First Marblehead: Worth $10 or $60?

First Marblehead (FMD) is a classic conundrum: low P/E, strong growth, a big end market, complicated accounting, customer concentration risk and lack of long term certainty in credit quality.

The Bull Case

1. It's cheap.
2. Fast growth. The market is growing at 25% to 30% and FMD's Astiva channel is growing at 90%+ in terms of direct to consumer originations.
3. JP Morgan (JPM) and Bank of America (BAC) will leave at some point but not anytime soon. Even with out them the company's reliance on them is shrinking from 65% of origination only a few years ago to now 40%.
4. Not a true finanical since they don't carry loans or credit risk on the balance sheet.

The Bear Case

1. JPM and BAC are still 40% of originations and that the cost to acquire assets through the company's Astiva brand is higher then investors realize given the heavy use of T.V.
2. At some point these margins are coming down. Truthfully probably not for a couple of years.
3. They are a financial since they carry a residual on the balance sheet. That this is mispriced when viewing where the "BBB" traunches trade in the secondary market at roughly $0.88 on the $1. This probably doesn't take into consideration prepayment assumption being wrong.
4. That the "earnings" of this company are predicated on under collateralizing their securitizations. If they were required by the either the rating agencies or investors to change this model, the earnings of this company would be significantly lower. In essence the stock market is putting a different implied value of the the NAV of the assets due to timing differneces in cash reciepts nothing more. The underlying asset is worth no more or no less.

I'm sitting on the fence, and frankly, I loath these types of stocks.

I could argue with equal energy that the stock is worth $10 as I could argue it is worth $60.

Disclosure: none

Comments

[altidude:]

FMD has $3+ per share in net cash on the BS, and--even with your suggested (minimum) 12% haircut for their residuals--another $8-$9 per share (maybe $5-$6 after tax) there. So, $10 seems like a liquidation-type downside.

Also, their latest securitization came during the doldrums of the credit crunch in September, yet they exceeded expectations regarding the size of the deal and the yields they received. (Consensus analyst expectations were consistently revised upward after FMD released its preliminary deal size and fee estimates.)

While prepayment risk in the trusts is a concern, the debt is generally floating rate, so I wouldn't think the debt investors in those trust are too concerned about reinvestment risk anyway. (Of course, prepayments could lower FMD's residual takes.) And, for the average student loan in the trust to be worthless, you'd need to see the student default, then the co-signors, then TERI (which guarantees the loans).

Also, as regards undercollateralization of the trusts, this "seems" (to me) to be worse than it is, as the loans generally acrue non-cash interest while the kid is in school. This non-cash interest gets applied to the loan balance. So, the undercollateralization rectifies itself reasonably quickly, as the non-cash interest increases the size of the trust assets relative to liabilities.

I'd put a no-growth value on FMD's FY07 results at about $45-$50 per share. And that's a no-growth assumption in the private student loan industry, which will benefit seemingly indefinitely from the 1) increased demand for higher education; 2) large and growing funding gap between federal assistance and the actual cost of higher-level education; and 3) higher-level education inflation, which has been (and looks to continue) growing significantly faster than personal incomes.

FMD is a high-growth business being valued like it's going out of business. I just don't see that happening. (And we haven't even discussed its plans to use its connections with students to offer other financial products like banking services, insurance, credit cards, etc. to further leverage its processing infrastructure and connections with students.)

Needless to say, I'm long FMD.

2007 Nov 05 01:43 PM

[FIG trader:]

Why hasn't anyone uncovered this gem of a stock? considering how they are practically giving it away. Seems like even the "pom-pom" crowd is throwing in the towel.

2007 Nov 27 01:11 PM

[italaw:]

When the credit markets crumbled, FMD evaporated. Will it go to zero?

2008 Apr 01 11:17 AM