Last fall, the University of Idaho announced a deal to purchase the University of Phoenix, a private online education company. That the U of I would be interested in purchasing an online education company is not totally unexpected. Several other universities have done the same.
However, there is a significant difference between those purchases and the U of I’s proposed purchase when it comes to size, structure and cost.
Among recent examples, Purdue University purchased Kaplan University for $1, the University of Arizona purchased Ashford for $1, and the University of Arkansas (which declined to purchase the University of Phoenix) purchased Grantham for $1.
In each of these cases, the public universities purchased private companies much smaller than themselves and at basically zero cost. In Idaho, the U of I is proposing to do just the opposite.
The size of Phoenix compared to the U of I is noteworthy. Phoenix’s student population of 85,000 exceeds the student population of U of I, Boise State University, Idaho State University, Lewis Clark State College, and a couple of Idaho community colleges combined – basically, larger than the entire Idaho university system.
The cost? $550 million to be paid by leveraging Phoenix for an astonishing $685 million in debt.
Then an even more remarkable aspect of this proposed acquisition is that the U of I, a public Idaho institution, plans to complete this transaction without any public meetings and debate and without approval by the Idaho Legislature.
How is that possible?
The Idaho State Board of Education surprisingly has allowed the U of I to move forward on this deal with no public meetings. State Board rules mandate disclosure for matters far less significant. Yet, the State Board has refused to hold public meetings, debate, and discussion about the biggest change in the history of Idaho’s higher education system.
The State Board argues it had the legal right initially to meet in executive session due to confidentiality concerns, but that time has passed. The acquisition has been announced and confidentiality is no longer a concern. But beyond that, it misses the main point. The State Board has a public duty to facilitate public meetings and extensive debate for a transaction so large and so transformative of Idaho’s higher education system.
As for obtaining approval of the Idaho Legislature, the U of I is basically stiff-arming them. The U of I’s unwillingness to submit to legislative approval is based on an age-old and legally questionable argument that the U of I is a constitutionally independent entity not subject to regulation by the Idaho Legislature. Given the size of this deal, I wonder what else the U of I can do without legislative approval?
The problem with U of I’s assertion is that its own course of action and behavior over the course of its history undermines its argument.
Throughout its history and pursuant to Idaho law, the U of I has been governed and controlled by the Idaho State Board of Education, an Idaho state entity funded and regulated by the Idaho Legislature. Members of the State Board serve as the sole members of U of I’s Board of Regents (U of I’s board of directors). And, the U of I’s state-appropriated funding and line items governing its ongoing affairs have been, and continue to be, approved by the Legislature.
It defies logic that legislative approval would be required to support UI’s primary funding, but approval would not be required for an acquisition of a new university larger than Idaho’s entire university system, involving one of the biggest debt offerings in the history of the state.
Another reason U of I justifies its unwillingness to be subject to public scrutiny is its assertion that its purchase of Phoenix is basically risk free to the U of I and the state of Idaho. This, too, is subject to significant debate.
Phoenix’s reputational problems alone create a substantial risk. They are so well known they are almost synonymous with Phoenix’s name. Unfortunately, Phoenix’s brand, which is best known for hard-sell student loan tactics, fraud, government fines and shareholder lawsuits, is more prominent than U of I’s brand and risks overshadowing U of I’s positive academic image.
On the financial side, anyone involved in corporate acquisitions knows a $550 million corporate purchase based on leveraging the acquired business for $685 million in debt carries significant risk.
The details of this deal matter. Unfortunately, without public meetings and debate and the usual legislative approval process, the details are not well understood.
To purchase Phoenix, the U of I proposes to leverage Phoenix’s own cash flow and assets to obtain the $685 million needed to pay for Phoenix, in what is called a “leveraged buyout.” Phoenix will issue $685 million in corporate bonds anticipated to be “bb” rated (known as “high risk” or “speculative” bonds). Phoenix’s estimated debt service will be $60 million to $70 million per year.
It sounds risky, and it is. Studies show companies purchased through leveraged buyouts can be ten times more likely to fail (20% vs. 2% failure rate) compared to those bought through conventional means. The debt overhang at times is too difficult to overcome. Leveraged buyouts are typically used by high-risk, private-equity firms, not public institutions.
The U of I hopes to insulate the U of I from Phoenix’s debt by creating a separate, nonprofit company (named FourThree) to buy Phoenix, but there are numerous reasons for concern regardless of the structure. For one, FourThree (which will continue under the brand of “The University of Phoenix”) (“Phoenix”) will be owned 100% by the U of I Board of Regents.
U of I tries to get around this by suggesting the U of I Board of Regents will “own” Phoenix, but the U of I will only “affiliate” with Phoenix.
The fact is the U of I cannot legally separate itself from its own Board of Regents. The “U of I Board of Regents” is the “U of I”. The U of I will not only “affiliate” with Phoenix, it will own 100% of Phoenix.
Additionally, as sole owner, the U of I through its Board of Regents (and the State Board) will appoint all the directors of Phoenix, including “independent” directors, giving the U of I what is known in corporate parlance as “effective control” over Phoenix. That is not helpful when it comes to insulating U of I from Phoenix’s debts.
To improve the terms of Phoenix’s corporate bonds, the U of I has also agreed to guarantee up to $9.9 million per year in payments to Phoenix’s bondholders. Not only is this a direct risk, but it signals the U of I’s willingness to support the bonds, notwithstanding the limitation. The U of I has further acknowledged that the ratings of U of I’s existing bonds will be downgraded as a result of this transaction. There is more.
The U of I has offered to provide Phoenix a $25 million letter of credit. And even more concerning, it has offered to step into Phoenix’s shoes to reimburse the U.S. Department of Education for any Phoenix student loans forgiven by the department. Phoenix has already paid $37 million for student loan forgiveness.
Perhaps most concerning is U of I’s plan to take $10+ million in cash from Phoenix each year. This appears to be one of the primary reasons and benefits for U of I to do the deal. But for all the benefit in the near term, taking cash from Phoenix is likely the most damaging when it comes to insulation from Phoenix’s debts.
The U of I responds to these risks by stating that Phoenix’s current financials can more than cover the debt service and any other ongoing risks of the business. The problem is the U of I will own Phoenix for a long time and the term of the bonds will be anywhere from 15 – 30 years. Companies and markets and technologies change.
One of the more troubling aspects of this deal is U of I’s lack of transparency and disclosure of Phoenix’s financial status. Unlike corporate deals of this magnitude where multi-year full financial statements are provided to stakeholders, the U of I has provided only a one-page summary income sheet and no balance sheet or other information regarding Phoenix’s liabilities.
One without the other is insufficient at best and misleading at worst. For example, the U of I repeatedly refers to Phoenix having $200 million in cash. Without knowing Phoenix’s liabilities, this reference is of little use.
Basically, we have only U of I’s word for Phoenix’s financial status. In fulfilling its duties to Idaho taxpayers U of I merely states it has done its due diligence, “trust us.”
One thing is certain, given the size of Phoenix, the size of its debts and U of I’s 100% ownership and control, if Phoenix begins to falter, it will be the sneeze heard around Idaho’s world. Even the threat of failure will send chills through the U of I, the State Board of Education, and the State.
In such an event, U of I’s $9.9 million guarantee limitation will likely melt away and the U of I, the State Board and the State will do whatever it takes to avoid a threatened failure.
And for good reason. A default by Phoenix would be catastrophic.
Phoenix’s bondholders and creditors would immediately seek the deepest pockets available, despite the existence of secured assets, and its first targets would be the 100% owner and controller of Phoenix: the U of I, the Idaho State Board of Education and, very likely, the state of Idaho.
Even if corporate separation were defendable, the practical reality is the U of I and the State Board would be under tremendous pressure to settle any claims against it, rather than go to court and risk $685 million in damages.
Any settlement could involve hundreds of millions. The cash received by the U of I would likely be required to be returned, and ownership of Phoenix would likely pass to the bondholders and creditors. The impact on the U of I and the State Board would be immeasurable.
Neither the U of I nor the Idaho State Board of Education has the resources to deal with this downside risk and would be required to look to the state of Idaho and Idaho’s taxpayers for help. The general corporate view is if you can’t handle the downside risk, you shouldn’t do the deal.
Despite U of I’s repeated assurances, there is no such thing as little or no risk when it comes to corporate acquisitions and debt offerings, particularly in “leveraged buyouts”. The U of I should be upfront about this. The risk involved in this deal is very high.
The U of I seems to be doing everything it can to avoid public scrutiny of this transaction. Why? “We know best,” “trust us” and “there is no risk” – is its mantra. Typically, when I hear these words, huge red flags go up. I don’t think I am alone.
No transaction of this size, scope and risk should be allowed to occur without public meetings and legislative approval using primarily one-sided, self-serving information streams, guest editorials, a “Frequently Asked Questions” website and one-sided presentations.
As a matter of public policy and duty and in the interest of the entire U of I community, the state of Idaho and Idaho’s taxpayers, public meetings and debate by the Idaho State Board of Education and approval by the Idaho Legislature should be mandated.
As a former State Board member, I cannot imagine doing otherwise.