The for-profit education sector continues to offer up new answers for the question, "How much worse can it get?" The economy, tighter credit and a tarnished sector reputation continue to drive away prospective students, and the entire sector is looking to discounts, tuition cuts and cost-cutting to stanch the bleeding. While Apollo Group (Nasdaq:APOL) is likely to survive, investing in it still feels a little like reaching out for a falling knife.

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Tough Results, but a Better-Than-Expected Start to Fiscal 2013
Apollo Group's reported results for the fiscal first quarter were pretty brutal, though they were better than most sell-side analysts expected. Unfortunately, it's clear that no quick turnaround is in the offing here.

Revenue fell another 11% as the company reported a 15% drop in new student starts and a 14% drop in total enrollments for the quarter. Discounts were almost 7% of gross revenue (versus less than 6% last year), as the company continues to struggle in retaining/attracting students.

While Apollo continues to struggle with enrollment and revenue generation, the company's cost cuts are finding more success. Gross margin declined more than two points, and operating income fell about 17%, but the company's operating margin of 22.6% was still quite a bit better than most analysts expected. Marketing spending was down 2% (though up 130 basis points as a percentage of sales), while general operating and admissions advisory expenses were down significantly.

Will Smaller Be Better?
Apollo Group isn't fooling itself about the probability of a quick turnaround. To that end, the company is shutting down about 40% of its former square footage, closing 90 learning centers and 25 campuses. This will still leave the company with over 100 locations in 36 states, but it represents a pretty sharp pullback for a former growth darling.

It's still worth asking if this will be enough. The company said it is likely to be placed "on notice" by its accrediting body, principally because of declines in full-time faculty levels and the ratio of full-time students to faculty. At the same time, the company is working to get Title IV recertification from the Department of Education (which is pretty much essential for ongoing participation in federal aid programs).

Beyond this, there could still be an existential debate about the for-profit education sector. Many students have been disappointed in their experiences with for-profit education, either finding themselves unable to finish the programs or finding that the degrees they received aren't nearly as marketable as they had hoped. That may be less of a threat for a company such as Grand Canyon Education (Nasdaq:LOPE), which has a strong health care/nursing program, but it's still an industry-wide threat.

Time to Go Global?
While the U.S. for-profit education sector is in serious trouble, there still could be opportunities for Apollo outside North America. Companies such as New Oriental Education (NYSE:EDU) and Kroton are still seeing very good revenue growth prospects in China and Brazil, respectively, and Apollo has the financial resources to build a bigger international component to its business if management so chooses. Given how things are going in the U.S. and the prospects for growth in emerging markets, it seems like a logical move to make.

The Bottom Line
While American Public Education (Nasdaq:APEI) boasts a compelling price point and good outcomes data, and Grand Canyon has its focus on health care training, Apollo's best claim right now is likely its size and brand value. In time, I think the U.S. for-profit education sector will settle down, and when the dust clears Apollo will still be standing.

That said, analysts may still be a little too optimistic about the downside to revenue and the pace of the recovery. If the company can grow its revenue at a long-term compound annual growth rate of 1% (from fiscal 2012 levels) and lift its free cash flow margins back into the mid-teens (versus a trailing average of about 17.5% and 10% in the last fiscal year), the resulting free cash flow growth of roughly 5% suggests a substantially undervalued stock.

Brave investors may be attracted by the potential value here, but that value comes with a big warning that business conditions could still get much, much worse before turning around - and that turnaround may never actually come.

At the time of writing, Stephen D. Simpson did not own shares in any company mentioned in this article.

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