Grand Canyon Education, Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 5/5

Grand Canyon Education, Inc. (LOPE) is a publicly traded education services company that primarily focuses on providing educational services, primarily to Grand Canyon University (GCU), and it also offers services to other institutions.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Grand Canyon Education, Inc. (LOPE) operates in the higher education sector, providing services to Grand Canyon University (GCU) and other third-party institutions. LOPE’s primary revenue source is its service agreement with GCU. It is important to note that while technically a third party provider, it has a highly symbiotic relationship with GCU, as its campus was the original base for GCU and the two are intertwined in their operations.

Business Overview:

  • Service Agreement with GCU:

This agreement is the backbone of LOPE’s business. LOPE provides a comprehensive range of services to GCU which includes support for course development, marketing, information technology, finance, operations, and other ancillary services. It receives a substantial portion of its income in exchange for these services. The agreement is structured with a fee sharing model that ties the companies profitability together.

  • Non-university partners:

LOPE also provides online program support, curriculum development services, technology platforms, and marketing to other universities and schools that are not connected to GCU. This part of the business segment is small relative to the core operations, but provides some revenue diversification.

  • Revenue Distribution:

The vast majority of LOPE’s revenue comes from its services agreement with GCU, with only a small amount from its other non-university partners. This creates a very clear dependency on the long-term financial performance and standing of GCU.

  • Trends in the Industry:
    • Online Education Growth: The online education market is growing rapidly, driven by convenience, flexibility, and increasing acceptance of online learning. LOPE and GCU have had success using this trend and attracting a large number of online students.
    • Regulatory Environment: Higher education, and online education in particular, faces complex and evolving regulatory requirements. Changes in these regulations can impact the business operations, accreditation, and funding models of higher education companies.
    • Competition: The higher education sector is highly competitive with an ever growing number of universities and institutions offering similar programs and services to capture market share.

Moat Analysis: 2 / 5

  • Network effects: There are no network effects in this company. Although student body numbers and alumni network for GCU are a small advantage. There is nothing about the company that would create strong network effects.
  • Intangible assets: there is no brand or patents of proprietary technology.
  • Switching costs: There are very high switching costs for GCU to switch a technology or management partner, but since it is an internal relationship its technically part of one company. Any external clients of Lope would have little switching costs making it easy to be dropped for a cheaper partner.
  • Cost advantages: While there is a size advantage, LOPE doesn’t exhibit a structural advantage stemming from scale, locations, or access to proprietary resources compared to other providers.

  • Overall: While there is a degree of stickiness in the relationship between LOPE and GCU. LOPE relies heavily on a single client for revenue, with a small portion being distributed among a wide group of schools. This reliance, combined with the structural characteristics of their business, gives it a weak moat.

    • Justification for Moat Rating:

The core of LOPE’s moat is centered around the relationship with its main customer, GCU. However, as GCU is a customer that is essentially tied to Lope, this type of relationship should have a low rating for moat and stability since the relationship is almost symbiotic. This relationship is subject to change. With that in mind, other characteristics such as switching costs and network effects also come out to a very weak moat. The high reliance on a single client, limits its rating to a 2/5.

Risks to the Moat and Business Resilience:

  • Regulatory risks: The company faces the possibility of changes in the regulatory environment which could reduce demand for its services. Financial regulations and student aid programs could be altered which can negatively effect the whole company and its business partners. For example, a sudden change in policy regarding federal student aid, which heavily subsidizes the entire education sector, could lead to financial distress in the industry.
  • Dependence on GCU: LOPE’s primary financial vulnerability is the dependence on the financial health and standing of GCU. Any adverse changes in GCU’s performance or its regulatory environment could have huge implications on LOPE.
  • Competition: The industry is highly competitive, and other organizations offering similar services could gain an advantage over LOPE. This could also lead to clients being poached to competitors with better prices.
  • Technology obsolescence: Education technology is quickly evolving, with new platforms and tools constantly emerging. If LOPE fails to adopt new technology it can lead to a loss in market share and profitability.
  • Economic downturns: A general economic recession or downturn could lead to lower enrollment rates and less funding for education programs, which would harm LOPE’s and its client’s operations and profitability.
  • Management quality: There has to be a good management team for the business to survive. But LOPE also requires that the management at GCU also be able to effectively manage the business. If not, their performance could worsen, which will impact Lope.
  • Business Resilience: Although the company faces quite a few risks, one positive factor that works as a hedge for these risks is their diversified revenue. While its reliance on GCU is high, the company can expand its services to different universities. In addition, the partnership with GCU is likely to be long lasting because of its importance to the business and high switching costs.

Financial Analysis:

  • Revenue: Revenue has shown steady growth over the recent years, with most of it derived from its service agreement with GCU, and very little from other sources. Recent reporting shows a decline in revenue. This highlights their reliance on a single client and how it can be a problem.

The primary source of revenue is from service agreements, which should grow with student enrollment at their university partners.

  • Margins: Gross profit margins are very high because most expenses from marketing, employee, and infrastructure are on a service, and don’t need physical products for sale. The operating margins are relatively high, but this is offset by other expenses. Operating margins have recently dipped due to higher expenses in certain areas, and the trend may continue in the short term.
  • Profitability: LOPE has maintained decent net income, but the trend is not consistent and can vary a lot depending on different expenses during different quarters. Net income has been growing but has been impacted by restructuring and litigation in the recent year.
  • Cash Flow: LOPE’s operations generate a good amount of free cash flow, indicating their ability to sustain its business in the long term. Capital expenditures are moderate.

  • Balance Sheet: LOPE has a very strong and healthy balance sheet. It has large amounts of cash, and very little debt. This creates a financial position which is more than sufficient to face any economic headwinds that it can face. It also has very high liquidity, allowing to weather any short term downturns.

    • Justification for Balance Sheet Health Rating:

With very little debt, high cash and liquidity, and very little liability, the company demonstrates a strong position. They should have no problem with their solvency. Thus its a 5/5 rating.

Understandability Rating: 2 / 5

  • The business model is somewhat complex because of its tie to GCU and other external universities. It may take some effort to fully understand how their financials are being reported and their reliance on another entity. The reliance on the educational sector, means that external factors, such as regulations can effect the business. But overall, it is a rather straightforward business model to grasp with a good understanding of universities and financials.

    • Justification for Understandability Rating:

While the business model is easy to grasp, a few things like the dependency on a single source of revenue, and the nuances of their financial statements and accounting methods might confuse some new investors. Thus a 2/5 rating.

Recent Concerns, Controversies and Problems

  • Share Repurchase Program: The company has had a large number of share buybacks over the past years and has been reducing outstanding shares, this is likely to continue. While this shows that the company thinks its shares are undervalued, it is also something that can increase stock prices without any underlying growth in profitability or value.
  • Lawsuit: There is an ongoing lawsuit against the company with several allegations, including the company and its executives are accused of falsifying financials, this may be a huge liability on the future performance and share price. The outcome of the lawsuit is currently unclear.

It is imperative to keep a close eye on the developments related to this lawsuit as it could have big implications on the company’s future.

  • Restructuring: There has been recent restructuring of some parts of the business, this could impact the short term performance of the company, but hopefully is an effort to make it more efficient in the long run. The company continues to move from a heavy reliance on marketing to building a strong school which attracts students. This trend may affect the operating margins of the company.

In conclusion, LOPE is a company that has a weak moat, mainly due to its reliance on a single customer and lack of competitive advantages. Its balance sheet is very strong and the business is fairly easy to understand once you go into its details.