
• Stocks look cheap
• Structural issues
• Business funded by government largesse in the form of
student loans (risk resides with taxpayer and student)
• Questionable educational outcomes
• Business fundamentals in decline
• Title IV federal student loan funding well “drying up”
• New regulations holding companies accountable in relation
to “gainful employment” and other performance/integrity
criteria
• Declining new student enrollment
• Revenue pressure, negative earnings leverage, w/c issues
* Based on the presentation from James Chanos, Kynikos Associates, at VALUEx Vail (June 16, 2011).
15

16. The ”Bear” Case: In Print
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- NYT, 3 Aug 2010
16

17. Before We Declare the Business Model
Dead (and the Stocks Zeroes), Consider…
Impact of the "gainful employment" rule enacted on June 2, 2011
(as estimated by the U.S. Department of Education)
# of Gainful % of Program s % of Program s
Em ploym ent That Fail That Lose
School Category Program s At Least Once Eligibility by FY15
Public 37,218 3% 1%
Non-Profit 5,072 5% 1%
For-Profit 13,155 18% 5%
Total 55,445 8% 2%
Only 5% of for-profit programs
are to lose eligibility by 2015!
“The Department believes that institutions will strengthen their educational
programs to meet these higher standards, and relatively few programs will fail.”
- Federal Register / Vol. 76, No. 113 / Monday, June 13, 2011 / Rules and Regulations / 34390
17

18. “Gainful Employment” Rule:
Not a Red Card for the For-Profit Industry!
• Programs must pass at least one of the three metrics to
remain eligible for federal student aid funding:
• Repayment rate: At least 35% of loans (dollar-based) are being repaid (a $1
decline in the loan balance per year suffices!).
• Debt to total earnings ratio: The annual loan payment may not exceed
12% of typical graduates’ total earnings.
• Debt to discretionary income ratio: The annual loan payment may not
exceed 30% of typical graduates’ discretionary income.
• To lose eligibility, programs must fail measures in 3 out of 4
years.
• Final rule “watered down” from initial proposals
• First programs become ineligible in 2015 (not 2012).
• No enrollment growth restrictions.
• Debt payment timelines extended up to 20 years (not 10 years)
18
• Emphasis on giving schools the “opportunity to improve”

19. Lenient Regulation? Sounds Familiar…
Selected regulated industries
that are alive and kicking after left for dead by some:
•Rating agencies
•Sell-side equity research and banking in general
•Gulf of Mexico oil drillers
•Health insurers
•For-profit education companies?
19

20. Structural Issues: The Other Side of the
Coin
• 88 million U.S. adults are without a college degree (67% of
population above age 25).1
• 33 million U.S. adults above age 25 have some college experience,
but no degree.1
• Current estimates show a shortfall of 13-16 million graduates to
meet goals of the Obama Administration.2
Private sector is needed
to achieve U.S. educational goals.
1
Source: U.S. Department of Commerce, Census Bureau, Current Population Survey (CPS), March 2009.
2
Source: National Center for Higher Education Management Systems.
20

21. For-Profit Education: Here to Stay
• Sizeable: 10%+ of total U.S. postsecondary students attend for-profit colleges
(up from ~3% in 2000). There are ~4 million students in for-profit education programs.
• Needed to achieve U.S. educational goals: Current estimates
show a shortfall of 13-16 million graduates to meet Obama’s goals by 2020.
• Benefits from political expedience: Politicians are unlikely to throw
millions of students on the street by cutting for-profit funding; for-profit education has
an effective lobby and many (voting) students and teachers (90,000+ parties
submitted comments on the proposed Dept. of Education rules; 75% opposed the
rules).
• Tough to attack: Many for-profit students are minorities or people who
otherwise would not get an education. Outcomes are difficult to assess. As public
schools may not be doing better, crucifying for-profits may expose bigger waste in the
system.
• Not the first government-funded sector with questionable
outcomes/practices: See healthcare, defense contracting, recent bailouts
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etc.

22. The Economy Factor
• Educational outcomes difficult to judge in the weak
economy of 2009/10. Like in many other industries, bad practices were
exposed during weak economic times. But that does not mean the entire industry is a
fraud. Job placements and student loan repayment rates have cyclical elements.
• Student loan repayments are likely to improve as the
economy gets better and unemployment reduces over time.
• Recent economic weakness may explain regulators’
multi-year approach when testing programs’ performance and eligibility for
future funding. This gives companies time to adapt and improve.
22

23. From “Bear” Case to “Base” Case
Potential "base" case for selected companies that screen highly on TTM EBIT/EV:
Career Corinthian Lincoln
Assumes revenue at 20% below the
Education Colleges Educational
TTM revenue level (industry new student
(CECO) (COCO) (LINC)
starts declined an estimated ~20% y-y,
TTM rev enue (tw elv e months to 3/2011) $2.1 billion $1.9 billion $0.6 billion
on average, in 1Q11)1
Discount factor 20% 20% 20%
Estimated normalized rev enue $1.7 billion $1.5 billion $0.5 billion
In-line or below the average ~10% EBIT
Estimated normalized EBIT margin 10% 5% 10%
margin of the U.S. defense industry —
Estimated normalized EBIT $170 million $80 million $50 million
Fair v alue multiple 10x 10x 10x
another government-funded sector2
Estimated enterprise v alue $1,700 million $800 million $500 million
Plus/(Minus): Net cash/(debt) 400 million -160 million 0 million
$2,100 million $640 million $500 million
Estimated fair value of the equity
$27 per share $8 per share $22 per share Estimated intrinsic values are modestly
Implied upside to recent stock price 19% 68% 14% higher than recent market values
Implied EV-to-TTM revenue 0.8x 0.4x 0.8x
Industry avg est. EV-to-TTM revenue 1.3x 1.3x 1.3x
(Discount)/premium to industry average -39% -68% -39%
1
1Q11 new student starts: CECO (-14% y-y); COCO (-22% y-y); LINC (-39% y-y). The industry figure is estimated based on new student starts of
the three featured companies, in addition to Apollo, Bridgepoint, Capella, DeVry, Grand Canyon, ITT, and Strayer.
2
EBIT margins (TTM/5-year average): CECO (16%/10%); COCO (9%/7%); LINC (18%/12%). Trailing EBIT margins at CECO and COCO exclude
the impairment of goodwill/intangibles. The defense industry EBIT margin of ~10% is based on the five-year average operating margins for Northrop
Grumman, Raytheon, Lockheed Martin, General Dynamics and Boeing for 2006-10.
23

24. Potential “Bull” Case?
Potential “bull" case for selected companies that screen highly on TTM EBIT/EV:
Career Corinthian Lincoln
Education Colleges Educational
Assumes revenue at 10% below the
(CECO) (COCO) (LINC)
revenue level of the trailing twelve months
TTM rev enue (tw elv e months to 3/2011) $2.1 billion $1.9 billion $0.6 billion
Discount factor 10% 10% 10%
Estimated normalized rev enue $1.9 billion $1.7 billion $0.6 billion
Estimated normalized EBIT margin 15% 10% 15% In-line or modestly above the average
Estimated normalized EBIT $290 million $170 million $90 million ~10% EBIT margin of the U.S. defense
Fair v alue multiple 10x 10x 10x industry — another government-funded
Estimated enterprise v alue $2,900 million $1,700 million $900 million sector
Plus/(Minus): Net cash/(debt) 400 million -160 million 0 million
$3,300 million $1,540 million $900 million
Estimated fair value of the equity
$43 per share $18 per share $40 per share Estimated intrinsic values are significantly
Implied upside to recent stock price 87% 303% 105% higher than recent market values
Implied EV-to-TTM revenue 1.4x 0.9x 1.4x
Industry avg est. EV-to-TTM revenue 1.3x 1.3x 1.3x
(Discount)/premium to industry average 4% -32% 10%
Recent market valuations leave
significant upside potential for selected stocks.
24

25. Some Last Thoughts and Facts
• Bridgepoint’s new student starts grew 13% y-y in the March quarter.
• Most for-profit education companies have strong balance sheets and
are buying back shares.
• Valuations are diverging (Corinthian’s EV-to-trailing adjusted EBIT is
~3x versus Strayer and DeVry at ~8x). Potential for M&A?
• Internet-focused companies have inherently scalable, high-margin
models, which may not change drastically with increased regulation.
• Intriguing non-U.S. opportunities (e.g. Apollo/Carlyle JV in the U.K.).
• Increasing entry barriers due to regulatory scrutiny?
25

26. For-Profit Education: Conclusions
• Typical “Magic Formula” Candidates
• “Bear Case” May Have Run Its Course
• Current Risk-Reward Appears Attractive for Specific
Candidates (or for a “Basket” Approach)
• “Magic Formula” Beats Shorting!
26

27. Resources and Contact Information
• Magic Formula
• Joel Greenblatt: “The Little Book That Beats The Market”
• www.magicformulainvesting.com
• www.formulainvesting.com
• U.S. For-Profit Education
• Bear case: Jim Chanos at Ira Sohn (May 2009) and VALUEx Vail (June
2011); Steve Eisman at Ira Sohn (May 2010)
• Bull case: Case Study—University of Phoenix, Nexus Research &
Policy Center (August 2010)
• The Manual of Ideas
• www.manualofideas.com
• oliver@manualofideas.com
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