First Marblehead: Hostage to the Credit Market

Ryan writes:

You wrote about First Marblehead (FMD) a while back. The stock got killed yesterday by the TERI bankruptcy and I'm wondering if you think it's worth picking up shares.

Yes, it did get killed Tuesday, and that wasn't the first time, either. It's down to less than $5 from more than $40 a year ago. I sent a report to Kelly Letter subscribers Tuesday night, from which the following is adapted:

It's too late to sell. The time for selling this stock was a year ago. That narrows the options to initiating a position, holding a current position, or adding to a current position.

This is a maddening situation of seeing a great company smacked down for having done nothing wrong. There are no accounting irregularities, no failure to find new business, no product delays, no lack of due diligence as we saw with sub-prime lenders. All was going swimmingly for Marblehead until the credit market closed. Through no fault of its own, the doors to its store are locked shut.

The loans that it packaged and sold as bonds are performing well, according to Marblehead. It hasn't needed to rely on TERI. Of course, just when things are dicey enough that it would be nice to have a strong backer, Marblehead's backer fled the scene. I suggest turning to Warren Buffett's Berkshire Hathaway (BRK.A) for future financial backup.

We could analyze the situation a hundred different ways but what it all really comes down to is this: First Marblehead is hostage to the credit market.

If that market gets going soon, Marblehead will be fine and the shares should rocket higher. They could erase recent losses in a single week.

If that market remains closed for too long, Marblehead is doomed. It could go the way of Bear Stearns (BSC), acquired by a bigger company for a buck or two and then seeing that company go gangbusters with FMD's profits when the credit market wakes up.

Now, lest you think all is lost, remember that a lot is going on behind the scenes in financial markets these days. Just as those investing in Bear Stearns saw their $2 stock become a $10 stock with one announcement from JPMorgan (JPM), so could we see good things come to FMD out of the blue.

Remember that Goldman Sachs (GS) invested $261 million in Marblehead last December. Some $60 million bought FMD at $11.24, and the remaining $201 million is slated to buy at $15. That deal puts Goldman Sachs down pretty far at the moment, and I have a feeling Goldman isn't happy about that. It's good to have Goldman on your side.

If you're looking for somewhere to take some risk, I think buying Marblehead at these prices will work. Don't use your lunch money, of course. Use the money you set aside for just such moments when you think it could really pay, or really disappear -- but not ruin your life by doing so.

Comments

[teknikk7:]

Lunch money you say?

I just used my rent money to buy some shares...

2008 Apr 09 06:49 AM

[FIG trader:]

Please do tell. Analyze this for us at least one way, for Xmas sake. On the other hand, for those who viewed this as a short in the 30's 40's or 50's, you may want to try a flier at tis in the next few months well below yesterday's close. But if course if you are operating on even a fraction of the same assumptions as many did over the last three years, fuggedaboutit. You need Paulson like hedgefund returns to recoup you initial investment. Personally, it may be worth revisiting the whole scheme, i can think of long-term scenarios of value building

2008 Apr 09 07:53 AM

[Dan Jacome:]

Tom Brown got killed.

2008 Apr 09 10:32 AM

[Dan Jacome:]

Playing the bounce today

2008 Apr 09 10:32 AM

[Dan Jacome:]

playing FMD for a + 6% bounce after it got crushed 40% yesterday. Could see $5.75 print by day end as name is more "victim" of credit crunch then management misexecution.........

2008 Apr 09 10:47 AM

[Chandler Lutz:]

First Marblehead is a pretty interesting story at this point as the company is trying to transition from being solely an intermediary to a generator of student loans. I do agree that if Marblehead can survive the down downturn they can provide great returns to shareholders.

As far as Buffett being the savior...well, I see that as highly unlikely considering FMD has only a 550 million dollar market cap and obviously doesn't have a a consistent business model.

2008 Apr 09 11:43 AM

[Passerby37:]

Thanks Jason,

Great Commentary. The line about having "Goldman on your side" made me pause however.

Goldman is on Goldman's side. No one else's. If sufficent returns cannot be generated from purchases at $11.24 - $15.00, a grab at the whole pie at under $5 would be the next logical move.

It all depends... will the financial markets remain locked long enough to force management's hand? This TERI issue suddenly has taken on a whole new meaning for me.

2008 Apr 09 03:57 PM

[valueinvest...:]

I would rather just go to Vegas with the amount of money I would put in FMD.

2008 Apr 09 04:08 PM

[BlueDome:]

One thing people should remember, doesn't matter (for investors) if FMD was screwed unfairly. It's still screwed.

I'm selling all at a big loss.

Reasons:
1. FMD must have known that TERI was about to file bankruptcy.
Bet they have already tried and can't find another guarantor.
If they find one the terms will be bad.

2. The reason TERI filed bankruptcy is that the loan portfolios
that FMD securitized were (are) underperforming. They were all
downgraded by Fitch and then a bank forced TERI to set aside more capital to cover the losses, which it couldn't do. Whether all this was caused just by recession or by fault of FMD will never be known,
but it looks bad for FMD.

3. FMD is being sued left and right because of #2.

4. FMD's big moat is a database of historical data that is supposed to prevent exactly what is happening right now.

5. Goldman sachs pulls out of big $1billion bailout.

It looks like FMD burns the rest of its cash over 3 quarters then fails. Or, it gets bought for pennies on the dollar by
someone huge. Even if everything turns around, the terms of any
deals they can make will be horrible for awhile til they restablish
a reputation.

Funny how this played out over a couple of months yet nobody pushing the stock (like Motley Fool - Rule Breakers and Inside Value newsletters) was following closely enough to warn suckers like me. The Fitch downgrade should have been a big red flag.

2008 Apr 14 06:13 PM