The document summarizes Oliver Mihaljevic's presentation on using a "Magic Formula" stock screening approach to identify investment opportunities in the U.S. for-profit education sector. It describes the Magic Formula methodology and explains why for-profit education stocks screen well but face regulatory risks. It also considers arguments for both bearish and bullish cases for these companies and concludes some may offer attractive risk-reward.

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

4. “Good” and “cheap” stocks

6. Investment case often rests on monetizing non-core and/or excess assets

8. (Current assets minus total liabilities) > market value

10. Turnarounds

11. Spinoffs

12. “Jockey” stocks3

14. “Good”: Trailing EBIT / Capital employedGoal:Pay a low price for companies likely to reinvest capital at high rates of return. 4

16. Advocated by Joel Greenblatt

17. Makes Sense

18. Simple

19. 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 5

20. 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)* * Source: www.magicformulainvesting.com

23. Questionable due to regulatory risk: most companies derive 80%+ of revenue from Title IV* federal student financial aid (threat to key revenue source!).

24. Growing industry?

25. 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… 8 * Title IV of the Higher Education Act of 1965 covers the administration of federal aid to students.

26. 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

28. 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

29. U.S. For-Profit Education Stocks—“Value Traps” orTypical “Magic Formula” Candidates?

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

31. U.S. For-Profit Education: Recent Valuation 14 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). 3 Trailing EBIT excludes impairment of goodwill/intangibles (and, at Apollo only, estimated litigation losses).

33. Structural issues

34. Business funded by government largesse in the form of student loans (risk resides with taxpayer and student)

35. Questionable educational outcomes

36. Business fundamentals in decline

37. Title IV federal student loan funding well “drying up”

38. New regulations holding companies accountable in relation to “gainful employment” and other performance/integrity criteria

39. Declining new student enrollment

40. Revenue pressure, negative earnings leverage, w/c issues15 * Based on the presentation from James Chanos, Kynikos Associates, at VALUEx Vail (June 16, 2011).

41. The ”Bear” Case: In Print 16 “U.S. senator lashes out at for-profit education” - Reuters, Aug 4, 2010 “Enrollment Drop Hammers For-Profit Education Sector” - Forbes, 10 Jan 2011 “For-Profit Education: Classic Value Trap” - James Chanos, 16 Jun 2011 “For-Profit Schools Under Fire, Stocks Down Nearly 30 Percent for the Year” - CNBC, 17 Dec 2010 “For-Profit Colleges Under Growing Scrutiny.” - WSJ, 27 May 2011 “For-Profit Colleges Mislead Students, Report Finds” - NYT, 3 Aug 2010

42. Before We Declare the Business Model Dead (and the Stocks Zeroes), Consider… 17 Impact of the "gainful employment" rule enacted on June 2, 2011 (as estimated by the U.S. Department of Education) 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

44. Debt‐to‐total earnings ratio: The annual loan payment may not exceed 12% of typical graduates’ total earnings.

45. Debt‐to‐discretionary income ratio: The annual loan payment may not exceed 30% of typical graduates’ discretionary income.

47. No enrollment growth restrictions.

48. Debt payment timelines extended up to 20 years (not 10 years)

49. Emphasis on giving schools the “opportunity to improve”18

50. 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

51. 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 20 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.

52. 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 etc. 21

53. 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

54. From “Bear” Case to “Base” Case Potential "base" case for selected companies that screen highly on TTM EBIT/EV: 23 Assumes revenue at 20% below the TTM revenue level(industry new student starts declined an estimated ~20% y-y, on average, in 1Q11)1 In-line or below the average ~10% EBIT margin of the U.S. defense industry — another government-funded sector2 Estimated intrinsic values are modestly higher than recent market values 11Q11 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. 2EBIT 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.

55. Potential “Bull” Case? 24 Potential “bull" case for selected companies that screen highly on TTM EBIT/EV: Assumes revenue at 10% below the revenue level of the trailing twelve months In-line or modestly above the average ~10% EBIT margin of the U.S. defense industry — another government-funded sector Estimated intrinsic values are significantly higher than recent market values Recent market valuations leave significant upside potential for selected stocks.

56. 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

57. 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

59. Joel Greenblatt: “The Little Book That Beats The Market”

60. www.magicformulainvesting.com

63. oliver@manualofideas.com27

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