​Financial Myths: Look Before You Leap — Part I

Michael McTague  |



April 2017 Myth Buster

Apollo Education Group (APOL), the once mighty parent of the University of Phoenix, has picked up from its recent penny stock status. Yes, penny stock: its 52-week low was $0.12. APOL no longer reports its financials. The company is now the property of Vistria Group, LLC. The new owner (officially, partner) and the leaders of the for-profit education giant have announced a “transition plan.”

The Look Before You Leap myth allows us to investigate some peculiar financial partnerships. As investors know, there are many out there. The leapers are those who wish to invest their hard-earned cash in an attractive opportunity. The leapees (alright, there is no such word) are the happy recipients of the cash infusion. Both should look before the leap takes place.

The massive piles of public cash – brought about by low interest rates over a long period of time – and private cash – brought about by investors who can put their hands on money available at low interest rates – have created a feeding frenzy. Cash used to be scarce. Ubiquitous cash has changed the demeanor of givers and takers.

Ready cash proves a great benefit to many organizations with a tremendous product. For example, small pharmaceutical companies who need that green shot in the arm to get through the rigorous FDA process. Or, the entrepreneur who has found a reasonable pool of oil but needs to go beyond the excitement of finding the stash to the longer, more painful and expensive process of drawing the black gold to the surface. Real gold also needs cash before being turned into beautiful coins. The problem is that the relationship between the cash holders and the cash-needers is seldom as rosy as the first conversation implies.

Finding the Bright Future

The Apollo/Vistria tie up is in its early stages. We’ll see if the parties have learned anything useful from previous cash infusions. Let’s begin with a basic principle of why those with the cash might consider such a leap: A viable organization holds real future possibilities. If this were the case, all the cash starved company would need is a reasonable cash flow from its partner. Initial Public Offerings (IPOs) were slow in 2016, which was more a reflection on the overall mood of the market than on the value of the new pharmaceuticals being developed. A second category is the long-standing producer of a well-respected consumer product that has faced a blistering advertizing campaign from a competitor. Both situations would seem to meet the criterion.

The Archer Descending

Let’s look more carefully at Apollo. The bullish view sees a great company, which has simply fallen on hard times because the Obama Administration had a chip on its shoulder against for-profit schools. Thousands of happy graduates and students over the years show the viability of this innovative educational giant. Beware: there is bearish view. The large chains that went under in recent years – ITT Education (ESINQ), Corinthian Colleges (COCO), many Career Education (CECO) units – did not go belly up because of the Obama Administration. They were all guilty of basic wrongdoing: false reporting, poor graduation and job placement rates, failing to handle Title IV funds properly, poor student service. The Trump Administration will not float the boats of poorly performing school chains that ignore or violate federal regulations.

The motivation of Apollo, the recipient, is clear – to get needed funds. What does Altria have in mind? For that matter, what about the other Altria-like organizations making similar investments? It would be good to know what the “transition plan” looks like. Here are two possibilities:

These dueling scenarios make for very different transition plans. A means a stronger bottom line with more profit squeezed out. B offers a dynamic, new vision that will move the organization ahead against its competitors. There should be a sliding scale from Scenario A to B. On the extreme A end, the bottom line is everything. If that is all the cash investor does, they fall into the trap of It’s All About Money. Scenario B means the investors and the struggling company understand that the future will be bright if they improve quality and boost the product. Unfortunately, in today’s environment, A dominates B by a wide margin.

Some Leap Before They Look

The strategic value of B over A may sound obvious. But, if it is obvious, why did Verizon (VZ) acquire Yahoo? Many failed acquisitions could be named, such as Microsoft (MSFT) acquiring Nokia; News Corp. (NWSA) buying MySpace – Yes, tech deals are an easy target! – and Glaxo Wellcome (now GlaxoSmithKline [ADR]) purchasing Smith Kline. Verizon and Yahoo is a recent example. Astute investors will note that Warren Buffett who was widely criticized by casual observers for acquiring Burlington Northern Railroad (BNI), which also transports his clean coal, has had the good sense to avoid these goofs.

These few instances of leaping before looking show the validity of the principle that investments require a viable organization that holds real future possibilities. Next month, the Myth Buster will consider a new set of financial challenges related to this intriguing myth.

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Michael McTague, Ph.D. is Executive Vice President at Able Global Partners in New York, a private equity firm.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
APOL Apollo Education Group Inc. n/a n/a n/a 0 Trade
VZ Verizon Communications Inc. 57.22 -0.19 -0.33 7,916,651 Trade
NWSA News Corporation 13.22 -0.36 -2.65 2,936,466 Trade
MSFT Microsoft Corporation 136.27 -0.81 -0.59 20,218,495 Trade

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