TWST: Our current focus is on education, and it's been a pretty hot sector of the market. What's going on? What's driving investor interest in this space at this point?

Mr. Craig: Well, it's interesting you described it as being hot. It was certainly hot from 2007 through the very early part of 2009 at least on a relative performance basis, and basically since the end of February, early March, the relative performance of this group has waned considerably. There have been two major concerns that have been driving that. First and foremost is the prospect of an eventual economic recovery and the impact that is going to have on the growth rates of these companies, which almost without exception has been well above historic norms, fueled by individuals going back for retraining and retooling. Despite unemployment rates still rising, that has led to rotation out of more countercyclical names, and into more leverage beneficiaries of an economic rebound. So concerns about slowing growth has been one of the major factors and the other major factor has been concerns about the regulatory environment. Concerns that conditions under the new Democratic administration and the new leadership within the DOE are going to become more onerous and that in turn is going to negatively influence growth rates and profitability.

TWST: Let's start with the economic issue first. Certainly these guys have benefited as the economy has slowed. How long does it take for a reversal to happen? Isn't it a while?

Mr. Herman: That will take quite some time and it depends on a variety of factors. Clearly the challenging call is just how quickly the economy recovers, the trajectory of recovery. We have lost 6.5 million jobs since the start of the recession in early 2008. The unemployment levels for the less educated are obviously much higher. In fact you are twice as likely to be unemployed if you don't have a bachelor's degree than if you do have one. The rate is about 9.6% vs. 4.7%. When you look at the business model, certain programs are more or less cyclical, and those companies that have longer student durations would tend to have less sensitivity to the cycle. In other words, the students that enter the educational pipeline seeking a bachelor's degree or doctoral degree would have a longer duration and therefore revenue and earnings annuity stream vs. those with a very short duration programs. The later is more economically sensitive than the former.

TWST: So it really depends upon where you are situated to a degree?

Mr. Herman: Correct.

TWST: As the economy gets better is there a sharp drop off in enrollment? Or does it take a while to really affect the business?

Mr. Craig: There will be some pretty dramatic declines we think in enrollment growth rates. Take Apollo (APOL) for example, off of a base of 420,000 students, they are currently generating somewhere between 20 and 25% total enrollment growth that we think is roughly twice, maybe a little over twice what a normalized rate of growth would be. But as Jerry mentioned, there is a lot of debate right now as to how long it's going to take for this economy to recover, when is unemployment going to peak, and then once it does peak, how fast will it roll over. Other companies are growing much more in line with what we would regard as a more sustainable growth rate. So it really depends on the company and, as Jerry mentioned, on market positioning.

Mr. Herman: As I mentioned there are varying degrees of cyclicality on a programic basis. We can see that playing out at certain companies today, as an example, allied health programs are exceptionally strong and arguably among the most countercyclical programs. In these programs there have been very high rates of enrollment growth. So if the weak economy is driving students to these programs because of the perceived safety in careers in the field, one might argue that these programs are most countercyclical. Thus these programs might see enrollment growth impacted perhaps more quickly or more substantially when the economy improves.

TWST: And instead of heading from the whole notion of healthcare?

Mr. Herman: Yes, generally but I am not so sure that the whole healthcare debate going on right now is a major influence on enrollment. I would argue that healthcare is generally perceived to be recession resistant and that makes it appealing to potential students.

TWST: Let's touch on the other side of the equation, you brought up the regulatory side. What's on the horizon that investors are worried about?

Mr. Craig: There are a number of elements to that. What really heightened concerns was the May 26th posting of a notice of negotiated rule-making in the Federal Register, which deals with a number of subjects that are germane to the for-profits, items like incentive compensation to recruiters, and employment in a recognized occupation. There were a series of meetings that were held back a couple of months ago, and that process is still continuing. The DOE is still digesting all of that information and over the course of the next few weeks, they will announce negotiation committees. Then sometime towards the April, May period of next year, we should see some additional regulation arising out of this process. What the Street has been concerned about is that either changes or modifications to existing regulation or new regulations might be significant enough to impact the rates of growth and the levels of profitability. We don't really believe that. That hasn't been typical of the way they operate, but nonetheless, it's very difficult to know what's the final outcome is going to be.

TWST: But isn't the administration in general favorable to education, and retraining and all those good things?

Mr. Craig: They absolutely are and that's one of the interesting cross currents that's occurring here. If you take Obama at his word about the goal of returning the US to a position of prominence by 2020 in terms of the percentage of adults with college degrees, then absolutely the for-Profit community, which now comprises something approaching 10% of the market, is going to have to be part of the solution.

TWST: So it's the typical Wall Street, unfounded fears that are the issue?

Mr. Craig: I don't know whether I'd go that far. Jerry and I have fortunately or unfortunately been through several legal regulatory cycles, if you will in this space, and what is typical of Wall Street is that people at the outset of these periods of heightened activity, automatically assume the worst. Once the reality starts to set in that the ultimate outcome is going to be much more benign or middle of the road, then the stocks tend to react accordingly.

TWST: As we look at over the next couple of years in this space, where are the growth opportunities for the operators?

Mr. Herman: It's a continuation of the already existing business model and that includes geographic expansion, new campuses; additional programs being offered, broadening out participation within the education hierarchy, and online. Those factors are all still relevant. Continued execution of that model and a continued market shift towards the for-profit sector should help drive growth. However, growth rates will not sustained at these levels. However, you can reason that the secular theme in this industry has perhaps been enhanced by President Obama's vision to make the US the most educated country in the world along with the realization that the traditional schools are having great difficulty in funding their respective institutions and students. The notion of market-funded education is probably one that's going to get quite a bit of discussion over the next few years we believe.

Mr. Craig: Based on the gist of your question, I think it's important to point out that we still regard this as a growth industry. Unlike some of the valuations that you see reflected in the marketplace currently, if you take a look at the long-term socio-economic and demographic trends, only 27% of students now are traditional students, and the for-Profit community specializes in serving the non-traditional students. The number of individuals over the age of 25 participating in post-secondary education is forecast to increase 20+% by the time we are in the 2015, 2020 timeframe. That again speaks to the target market for these companies, so this is still a growth business.

TWST: Although the growth coming off this spike maybe somewhat slower.

Mr. Craig: Correct.

TWST: You mentioned overseas expansion. I know that was a theme over a year or so ago. Is that still something the industry is looking at, despite the economies worldwide?

Mr. Herman: Yes. Most definitely there are a couple of good examples of that. Apollo Global, a joint venture between Apollo Group and the Carlyle Group has made some international investments, so far in point Chile, Mexico, and most recently the UK. Laureate, which was the public company that went private in 2007, and at some point, probably will come public again, has been very active internationally and now has roughly a half a million students, by its count even larger than Apollo Group and which has the vast majority of students in international markets. Likewise, the online market attracts a lot of international students as well. What's interesting is that, if you look at post-secondary education in the developing parts of the world, as much as 30% of post-secondary education is market-funded. We have established in this conversation earlier that here in the US, it's substantially less than that.

TWST: Is that a number the US can reach at some point?

Mr. Herman: 30 might take a while, but 20 would essentially more than double the current size of the business.

TWST: With that kind of growth looking out, is the industry able to find the staff they need to build the positions?

Mr. Craig: Yes. Certainly on a near-term basis, that's not expected to be a problem. There is no shortage of individuals who want to teach and that, by the way, speaks to a major concern. These companies are growing at very rapid rates and are they able to maintain educational quality doing so, and the real gating factor in maintaining quality is people. You need individuals to teach. You need individuals to run the campus infrastructure, and so on, and right now, that's not been a problem. If we go back to a point at which this economy is essentially at full employment, then depending on what sector you are in, some of those challenges might emerge, but right now, that's not a problem.

TWST: As we look forward, I know government has paid for a lot of this education. What's the funding outlook given the general financial issues the country is facing here?

Mr. Herman: If anything, the utilization of government funding has increased and the best measure of that is Title IV. Title IV as a percentage of revenue for all institutions continues to increase for 2 basic reasons: 1) incremental funding has been made available through legislative changes over the course of last year or so. The government is providing more funding to students. And 2) students are accessing Title IV funding in part because of greater financial need given the overall economic picture, and the need to borrow more or to access more grants. In general, the student funding environment, particularly from a government perspective, has been very favorable. There are still challenges in private lending. Some students are having difficulty getting loans other than from the government, especially for those that have little or no credit.

TWST: Is that leading the industry to provide more financing itself?

Mr. Craig: Where gap funding is still necessary, several of these companies are stepping in and providing internal lending to their students. Now that's been the source of some level of controversy, it's obviously not a core competency, it's an element of higher risk. But nonetheless, these are open access universities that pride themselves on that access. They are not in the business of turning away students that are academically qualified for the program. In addition, from an economic point of view, it makes perfect sense to have that individual in the classroom as opposed to not having the individual.

TWST: Is that going to come back to bite the companies at some point or are they pretty well reserved and covered account for what's going on in the economy?

Mr. Herman: A very good question that many investors are grappling with right now. Cohort default rates are in part a measure of that, but for those companies that are providing funding to students for the first time, there is little or no track record and it is necessitating a lot of pencil-pushing to figure out what the sensitivities are based on different levels of default.

Mr. Craig: These companies know what makes a successful student. And successful students who graduate, who find meaningful employment, are much less likely to default on their loans. So they are not without at least some ammunition to determine who to lend money to.

TWST: I know in the past where you were seeing some consolidation in this space, are we gone or is more likely?

Mr. Herman: We believe there will be additional rounds of consolidation. There are increasing cash flows being generated at these companies given the demand, the volume growth, and obviously the corresponding revenue and cash flow growth. There are companies that are small enough to be interesting acquisition candidates that would provide some benefit to the acquirer, whether it be program diversification, geographic diversification, or regulatory access. There are going to be additional IPOs. We wouldn't be surprised to see additional going private transactions given the current enterprise values, the EBITDA valuations, are actually well below the multiples that some of the previous going private transactions took place at. One caveat is that credit conditions are a lot tighter than what they were in the 2006, 2007 time frame when some of those high profile deals were done.

TWST: But we could see some of those coming back to the marketplace.

Mr. Herman: Yes, some coming back and some going private.

TWST: Two-way street, that's interesting. As always with this group the pluses seem to outweigh the minuses, what are the risks at this point other than the regulatory issue that we talked about?

Mr. Craig: It is a fact at some point this economy will recover, unemployment will come down, and as we discussed, that will have some negative influence on growth rates. On the regulatory side, again we think the ultimate outcome is going to be relatively benign, at least relative to some of the current thought process on Wall Street, but it's going to be an overhang that's going to persist for a while. As I mentioned to you, these very high rates of growth entail some added risks in terms of maintaining educational quality and so there is elevated execution risk. In addition, there are still some legal issues outstanding against several of the companies in this group. Qui-tam actions are still prevalent, unfortunately, and based on history, they are not likely to be resolved anytime soon. But, on balance, we remain very positive about the long-term potential of the business.

TWST: As you look at the space, is it going to be the higher ad space that continues to kind of lead the way here?

Mr. Herman: When we talked about post-secondary education, we largely talk about it having countercyclical tendencies. When you delve into the ranks of K-12 it is largely cyclical because that market is funded by state and local budgets. From an investment perspective under the scenario of an improving economy, there might be some appealing opportunities developing in the K-12 space, although there is not a lot of marketability there. At least for now, the sweet spot continues to be post-secondary education.

TWST: As you talk to investors, is they are still on the interest level given that the group has pulled back or is that enhanced interest?

Mr. Craig: I think the interest levels are picking up here especially as some accounts begin operating under the idea that perhaps this short-term trade in terms of seeking out leveraged beneficiaries of an economic rebound and selling counter-cyclicals or safe-havens has perhaps gone too far. If there is some pullback in those names, that could result in our names experiencing better relative performance. It's interesting to note that since Jerry and I have been covering the group, the highest relative multiple was achieved last November and within less than a year, we are back down to near all-time lows. So the swing has been dramatic and that alone is starting to attract attention. Given recent valuations, GARP and even value players are staring to look at them.

Mr. Herman: Keep in mind that the aggregate market capitalization of the post- secondary sector is about $25 billion. So there's not tremendous liquidity in this space. It can tend to get crowded long and crowded short. While the business is model is not volatile, in fact pretty stable; it generally is a very volatile group of stocks. That volatility can either work to your advantage or disadvantage. Just look at what has happened over the course of the last twelve months, if you go back to October of 2008 through February of 2009, the composite was up 65%. By May of this year, it had retraced 30%. So it's a volatile group for sure and the stocks have generally underperformed the market since its trough.

TWST: But is it not a little more volatile than norm, whatever norm may take?

Mr. Herman: I would suggest yes because there is a lot going on..the economic questions, the policy and legislative questions, obviously much better than expected volume, revenue and earnings growth, all pushing and pulling in different directions.

TWST: What are you telling investors to do at this juncture?

Mr. Craig: We continue to be positive on the group. We don't follow every company in the sector, we follow most of them and most of those quite frankly are rated buy and have been rated buy for some time. We think these valuations are attractive and there are various ways you can play this group. If you take a longer-term perspective, then in our opinion, the best attributes to look for are relative nascency or small size, quality as measured by student outcomes and satisfaction and value proposition for the student. Valuation is of secondary importance. On a near-term basis, if valuation is what drives your investment decision, then there is an awful lot to work with here because, in our opinion, PE's are very attractive relative to sustainable rates of growth.

TWST: What's at the top of your list at this point?

Mr. Herman: Again, I think it depends on the investor. From a thematic perspective, given the backdrop and the vision of this Administration, there are certain companies clearly positioned to be part of the solution to the problem of the shortage of post-secondary education capacity. Companies that we believe are positioned to help solve that problem and also have good student outcomes and academic performance include the likes of DeVry (DV) and Strayer (STRA) and Capella (CPLA), and even Apollo. Those companies have generally very solid metrics.

TWST: Those are the names, couple of which have had problems in the past with managements, are those largely been resolved at this point?

Mr. Craig: There has been management transition at these organizations and we think on balance that's gone very smoothly. Strayer's management, which came in at the start of the decade has done a marvelous job of executing on an accelerated and well defined growth path that they have not deviated from. In the case of Capella, there has recently been management succession as founder Steve Shank has decided to exit from day to day operations, but we feel pretty highly about the successor. The same is true for DeVry. In Apollo's case, it's an unusual circumstance where individuals from our business, from the investment business are now co-CEOs of that company, but in the case of both, we think very highly of their capability.

TWST: So those are the types of names that would be prime beneficiaries of what we've been talking about in this environment?

Mr. Herman: That's correct.

TWST: Anybody that is having a tough time and is not going to kind of succeed as well as these companies as we look forward?

Mr. Herman: We don't have any Sell recommendations right now given the economic circumstance and what generally are, either very good or improving fundamentals. Again there are certain companies that have slightly higher risk profile given what seems to be greater scrutiny on the post-secondary market generally. Clearly there are rising cohort default rates in a weak economy. There is downward pressure on placement rates in a weakening economy and some companies are more challenged with that circumstance. Some companies have challenges with 90/10 compliance. But there are really no companies in the group that we are telling investors at this point to be running away from. The fundamentals in the business are pretty strong and with valuations where they are, there is a strong case to be made for selling the stocks because of unrealistically high valuations.

TWST: Valuation for the group has come in sharply, what's it going to take to get it going back up again?

Mr. Craig: I think some clarity as to the trajectory of the economic recovery and some clarity surrounding the regulatory issues, which should be forthcoming, but unfortunately that may not happen tomorrow. It's going to take some time, but it is a very transparent process. Investors will get a pretty good idea of just exactly what the mindset is of those that are in charge of devising or changing those regulations. Right now, those are really the key determinants. Business is good, the earnings streams are solid, they are beating numbers, and at some point, we know that growth is going to slow, but we would argue that has already been fully baked into the stock prices.

TWST: That's not going to surprise anybody?

Mr. Craig: It shouldn't. As we noted earlier, in many cases, the multiples are very much in line with what we'd regard as sustainable rates of growth, not current rates of growth.

TWST: Thank you. (TJM)

ROBERT L. CRAIG Stifel Nicolaus 1 Financial Plaza, 501 N Broadway St. Louis, MO 63102 (216) 430-1733

JERRY R. HERMAN Stifel Nicolaus 1 Financial Plaza, 501 N Broadway St. Louis, MO 63102 (216) 430-1734