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Apollo Outlook Weighs on School Stocks

Apollo Group, parent of the University of Phoenix, warns that student enrollment will fall more than 40% in fiscal 2011.

(Updated with analyst commentary, background information and stock prices.)

PHOENIX (

TheStreet

) -- Stocks in the for-profit education sector were deep in negative territory Thursday after

Apollo Group

(APOL)

warned that enrollment would be down more than 40% in fiscal 2011's first and second quarters.

Shares of Apollo, parent company of The University of Phoenix and other for-profit schools, plummeted more than 20% in the first minutes of trading despite its posting of better-than-expected quarterly earnings after the closing bell Wednesday.

Apollo withdrew its outlook and warned it would fall out of compliance with what is called the 90:10 rule in fiscal 2012. The rule stipulates that no more than 90% of a for-profit education provider's revenue may be generated from Department of Education's federal student aid program.

Apollo would have to increase its tuition rates if access to federal aid is cut off, further inhibiting student enrollment.

"What a disaster," said Sterne Agee & Leach analyst Arvind Bhatia. "The industry is starting to see some signs of more meaningful slowdown than anyone had expected two months ago."

One reason for the significant decline in student enrollment is Apollo's implementation of a mandatory three-week orientation, beginning Nov. 1, for all new students enrolling at University of Phoenix with fewer than 24 transfer credits.

The program will help to counter criticisms Apollo and a number of its peers have faced claiming that for-profit schools saddle their students with debt yet leave them unequipped for the job market and a means with which to repay the hefty loans.

Stocks in the for-profit education sector have been volatile in recent months. The

S&P 1500 Education Index

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, which tracks the industry, dove 34% from June through August, a retreat that began after the Obama administration announced June 16 that it would seek regulations aimed at stanching for-profit schools' high rate of student-loan defaults and curbing their aggressive marketing practices.

That was followed by a series of proposals to meet those objectives from the Department of Education, including one that would reduce schools' ability to make federal loans based on the rate of their students' loan defaults.

Repayment rates at for-profit schools were just 36% in fiscal 2009, according to research from the Institute for College Access and Success, a student-advocacy group. At private nonprofit schools the repayment rate was 56%, and at state colleges and universities the rate was 54%.

>>Corinthian Miss Drags on School Stocks

Under the Department of Education's proposed "gainful employment" rule, federal aid would be cut for schools where less than 45% of students are able to repay their loans. Additionally, schools would only be eligible for federal aid if student debt remains below 8% of total income or below 20% of discretionary income.

The Higher Education Act of 1965 requires that programs in need of federal aid provide their students "gainful employment in a recognized profession." Since as much as 90% of for-profit schools' revenue is tied to government loans, losing the right to offer them would be devastating to earnings.

"We have taken and intend to continue to take a leadership role within the proprietary sector by providing students with a good value for their educational investment while employing marketing practices that fully and fairly inform our students about the educational options available to them, as well as the costs and potential benefits of an education," said Apollo Co-CEO Chas Edelstein.

Apollo will also discontinue compensating employees based on enrollment results, as it works to smooth over recent criticism about its recruiting practices.

Shares of Apollo nosedived 24.9% in morning trading Thursday, leading the rest of the sector lower as well. Shares of

Corinthian Colleges

(COCO) - Get Vita Coco Company, Inc. Report

, which operates

Everest colleges, tumbled 18.8%. Kaplan's parent

Washington Post

(WPO)

fell 5.5% and

Career Education

(CECO) - Get Career Education Corporation Report

fell 17.1%.

DeVry

(DV)

,

ITT Educational

(ESI) - Get Element Solutions Inc Report

,

Strayer Education

(STRA) - Get Strategic Education, Inc. Report

and

Education Management

(EDMC)

were all down by double-digit percentages, as were shares of

Grand Canyon Education

(LOPE) - Get Grand Canyon Education, Inc. Report

,

Bridgepoint Education

(BPI) - Get Zovio, Inc. Report

and

Lincoln Educational Services

(LINC) - Get Lincoln Educational Services Corporation Report

.

Analysts from Stifel Nicolaus and FBR Capital issued downgrades on Apollo shares Thursday. Stifel Nicolaus downgraded the stock to hold from buy. FBR downgraded the stock to underperform from market perform, and lowered its price target to $40, from $49.

Analysts from RBC Capital Markets reiterated a sector perform rating, but lowered their price target on Apollo to $45 from $55.

Citigroup analyst James Samford initiated coverage of the for-profit education group Tuesday morning, rating those favorably those that focus on online education programs and negatively those more focused on more traditional school settings.

Samford's buy-rated stocks included

American Public Education

(APEI) - Get American Public Education, Inc. Report

, Bridgepoint,

Capella Education

(CPLA) - Get Capella Education Company Report

, DeVry and Grand Canyon.

The analyst's hold-rated stocks included Career Education, Corinthian and ITT.

He noted that the group overall is an "attractive long-term growth opportunity," with the best upside primarily in online schools. He estimates that of half of the 8 million students expected to take at least one course in 2015 will be exclusively online, compared with 40% out of 5 million in 2009.

Analysts from UBS also initiated coverage on the for-profit education group Tuesday, according to data from

Briefing.com

. Washington Post, Grand Canyon and American Public Education were rated buy with price targets of $475, $35 and $45, respectively.

Coverage of Strayer, ITT, DeVry, Corinthian, Career Education and Apollo Group were initiated with neutral ratings.

-- Written by Miriam Marcus Reimer in New York.

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