'Next big thing': Learn something from Vocation's collapse

One sector has arguably done a better job of destroying shareholder value than any other over the past few years.

Welcome to vocational education and training (VET), a world where governments have handed over billions of dollars to businesses that appear to have delivered sub-standard education to students who are ill-equipped financially – and sometimes physically and mentally – to complete overpriced courses they were sold, but didn't want.

Naturally, the model generated high rates of profit growth without triggering any underlying concerns.

"How good is Australian Careers Network (ACN)?," asked one broker at a company presentation. "It's growing like crazy!".

It sure was.

'The next big thing'

The rise and fall of stocks like Vocation and ACN offer some vital lessons for investors intent on avoiding the "next big thing".

Waste the learning opportunity at your peril.

For eons, TAFE was the cornerstone of vocational education, offering high-quality courses at affordable prices.

By introducing competition – "contestability" as it was called – more courses would become more accessible to a higher number of students, or so the theory went.

It didn't work out like that.

Private operators cherry-picked the most profitable courses, leaving TAFE to deliver the expensive, low-margin programs.

Low-cost loans

More significantly, in an act of monumental stupidity, government funding caps were removed, allowing students to take out low-cost loans for approved diploma courses up to a value of $95,000.

Governments paid the fee for the entire course upon student registration but colleges only incurred costs as lessons were delivered (in many cases sub-contracted).

If a student dropped out, as many did, the college kept its fees and the student kept the debt.

If someone had designed a system to deliver exactly the wrong result for students, investors and taxpayers, it would look like this.

The cost of the ludicrous financial incentives naturally fell on the taxpayer.

Spending balloons

In 2012, government expenditure in the sector ran to $325 million.

By the end of 2014 it had hit almost $1.8 billion. Enterprising opportunists had quickly found their way to a rich plunder and were keen to cash in.

Vocation, one of the biggest providers, listed in December 2013 at $1.89 a share.

It reached a high of $3.31 in September 2014 and entered administration at 12¢ a share in November last year.

It now faces three class action lawsuits.

In total, founders, staff and directors sold about two-thirds of their shares into the float.

Australian Careers Network's story wasn't much different.

It listed at an issue price of $1.70 in December 2014 and by October last year had risen above $3.40. After burning through $10.4 million in the December quarter and with just $13.5m remaining in the kitty, it entered voluntary administration a few weeks ago.

Both companies had expanded quickly, taking on debt to do so.

But what really bought them undone was federal and state governments realising the extent of their own stupidity.

A scathing senate hearing described government oversight as a "failure" and the misbehaviour of some private providers as "rampant and unethical".

Eventually, the money pump was shut down.

Easy to predict, right?

Well, sort of.

Seeing the forest for the trees

Whilst we didn't recommend any stocks in this sector, we did get roped a similar situation more than six years ago.

Ostensibly, managed investment scheme (MIS) stocks like Forrest Enterprises, Great Southern Plantations and Timbercorp were agribusiness investment managers.

They would buy land, plant trees or crops like almonds and olives, and then manage them on behalf of investors.

The trouble was that scheme investors weren't getting anywhere near the returns promised.

And yet they kept purchasing MIS products because they got a nice up front tax deduction in the year of their investment.

A fat 10 per cent commission paid by the company to the financial planners no doubt helped.

Dud products

Just as in vocational education, the products were rubbish but the incentives to sell and purchase them were strong.

At the 2006 Berkshire Hathaway annual meeting, Charlie Munger said: "You don't make clay out of turds".

The MIS sector and vocational training companies sold turds.

The dream of a good education, rather than the reality of a poor one, is a dud product, as is a nice tax deduction travelling under the guise of an MIS that returns less than your initial capital.

Of course, if you incentivise the selling of a dud product you can get away with it for a while.

Eventually, though, the duped investor stirs, looks into his empty pockets and looks around for a thief.

That's when the investment case goes up in smoke.

If the product is a charade, one that wouldn't exist without favourable legislation and a nice sales commission, it usually isn't a good business. You can't make clay from a turd.

Disclosure: The author John Addis made money on Great Southern before losing it on Timbercorp. He has learnt his lesson.