The Short Case for Sallie Mae

Sallie Mae (SLM) is one of the best short ideas among stocks in the Financial Services sector. At the current premium to book value (5.3x) and at 15x times earnings, the current stock price is discounting 30% to 35% ROE for the student lender as far as the eye can see. The likelihood of relative underperformance in relation to the rest of the financial sector is high, assuming any of various high-probability scenarios.

Our base case scenario of short, intermediate, and long term interest rates of 4.00% to 6.00% through 2008 would translate into fair value for SLM of an estimated $30 a share, a price reachable by 2008. That even takes into account that consensus estimates are reasonably close to the mark (i.e. low double-digit earnings growth, and a deterioration in the ROE to the mid to high twenties by 2009).

The "optionality" is with the medium term probability of the SLM's ROE beginning a long-term slide to the low twenties, a not unreasonable outcome since market forces should chip away at these excess returns.

In a market where financial leverage is likely to be penalized, the valuation should contract accordingly. That could translate into underperformance of at least 1000 to 1500 basis points over two to three years (versus the consumer finance sector).

SLM 1-yr chart:

Comments

[FIG trader_:]

Ok not bad call on SLM, we're down 10% since the September 6th call when stock was around $50, and financials have been smoking hot. It looks like we may in for a big break below the lows right around here $46 very soon. This is technically a level where there is some rebound potential, but shorting on any strength is advisable. And if financials do back off here, the break seems more probable. Thank the Democrats for the "excuse" to sell (see heavy volume decline few days ago)

2006 Nov 10 01:34 PM

[FIG trader_:]

SLM's underperformance versus XLF (financials ETF) and SPX must continue to confuse investors, given raging bulls piling into all financials and reasonbaly bullish Street consenus (3 strong buys, 6 buys 5 holds). The stock is now at a very vulnerable level (technical) after repeated failed rallies in the last two months, What is the street missing? Even Merrill conference and repeated confidence in "growth" couldn't move the stock. I suspect it is a basic misunderstanding of valuation technique. Prudential says discounted CF (DCF) brings target price to $60 (and market capitalization of $26 billion) corresponding to 18 P/E multiple (middle range of high and low of last five years). HUH. Me says he's wrong. Fundamental long-term story (even assuming "growth")continues to suggest a stock worth closer to $30 to $35 (under the current good conditions for financials), given the likely decline in the ROE for the next five to seven years to the mid to high teens, as barriers to entry erode even further.

2006 Nov 22 01:05 PM