Capella makes the grade, and its shares soar

As more college students take classes online, Capella Education Co. of Minneapolis has graduated with honors in the marketplace.

Buoyed by a 55 percent increase in second-quarter earnings and a rising market for online education stocks, Capella's stock has more than doubled, from $20 a share at its November IPO to about $50 a share last week.

Stocks of for-profit college education companies "have done very well this year overall," said Trace Urdan, an analyst with Signal Hill Capital Group in Baltimore. "Capella benefited from that, even though it did better than the group."

Now, after raising $84 million in the IPO and $12.4 million more in a secondary offering, Capella ranks ninth in market capitalization among for-profit educational institutions, most of which teach classes partly or entirely online.

Total enrollment for all online degree programs remains relatively small -- about 1.5 million, or 9 percent of today's U.S. college population -- but it is growing 20 percent annually, said Amy Junker, an analyst at Robert W. Baird & Co. in Milwaukee. Traditional college enrollment is growing at no more than 2 percent annually, she said.

Capella is one of the few Internet colleges that have no classrooms and are exclusively online. Classes are taught by teachers working either from Capella's Minneapolis headquarters or out of their homes in other parts of the country.

As for tuition, Capella's charges are comparable with those for a private urban university that doesn't have the top brand name of say, a Harvard, said Stephen Shank, Capella's CEO and chairman. "At the graduate-student level, our tuition is comparable to what public schools charge for out-of-state tuition."

Shank asserts that Capella's appeal is based on the quality of its education, not just the convenience of allowing students to take classes on their own time.

"We have the same size classes as traditional classrooms, but we think the online learning format works better for the way people learn in their adult years," he said. "We require active participation in the class. It's an exploration or discovering type of learning model."

Capella isn't the only one pursuing this model. Based on market capitalization, Capella is less than one-tenth the size of the University of Phoenix, the giant of the online college market. In order to compete, Capella offers a limited number of degree programs and spends heavily on advertising.

Capella has focused on three areas -- education, health care and human services, and business and information technology management -- and offers degrees that most others don't, such as an online doctorate in psychology. It now has 870 courses and about 19,900 students, 84 percent of them seeking master or doctorate degrees.

The University of Phoenix has about 300,000 students, some studying at its 180 campuses rather than online.

A deliberate emphasis

Capella's emphasis on graduate degrees is deliberate. Analysts say that Capella has staked out the high end of the online market: students averaging 40 years old who are seeking advanced degrees for professional advancement. These students are more motivated than younger undergrads, and thus more likely to persevere until they graduate, analysts say.

To attract these students, Capella spends nearly one-third of its revenue on advertising, Shank said. Much of it is image-related marketing designed to get potential students to view Capella as a real learning institution rather than as a disembodied Internet entity, he said.

So far it has paid off.

Capella's second-quarter revenue and student enrollment grew 24 percent. At other online companies, 8 percent enrollment growth would be considered good, analyst Urdan said. "Capella is small to start with, so it's easier to grow enrollment at those rates than it would be for the University of Phoenix," he said. "But it's still strong top-line growth."

Operating income for the first six months of 2007 still lagged, at around 11 percent of revenue, half the industry average. But Wall Street expects Capella to close the gap in three to five years. Urdan predicts its operating income will reach 14.3 percent of revenue by 2009.

"Our three- to five-year objective is revenue and enrollment growth in the range of 18 to 22 percent a year, and operating earnings growth in the range of 25 to 30 percent a year," Shank said. Earnings growth should be possible, he said, because revenue will grow faster than fixed expenses such as advertising and because major expenditures, such as a $25 million computer system to run the business, are nearly paid off.

The shift to online college degrees has resulted in more government oversight as well. Capella was one of several online and traditional schools accused by government officials of student loan irregularities, and its financial aid director left after it was disclosed that he was a paid consultant for one of Capella's preferred student tuition lenders, Student Loan Xpress. In May, Capella settled with the attorneys general of Minnesota and New York without paying a fine.

"We're disappointed we got touched in this whole student loan affair by what was unfortunately a misjudgment by our financial aid person," Shank said.

Audited by the feds

Capella also was one of several companies recently audited by the U.S. Department of Education concerning unreturned loan money for students who dropped out but whose departures weren't immediately reported. Shank said the amount involved is less than $1 million.

Capella's biggest problem these days has little to do with technology or costs. Rather, it's the liquidity of its stock, Urdan said. Because only about 150,000 of Capella's 17.2 million shares trade on an average day, it's difficult for a big institutional investor to take a large position in the stock without driving up the price.

Capella can help solve the liquidity problem by encouraging more of its private investors to sell their shares. The problem, Urdan said, "is that not all of them want to sell."

Steve Alexander • 612-673-4553

Steve Alexander • alex@startribune.com