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'Pressure Cooker' Culture Faulted at Career Ed

While nothing has been proven, analysts say employees are under the gun to produce numbers.

The obsession with "meeting the numbers" hasn't gone away, and for some companies it could be causing big problems.

Career Education

(CECO) - Get Career Education Corporation Report

plunged 19% Thursday after a 28% decline Wednesday on news that an employee at one of its schools filed a complaint alleging that officials forged signatures and tampered with student files in an effort to inflate enrollment and the company's profits.

The firm has vigorously denied the claims, calling them potentially libelous, but some analysts are worried about Career Ed's "pressure cooker" work environment, which could have encouraged some employees to fudge numbers.

"Career Education's culture is extremely performance-oriented, which puts employees under tremendous pressure to make the numbers," said Bear Stearns analyst Jennifer Childe. "While that is part of the formula for company's success, it can obviously cause rogue employees to break the rules to meet their goals."

Career Education has had an impressive rise in recent years, going from just $4.80 at the end of 1999 to a high of $56.20 on Oct. 30. Between 1996 and 2002, the firm grew its earnings at a compound annual rate of more than 100% and has beaten analysts' estimates in all but one quarter since it went public, according to Standard & Poor's.

Other education stocks have had similar strong performances as enrollment growth has increased sharply thanks to the higher technological skills required for entry-level jobs and the growth of online education.

While trends in the education segment are no doubt positive, J.P. Morgan analyst Bradley Safalow said the complaint "has created a degree of uncertainty about the integrity of Career Education's enrollment practices and the manner in which it has been able to sustain growth."

UBS Warburg analyst Kelly Flynn said she has spoken with former employees who believe that Career Education fosters a "pressure cooker" work environment. She also noted that the company has seen a rise in bad debt recently, which leads her to question the quality of enrollment growth.

The complaint against Career Education, which was actually filed in September, comes from a former employee at the Brooks Institute for Photography in Southern California. A former employee of the company's Gibbs College in Montclair, N.J., also has filed a suit against the company on the grounds of wrongful termination.

"It now appears that this might be more than just a coincidence that two incidents of this nature have surfaced within the past month," Childe said.

If the allegations prove to be true, the school's accrediting body, the Accrediting Council for Independent Colleges and Schools (ACICS), has the power to revoke Brooks' accreditation through a formal review process, analysts say. That would prevent the school from offering federal grants and loans and effectively shut it down.

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But most analysts believe this outcome is highly unlikely because it would penalize the students. Instead, pundits believe the school could be placed on probation and face heightened regulatory scrutiny. Even if the Brooks' school were to be closed, the impact on earnings would be small. The school represents roughly 3% to 4% of the firm's total sales and about 3 to 4 cents of earnings, analysts say.

The risk, however, is that the behavior is found to be widespread among the company's other schools. "While I have the utmost respect for management at Career Education and confidence in their quality control systems, when you have 78 schools, tens of thousands of students and thousands of employees and staff members, it's difficult to know with certainty what's going on in the deep trenches," said Alexander Paris, an analyst at Barrington Research.

Paris said there is a "culture of growth" at Career Education and among the postsecondary education companies in general. "These have been star performers over the past three years, and with very few exceptions over the past 10 years," he said.

Still, Paris raised his rating on the stock to market perform from underperform, saying the longer-term outlook continues to be stellar "given the baby boom echo and the powerful demographics that are going to drive demand for education."

Other analysts reiterated strong buy ratings Thursday, saying that the stock would probably bounce back, just as it recovered from a 13% selloff after the wrongful-termination lawsuit was made public two weeks ago. Still, Bear Stearns' Childe isn't so optimistic.

"Given the seriousness of the claims and the fact that these issues could prove to be more widespread than initially thought, we are not expecting the same type of recovery," she said.

Career Ed fell 19%, or $7.73, at $31.75. Other education stocks also were under pressure Thursday, with

Corinthian Colleges

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

down 10%, or $6.53, at $55.55 and

Apollo

(APOL)

off by 4.6%, or $3.19, at $66.11.