Why Was the University of Phoenix Deal Rejected by Arkansas Trustees?

One of 2023’s hottest stories in online education has continued to develop: the University of Arkansas System’s Board of Trustees struck down a controversial resolution favoring a takeover of the for-profit University of Phoenix. After a contentious three-hour debate days before a preliminary session, on April 24, the board narrowly rejected an endorsement of the acquisition’s agreement by a five-to-four margin.

The proposal’s terms included a $535 million valuation of the University of Phoenix, although the actual offering price remains confidential. The terms also include guaranteed annual royalty payments of $20 million per year by Phoenix to license the University of Arkansas’ brand identity for 15 years.

Yet oddly enough, the vote didn’t necessarily cancel this proposed deal. The reason is that because of legal considerations, the UA System had to set up a nonprofit corporation to acquire Phoenix and gradually convert the for-profit college into a nonprofit. Because the seven-university Arkansas system would not directly purchase Phoenix, such an agreement does not technically require the board’s approval, so in that sense, the vote was merely advisory.

Nonetheless, University of Arkansas President Donald Bobbitt wanted the board to approve the resolution as a vote of confidence. In a statement, the system’s communications director Nate Hinkel said, “Dr. Bobbitt has previously said it would be difficult to move forward without support from the Board for this project. That statement remains true. He is certainly disappointed in the outcome of the meeting.”

Nevertheless, did Dr. Bobbitt defy the board and attempt to push the plan through without its support? The Washington Post reported that he had the legal authority to do so. However, reporter Debra Hale-Shelton of the Arkansas Times also pointed out that such a move probably would be unwise. That’s because Dr. Bobbitt’s contract expires on December 31, and an extension requires approval by the board.

Moreover, key stakeholders have expressed opposition to the proposal. In March, the faculty senate at the flagship Fayetteville campus adopted a resolution opposing the proposed deal. Then a few days later, the faculty senate and the student government association at the Little Rock campus adopted similar resolutions.

Of the trustees, the board’s vice-chairman Sheffield Nelson—an influential two-time gubernatorial candidate who ran against Bill Clinton in 1990—conveyed some of the harshest criticisms against the proposal. In voting against the resolution, Nelson alleged that the board had been kept in the dark for 18 months; meanwhile, Dr. Bobbitt’s team hammered out a draft agreement with negotiators from Apollo Global Management, the publicly-traded private equity firm that wants to sell off Phoenix. He argued that, “No one knows what they’re voting on.”

Echoing the principal argument of both faculty senate resolutions, Nelson also complained that Phoenix has a “terrible reputation.” He said he’d received countless phone calls from observers inside and outside the higher education industry recommending against any association with the for-profit college. “I think it’s a mess we don’t need to get our feet in,” he said.

Nelson’s condemnations of the University of Phoenix are valid. In our recent article “What a University of Phoenix Takeover Might Mean for Online Education,” we pointed out that Phoenix had agreed to a record $191 million Federal Trade Commission fraud settlement in December 2019 that reimbursed 147,000 Phoenix students almost $50 million. The FTC alleged that the college had lured students through deceptive TV advertising that claimed job recruiting partnerships with blue-chip employers like AT&T, Microsoft, Twitter, Adobe, and Yahoo!

However, those partnerships never existed. The terrible press coverage over that outrageously deceptive marketing campaign only compounded intense scrutiny of the school’s abysmal 13 percent graduation rate and poor post-graduation hiring outcomes.

What’s more, Phoenix’s predatory and deceptive marketing practices were hardly unique within the for-profit education industry. Other for-profit schools like Ashford University were shown in court documents to have engaged in aggressively deceptive telephone selling practices targeting groups traditionally underrepresented in higher education. These groups included veterans, women, and minorities—folks who also comprise the lion’s share of today’s students enrolled at Phoenix.

The resulting tsunami of bad press has destroyed the public’s confidence in the for-profit education industry, and the resulting public outrage drove a regulatory crackdown that substantially curtailed Phoenix’s enrollment and revenues. Today the school only reports 54,400 undergraduate degree candidates, an 83 percent plummet from the 470,000 such students during the school’s peak enrollment in 2010.

That crackdown is ongoing, and Higher Ed Dive’s Editor Natalie Schwartz argues that Phoenix will likely face more scrutiny: “The Biden Administration has pledged to crack down on for-profits and has tightened a slew of policies and regulations governing the sector—and more changes are looming,” she writes. A potential takeover of Phoenix will require approval by the U.S. Department of Education following a pre-acquisition review process that could last six months.

Moreover, if the Administration establishes through a forthcoming investigation that Phoenix misled students who enrolled, whoever owns Phoenix might be liable for millions of dollars in canceled federal student loan obligations, combined with Phoenix’s substantial exposure to similar claims arising out of a 2018 lawsuit. On April 13 the U.S. Supreme Court refused a petition by a group of mostly for-profit colleges—including Phoenix—to block a $6 billion settlement canceling the student loans of roughly 200,000 borrowers who alleged that their colleges defrauded them.

Under the Education Department’s borrower defense rule, student loan borrowers can ask the Department for debt forgiveness if a college had lied to them about aspects like their credits’ transferability, or about their job prospects or probable salary following graduation. The settlement resolves the 2018 Sweet v. Cardona class action litigation where borrowers who had attended 151 institutions accused the Department of ignoring their loan forgiveness applications. Twenty states, including Arkansas, had challenged the settlement.

As of early 2023, at least 48,890 such borrower defense claims were pending against Phoenix. The total amount of the college’s liability is not yet known.

One of the more remarkable aspects of the board meeting involved the debate focusing on significant aspects of the deal that were previously undisclosed by officials or unreported in the press. For example, some reasons why the UA System had to set up a separate nonprofit corporation known as Transformative Education Services to structure this deal have just now emerged.

One reason the UA System couldn’t buy Phoenix directly is that the constitution of the State of Arkansas precludes state entities from paying or assuming the liability or debt of “any county, town, city or other corporation.” That restriction obviates the possibility of a direct acquisition—meaning that the UA system cannot own Phoenix—and limits TES to bank loan or bond issue financing.

But other reasons also exist for setting up TES besides the constitutional mandate. Second, if bond financing were involved, the use of TES would protect the bond rating of the University of Arkansas. That’s because TES would have its own rating with agencies like Moody’s that would list it separately aside from the UA System. If the system acquired Phoenix as a wholly-owned subsidiary, Phoenix could drag down the system’s bond rating and damage the borrowing capabilities of its seven other universities.

The Washington Post had reported that TES was in talks with several banks outside the United States, but that Dr. Bobbitt had refused to identify them. And according to a Washington lawyer with expertise in university mergers and acquisitions, there’s a reason why the UA System was considering partnerships with international banks.

“A lot of U.S. banks now decline to loan money to [higher education] for-profits,” said attorney Neil Lefkowitz, who isn’t involved in the Phoenix proposal. He told the Arkansas Times that “a lot of banks have lost tens or hundreds of millions of dollars” from such loans.

Furthermore, a third reason for using TES would be to shield the UA system from legal exposure from lawsuits or regulatory actions that Schwartz and many other observers expect will impact Phoenix.

That way, the UA System would enjoy a “safe harbor” in the sense that it will not be legally responsible given the substantial probability that Phoenix will face upcoming lawsuits or—with an election year approaching—more regulatory enforcement actions. Moreover, in the event of litigation against Phoenix, this structure also means that the UA System and its board members would be immune from legal actions, along with civil liability or criminal punishment.

But a potential disadvantage of structuring TES to provide the safe harbor shield is that the University of Arkansas needs to have control or governance authority over Phoenix. The current plan only gives the UA System a minority role among an 11-member board controlling Phoenix, meaning that the system will have little if any power to take action on disagreements involving its new affiliate. And it’s difficult to imagine how the UA system’s leadership could justify payments of more than half a billion dollars to an entity over which it will exert no effective governance or control.

In fact, under the current draft agreement’s “no exit” provisions, the UA System would find itself locked into the contract for a decade without any effective control over the college it just bought, with the first opportunity to leave the agreement unavailable until the tenth year. Apparently, the only legal remedy that the UA System could bring to bear until then might exist if it can prove in court that Phoenix breached the contract materially.

Two trustees who voted against the resolution said that they did so in large part because of this lack of control and governance authority. They were Little Rock attorney Kevin Crass and the board’s chairman, Morril Harriman.

“If the chancellor of the University of Phoenix is doing something that we don’t think is consistent with the University of Arkansas’ mission, the UA System does not have the right to do anything about it,” Crass said. In addition, Harriman raised concerns about Phoenix’s reputation, warning that it would be “very, very difficult to change.” The chairman also questioned whether such an affiliation even aligned with the mission of the UA System.

Along with the reasons for setting up TES, some of the plan’s financial aspects raised eyebrows as well.

“The UA System is leveraging at least half-a-billion dollars to acquire the University of Phoenix for 20 million dollars worth of revenue,” said Dr. Stephen Caldwell, the chair of the faculty senate on the Fayetteville campus, in an interview with Arizona radio station KJZZ. “Which is barely a 4 percent return on the investment,” he added. “Is that better than the S&P 500? I’m not sure.”

Similarly, Lefkowitz questioned the $535 million valuation. He told the Arkansas Times that he believed Phoenix’s “diminished valuation” meant the school couldn’t expect much more than $200 million as a sale price. As justification, he cited Phoenix’s unresolved borrower defense claims, regulatory issues, and massive enrollment decline.

In our previous article, we speculated that the main benefit to the UA System from buying Phoenix is rapid scalability. Buying Phoenix would provide Arkansas with a swift and potentially formidable competitive advantage against all the other colleges entering the exploding online education market targeting early- and mid-career professionals. That’s because the Phoenix acquisition shortcuts the lengthy process of building a massively scalable online education platform requiring millions of dollars and years to complete.

Our assessment echoes the analysis presented to the board by Dr. Matthew Waller, the dean of UA’s Sam M. Walton College of Business. At the preliminary session on April 19, Dr. Waller emphasized that Phoenix has substantial expertise in developing new online courses and programs rapidly and cost-effectively. He also pointed out that Phoenix is at the forefront of several new technologies, like one system that assists course and curriculum designers by providing reconnaissance on the competencies and skills most needed by employers.

However, it remains unclear why many of the officials supporting the resolution expressed less compelling arguments only marginally related to Dr. Waller’s analysis. For example, the UA System’s Vice President for Academic Affairs Dr. Michael Moore asserted that these days, concerns about the University of Phoenix’s reputation are groundless. He told KJZZ that “most of those concerns are tied to business practices around specifically marketing or recruiting, and they really reflect the actions of prior ownership groups [when] there’s been a new team in place for years.”

However, Dr. Moore knows or should know that as recently as January 2023, Phoenix had been running a national ad campaign that appears to violate its 2019 settlement with the FTC.

To obtain its consent decree with the agency, Phoenix agreed that its future advertising had to be “non-misleading.” Nevertheless—and as this unlisted video demonstrates—by proclaiming “no out-of-state tuition” the campaign instead frames the for-profit school as a public, state-operated institution. The fact that Phoenix’s current leadership authorized this deceptive campaign to run ads for at least five months on major outlets like Facebook and YouTube defeats arguments that this “new team” eliminates any cause for ongoing concern about the school’s reputation.

Moreover, trustee Nate Todd argued only in general terms that the proposal provides the UA System with a more aggressive opportunity to embrace online education as a “transformational change that is happening in America.” He added that “this space is critical, in my assessment, to learning and the change in the environment where learning is taking place.”

Another trustee who voted for the resolution, Ed Fryar, offered an analogy with the 1973 decision by Federal Express to build its global Superhub at the Memphis International Airport after Little Rock National Airport refused to lengthen its runway. He said the University of Arkansas has an opportunity not to repeat that error.

“To me, this is a FedEx moment,” he said.