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Purdue’s deal for Kaplan packs low up-front costs, long terms and boundary-pushing details

Purdue University

Purdue University managed to make a big splash without fronting cash in its deal to acquire Kaplan University and its major online education presence.

That’s a key point in an era when public higher education institutions are increasingly saddled with tight state funding and rising cost pressures. But it comes with trade-offs. Purdue agreed to a lengthy contract requiring it to buy support services from parts of the Kaplan operation that will remain tied to a for-profit business. The contract limits Purdue’s early financial downside, but getting out of it in the future would come at significant expense.

Other details in the deal are also pushing the boundaries of what it means to be a public university. Purdue plans for the university it is acquiring from Kaplan to use no state appropriations and instead draw its operating funding from tuition and fund-raising. It has also been exempted from state open-records laws. As a result, opposition is mounting from faculty and open-government groups.

Purdue made waves last week when it announced the acquisition, a bold attempt to jump into the online space with both feet in order to better serve working adult students. The major land-grant university in Indiana will acquire the academic operations of Kaplan University, a for-profit chain that’s part of the publicly traded company Graham Holdings.

About 32,000 Kaplan students and 3,000 employees are set to become part of Purdue, which has almost no undergraduate presence in online-only programs. Purdue will turn the former Kaplan University into a new legal entity, an online-focused nonprofit university structured as a public benefit corporation. The new university will be slotted into Purdue’s current structure, which consists of a selective flagship campus in West Lafayette, Ind., and another set of regional campuses that together post head-count enrollment of nearly 69,000 when counting undergraduate, graduate and professional students. The new university will bear a yet-to-be-determined version of the Purdue name.

The deal for Kaplan University, which has been losing enrollment and revenue recently, can be seen as another in a long line of blows against an already struggling for-profit sector that has drawn sharp criticism for failing to graduate students and leaving them with high debt levels. It can also be seen as a buy-low opportunity for Purdue, which was able to sweep in and pick up a functioning operation with tens of thousands of students in a sector where it previously did not compete.

Purdue’s president, Mitch Daniels, cast the acquisition as a pivot to the future during an interview with Inside Higher Ed last week.

“I don’t know where online is going, but I want this university, when I’m long gone, to be a leader, to be prepared at least to compete,” said Daniels, a Republican former governor of Indiana. “We were not going to be there under the status quo today.”

But the deal’s financial details also set up a symbiotic relationship between the public institution of Purdue and for-profit operations that will remain under the Kaplan name. Kaplan retains the rights to the name Kaplan and the Kaplan Platform of information technology infrastructure.

Purdue will pay the nominal fee of $1 for Kaplan’s academic side. Instead of an up-front payment, Purdue has agreed that its new university will receive a range of support activities from Kaplan under a 30-year agreement. Those services will include technology support, help desk functions, human resources, admissions support, financial aid administration, marketing, international student recruiting, business office functions, accounting, first-year student advising and some test-preparation services.

Kaplan will be paid for the services it provides only after Purdue’s new university has generated enough revenue to cover its operating costs and, in some cases, other payments, according to documents filed with the U.S. Securities and Exchange Commission. For the first five years of the new university’s operation, it is guaranteed an annual “priority payment” of $10 million beyond its operating costs. If its revenue is not enough to cover the $10 million payment, Kaplan will cover any gap. The new university could also receive an efficiency payment if it finds savings in its budgeted operating costs.

After those required payments are met, Kaplan will receive money from Purdue’s new university for the services it provides. It will be reimbursed the costs of providing support activities. It will also receive a fee of 12.5 percent of the new university’s revenue.

In other words, Kaplan anticipates receiving payment for services provided plus a share of revenue. It is also, however, guaranteeing that Purdue’s new university will generate at least $10 million per year in new revenue for five years.

The deal’s structure looks in many ways like an online program management, or OPM, contract. But the revenue share is low by the standards of current contract standards, which often call for providers to receive four or five times the share Kaplan is in line to receive.

Also, the length of the services agreement is unusual. Many institutions are looking for shorter OPM contracts right now, according to an annual report from consulting and research firm Eduventures. A three-decade contract is essentially unheard-of.

“It seems like a low percentage, given the length of the contract,” said Howard Lurie, principal analyst of online and continuing education at Eduventures. “The largest OPM providers will range between 45 percent and 65 percent revenue share that they’re taking from the institution.”

Purdue and Kaplan did not share estimates for the fees that would be paid under the agreements. Kaplan’s higher education business segment, which is made up of Kaplan University, generated $617 million in revenue in 2016, according to federal filings. The figure can’t be used for fee estimates, however, because Kaplan University’s School of Professional and Continuing Education is included in the higher education line item of federal filings but is not part of the Purdue deal. The school has roughly 3,700 business-to-business clients, and more than 460,000 students used its exam-preparation offerings in 2016.

Purdue’s new university can terminate the 30-year services agreement after its sixth year, according to documents filed with the SEC. To do so, it would have to pay a fee equivalent to 125 percent of the new university’s total revenue in the previous year.

The agreement automatically renews for five-year terms after its first 30 years. If Purdue’s new university opts out of the agreement after 30 years, it would have to pay a smaller fee — the equivalent of six times the fees it paid to Kaplan in the prior year.

Termination fees the university would pay would take the form of debt — 10-year senior notes. Purdue’s new university would also have the option to receive some assets Kaplan used to provide support services for no additional cost.

The contract also contains clauses for ending the deal without termination fees in the event the new university posts significant losses — $25 million in operating losses for three straight years or $75 million in aggregate operating losses.

Minimizing an institution’s up-front costs in exchange for service payments to a provider over a number of years is common in OPM agreements, public-private partnerships and real estate development deals that colleges and universities are increasingly pursuing. But using such a structure to finance the acquisition of an online university is uncommon, experts said.

The arrangement allows Purdue to hit the ground running in a new market at a time when it faces considerable financial constraints. The university’s state funding has been largely flat for several years, and Daniels said he expects to receive less in the upcoming year than Purdue did last year under a performance-based funding mechanism. The university has frozen tuition at West Lafayette, by far its largest and highest-priced campus, for several years.

“If you’re Purdue, and you’re getting $10 million annually, you don’t have the start-up costs of the baseline operation, which could be considerable,” said Brian Mitchell, the president of Brian Mitchell & Associates, a consulting firm with focuses including higher education strategic planning, governance, enrollment and financial health. “And after all that’s done, you think of 12.5 percent to Kaplan. That’s not a bad structure to think about.”

The Purdue deal fits into a national landscape where colleges and universities are under pricing pressure from politicians, students and the media, said Mitchell, who is also the director of the Edvance Foundation and the former president of Bucknell University in Pennsylvania. At the same time, they are faced with the rapid changes brought on by technology.

“These are overwhelming conditions that affect what they can do,” Mitchell said. “So if you’re Mitch Daniels and you want to be a maverick innovator, and you want to position Purdue to play at the level of the University of Michigan or Penn State, what do you do? You find new ways of thinking and reimagining your streams of revenue.”

Purdue’s move isn’t just important from the perspective of large public colleges and universities, Mitchell added. Small colleges that have hoped to find new sources of revenue by building small online programs will want to take note as well.

“Online seems to be going to scale,” he said. “So you’d better be careful.”

The Purdue deal also stands out because it is not the type of merger normally seen in higher education, said James E. Samels, the CEO and president of the Education Alliance and founder of Samels & Associates, a higher education law firm. He is also co-author of the book Consolidating Colleges and Merging Universities.

“This is yet another illustrative example of transaction-specific partnerships that have very little to do with the traditional merger,” Samels said.

This isn’t the first time a public institution has flirted with a for-profit. The University of Akron took part in controversial talks to partner with ITT Tech. Discussions over that partnership helped to galvanize faculty opposition to former university president Scott L. Scarborough, who ultimately agreed to leave the university last year after an ITT deal never materialized.

Purdue and Kaplan could face opposition from accreditors, lawmakers or faculty members. Regulators and accreditors have to approve the acquisition.

Faculty members are already sharply questioning the deal. Some have also expressed unhappiness that they were not involved in its formulation.

The Indiana chapter of the American Association of University Professors posted a statement Tuesday saying it strenuously objects to the deal because it was not transparent and because faculty input was not solicited before a decision was made. The AAUP also argued that faculty governance at the new university will be “practically nonexistent” and that nonprofit and for-profit institutions should not mix.

The two types of institution do differ in mission, Samels said.

“The public charter is a very different mission from Kaplan,” Samels said. “The mission of Purdue is really, at the end of the day, revenue neutral.”

Purdue is putting its reputation on the line for a shot at disrupting the higher education market, according to Reuters columnist Kate Duguid.

“The deal could either pre-empt a digital education revolution — or spread the bad behavior of for-profit schools even wider,” she wrote Monday.

One detail in the contract between Kaplan and Purdue likely to be scrutinized is how the new university’s budget will be crafted. Agreements between Kaplan and Purdue call for the creation of a four-person advisory committee made up of two representatives named by Purdue and two named by Kaplan. It would recommend a budget for the new university every year and be responsible for other actions like recommending tuition and fee levels and developing marketing plans.

Documents state that the advisory committee is subject to the authority of the new university’s Board of Trustees — a board to be made up of five members from the Purdue University Board of Trustees and one member of the current Kaplan University Board of Trustees. Still, critics have pointed to its existence as giving too much control to the for-profit entity that will continue to exist as Kaplan.

The deal is a way for Purdue’s president to privatize degrees from public higher education and to dumb down degrees, argued Bill Mullen, a professor of English and American studies at Purdue, in a Wednesday post on Academe Blog.

“In purchasing Kaplan to make money for Graham, he has sold the Purdue brand to Wall Street, continuing the trend he began as governor of Indiana when he slashed millions of dollars to public education, created the largest school voucher program in the country and attacked teachers and teachers’ unions,” Mullen wrote. “Indeed, the Kaplan deal stabs Purdue faculty hard in the back.”

Graham’s post contains signatures from almost 100 faculty members at public universities in Indiana in opposition to the Kaplan deal as an attack on academic freedom and faculty governance. Purdue’s University Senate plans to hold a meeting on the issue Thursday.

Daniels, however, has dismissed those who criticize the deal because it involves a for-profit educational provider.

“Those people should be celebrating today,” he said last week. “There will be one less of these dreaded for-profit universities out there, and we’ll be operating it as a public university and trying to do so in a way that lives up to standards we’ve always held ourselves to.”

But Indiana’s recently passed state budget carves out sunshine law exemptions for Purdue’s new university, the Lafayette Journal & Courier reported Wednesday. The new university will be exempt from state open-door laws, access to public-record laws and accounting for public funds codes.

Purdue’s legal counsel, Steve Schultz, told the newspaper that the exemptions were made because the new university will be run like a nonprofit corporation that is autonomous, separately funded without receiving state money, and separately operated. The new university is supposed to remain nimble and innovate, he said. He also made the case that the new university’s trustee meetings will likely be held at the same place and time as Purdue trustees’ meetings, arguing they will be held in a public setting “as a practical matter.”

Open-government advocates were not convinced. The exemptions are troubling, said Zachary Baiel, a West Lafayette resident who is the president of the Indiana Coalition for Open Government.

“Purdue is a public institution, and when you start to lose that kind of visibility on the actions that are going through at, in this case, a public land-grant university, it starts to be deeply concerning,” he said. “What is done in the name of the public?”

Source: Inside Higher Education – News

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