The Short Case for Sallie Mae

| About: SLM Corporation (SLM)

Sallie Mae (NYSE: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:

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