Lenders to ATI Enterprises, a privately held for-profit school operator once worth a half billion dollars, might not receive even pennies on the dollar for the $250 million they committed to the school just three years ago. The latest bids on the company’s remaining bank debt, which technically went into default in June, dropped to zero shortly after S&P Capital IQ’s LCD reported on Jan. 4 that ATI had begun to liquidate certain assets outside of a formal bankruptcy process.

In sum, the privately held enterprise fell victim to its dependence on public funds, as government oversight of the for-profit education industry — perhaps long overdue – grew exponentially tougher.

Even so, many professionals interviewed for this article viewed the plight of ATI as startling in the rapidity with which it imploded, given the line of savvy players involved.

The current owner is UK-based private equity giant BC Partners – which just last year raised an $8.6 billion fund, while the previous owners were middle-market investing private equity firms The Riverside Company and Primus Capital. Goldman Sachs, meanwhile, was the banker on the loan and advisor to BC Partners in its 2010 acquisition, and pieces were sold to multiple established institutional investors, including Apollo Investment Corp. and New Mountain Finance.

“It’s unusual for a company this big to have this binary an outcome,” observed a private equity professional. “Especially in the case of private equity. The closest comps are the venture capital investments in the tech era boom.”

ATI’s downfall comes at a time of increased pressure on the for-profit education industry – pressure expected to get even more intense during President Obama’s second term. The administration, for example, is likely to continue the implementation of its gainful-employment regulation passed in 2011, which would deny federal student aid to for-profit institutions where graduates have loan-repayment rates that are too low, or debt-to-income ratios that are too high.

Then there is the damning two-year investigation of the sector published in July of last year calling for enhanced transparency, stronger oversight and more meaningful protections. Senator Tom Harkin (D-Iowa), who spearheaded the investigation, is likely to retain the chairmanship of the Senate Education Committee now that Democrats retained control of the Senate. And last, but not least, the Consumer Financial Protection Bureau, the new agency started in Obama’s first term, has already opened investigations into student-lending practices, and looks as though it will maintain – if not increase – its strength with one of its original architects, Elizabeth Warren, gaining election to the Senate from Massachusetts.

No Title IV after 11

ATI, based in Texas, started as a small operation 50 years ago that eventually turned into a major money maker for the entrepreneurs that grew it to as many as 23 schools across five states, including seven in Texas. Despite the money and brainpower put into the school, in November the company decided to close all its schools under the ATI brand following a devastating two-year litany of bad press and regulatory scrutiny. Meanwhile, Corinthian College, another for-profit school backed by former ATI owners Primus, will take over the teaching of students of at least one of the company’s Florida campuses, according to sources.

Schools to remain open are those under the South Texas Vocational Technical Institute name and the Dallas Nursing Institute Brands, according to the Texas Workforce Commission (TWC), the state agency that oversees for-profit educational institutions, among other things. ATI did not respond to requests for comment on who will run the remaining institutions.

While normally a company shuttering more than half its operations and defaulting on debts would be expected to force it into bankruptcy, providing a legal structure for debtors and creditors to develop a reorganization plan and calculate values for recoveries, a recent court decision in another education bankruptcy revealed how ATI would not be able to follow the traditional bankruptcy path, according to sources familiar with the matter. In August, the Department of Education (DOE) revoked Title IV status for Lon Morris College, permanently stripping access to any Higher Education Act funding. In its letter notifying Lon Morris of its decision, DOE Director Mary Gust explained that any for-profit education company that files for Chapter 11 would not be eligible for financial aid programs, a statute that had been in place but that had not previously – or at least recently – been as explicitly enforced.

That left lenders in limbo, giving them little choice but to write off their investments completely.

There is a restructuring plan to hive off the company’s bad assets from those still operating, according to sources, but its legalities are uncertain. For example, what some refer to as the “good bank, bad bank” approach included an abrupt, unannounced, out-of-court liquidation of various assets. LCD, for example, learned about a 10-day auction featuring ATI assets used in its various certification programs, such as motorcycles, car engines, medical equipment, and hair-salon seats, which was completed Dec. 31. The third-party firm conducting the sale, Liquid Asset Partners, publicized the auction under the name “Career Training Facilities”, but an employee at Liquid Asset Partners confirmed to LCD that these were assets from ATI’s main North Richland Hills, Texas, campus.

There may be further sales for other campuses, according to the employee.

Mysterious worth

Goldman Sachs arranged $247.5 million in debt for ATI in 2009 in connection with a $485 million LBO that closed in January 2010, in which BC Partners, the company’s current private equity backers, bought ATI from Riverside and Primus at a price of $485 million. That price valued the company at 7.5x EBITDA.

BC Partners provided most of the $255 million equity investment (management had a stake in the school as well) as the larger private equity firm looked to take what middle-market operators had built and expand it with their greater resources.

The debt comprised a $140 million term loan along with a more expensive $90 million mezzanine portion that came behind the main term loan in priority. The package also included a $17.5 million revolver.

In the syndication, numerous funds and investors took portions of the debt, all of which have recently been forced to write their holdings down to near zero.

According to SEC filings, Apollo Investment Corp. (Nasdaq: AINV) has written down its $14.9 million portion of the term loan and its $43.3 million portion of the mezzanine facility to zero, though it still assigns some value to the $4.5 million worth of the revolver (AINV was founded by affiliates, but is not currently part of the well-known private equity firm Apollo Global Management; neither of the two are connected with for-profit education company Apollo Group).

New Mountain, for its part, wrote off its $4.4 million investment in the term loan to $330,000, roughly 7 cents on the dollar as of Sept. 30. New Mountain also held more than $1 million worth of the revolver. And Columbia Management, which held $1.5 million across the capital structure, also marked at pennies on the dollar as of Oct. 31, 2012.

Patrick Dalton, Apollo Investment’s former COO, specifically addressed his firm’s ATI write-down on a Nov. 2011 conference call.

“When you looked at that space, it’s in the crosshairs of a lot of regulators, it was in the crosshairs of Congress last year [with] gainful employment,” Dalton said. “Unfortunately, when you talk about highly regulated industries, there’s more regulation now than there was five, ten years ago around certain specific industries. Things can happen, it’s an unfortunate situation, but we took immediate steps. … We get good surprises sometimes. Sometimes, we get unfortunate surprises, and this one candidate was one.”

Other funds that may have owned portions of the loan include Marblegate Asset Management, a debt investing firm chaired by Henry Miller, co-founder of the eponymous distressed credit specialist Miller Buckfire; and hedge fund Visium Asset Management, according to sources. Neither responded to requests for comment.

Timing fate

Regulatory and investigative problems for the company began to emerge less than a year after BC Partners acquired the company, although sources, along with a review of regulatory documents, suggest those issues were largely attributable to activities conducted under the company’s previous owners, Riverside and Primus.

ATI’s decision to shutter the company’s doors came on the heels of a civil lawsuit filed on behalf of the DOE seeking damages from ATI for allegedly fabricated placement statistics, altered grades and attendance records, and falsified financial aid records, among other things, that the filing argued amounted to “fraudulent conduct in an attempt to secure federal aid for students who, but for ATI’s conduct, would have been illegible for assistance.”

The DOE complaint alleges that from 2007 through 2010, at three campuses in Dallas and North Richland Hills, Texas, ATI Enterprises knowingly misrepresented its job placement statistics to the TWC in order to maintain its state licensure, and therefore its eligibility for federal financial aid under Title IV of the Higher Education Act of 1965.

At the time of the January 2010 exit, Riverside and Primus were crowing in press releases about turbo-boosting overall revenues and EBITDA by 300% and 450%, respectively. In less than six years under their ownership, Riverside bragged, ATI had expanded campuses from eight to 23, added an online division, and grew the number of students served from 2,300 to 15,500. Suzanne Kriscunas, one of Riverside’s managing partners who spearheaded the investment, stated at the time, “We look forward to applying our talent and experience to future investments in this sector.”

Kriscunas did not respond to requests for comment.

Prior to Riverside and Primus, the schools were under the ownership of German-born businessman Joe Mehlmann, a detail-oriented entrepreneur who had played soccer for Notre Dame in the 1960s. While problems occasionally cropped up with recruiters under Mehlmann’s tenure, the issues were self-reported and dealt with in a way that allowed Mehlmann to maintain a good relationship with the TWC, according to sources familiar with operations at the time.

“ATI was a great school,” Mehlmann said when contacted by LCD for an interview. “Certain people took over and they were not being diligent,” he said, referring to Riverside and specifically the management they put in place.

While under the control of Riverside and Primus, ATI was headed by Arthur Benjamin, an operational expert – and animal rights activist – who was installed as CEO in 2005.  He remained with the company following the 2010 buyout, but resigned later that year, to be replaced internally. Sources told LCD that Benjamin was effectively asked to leave by BC Partners. Benjamin did not respond to requests for comment.

Mehlmann told LCD that he had no further role with the company after 2006 and that his final ownership stake was cashed out when BC Partners took over. Mehlmann said the DOE has not contacted him regarding the complaint, adding that the charges being brought against the company are “pretty egregious.”

“It’s pretty hard to forgive falsification of records,” he said.

“This looks like BC Partners got taken to the cleaners,” said one person close to the situation, citing the fact that within one year of buying the company, ATI was facing media and regulatory scrutiny.

“It’s the kind of thing where BC Partners didn’t see the red flags or do the due diligence,” said Mehlmann. “There are certain things in this business you just have to stay on top of. And it shouldn’t take a state agency for granted,” he said.

Spokesmen for BC Partners and ATI declined to comment. Primus and Riverside did not respond to requests for comment.

ATI is far from the only for-profit educator to come under fire for inappropriate practices. It was just one among 15 named by the Government Accountability Office in August 2010 on deceptive recruiting practices. Others cited in that report included another distressed credit Education Management Corp., as well as Kaplan College, part of the operation owned by The Washington Post Co. And the previously mentioned Senate investigation published in July of last year named six additional schools that were the subject of inflated placement numbers investigations.

A glimmer of hope           

ATI may have stood out from the rest, however, at least in part due to especially dogged reporting by Dallas-Ft. Worth-based WFAA News 8 on-air reporter Byron Harris, a 38-year veteran multiple-award winning muckraker. Harris’s scathing reports commenced airing around October 2010, after a “year-long” investigation.  Only after the public airing did regulators start getting involved. Indeed, the Senate investigation noted that the TWC only moved to revoke ATI’s license to operate in the state “after media reports.”

So it was in July 2011 that the TWC issued an order requiring ATI to stop signing up new students in certain programs due to suspected over-reporting of employment related to the vocational training received in those programs. Then, in August 2011, the state revoked the certificates for 22 programs taught at ATI schools.

Even so, the company’s business remained intact as late as April of last year, and there remained some hope for recovery. The licenses were reinstated for the remaining programs, according to copy of an April 2012 letter from TWC Deputy Director Laureen Biscoe to ATI obtained by LCD via an open records request. Several programs were slated for closure before and after the inquiry, but ATI had resolved the key issue with TWC, was in compliance, and regular certificates of approval had been reissued to all ATI-owned schools, according to the letter.

And there is evidence to suggest that by 2011 ATI was no longer nearly as out-of-compliance as alleged in 2010, when an outside accounting firm found that ATI over-reported job placement rates for 90% of the school’s programs for 2010, and that 63% had actual placement rates below TWC’s required threshold, according to the Senate investigation.

The TWC required ATI to contract with an independent third-party to verify the company’s fiscal year 2011 student employment reporting, stating that results showed over-reporting of 5% – which is 2 students out of the 40 – then the program would have to close. The third party review was completed by March 30, 2012, and showed that only one program had over-reported employment — Automotive Service in Dallas, which ATI had already slated for closure. ATI had reported 3 more students were employed than the third-party report found, bringing the employment rate down to 21.5% from 22.9%. Consequently, licenses were reinstated for the non-closed programs and ATI then had to give TWC monthly reports of student-level completion dates.

But by June last year ATI had defaulted on its term loan and likely had not paid interest on its term loan for months. And then the DOE filed its complaint in August, obliterating any hopes for a substantial recovery. The DOE’s complaint, filed with former ATI employees as whistleblowers, is against ATI entities, but does not explicitly name any owner, current or former, as a defendant. The DOE declined to answer several requests for comment as to where or from whom it hopes to seek the money that it is asking for in the complaint.  – Max Frumes

(Update: A previous version of this article indicated that ATI may have been looking for a teach-out partner in Arizona. That is not the case, according to current ATI CEO Michael Gries, who contacted LCD in response to the article.)