|Shares Out. (in M):||40||P/E||0||0|
|Market Cap (in $M):||2,415||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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· Nelnet (NNI) is a Lincoln, NE-based holding company that historically has been involved mainly in the student loan & student loan servicing markets. It is still in those businesses but is redeploying capital into new areas, chiefly a valuable and rapidly growing education software business that is worth over half the market cap. Chuplin1065 wrote up the stock on 10/23/17 at $58.50/share and I roughly agree with his thesis.
· Stock price $59.81/share, 40.4 million shares outstanding, $2,415 million market cap. Michael Dunlap, the founder and Chairman, owns 42% of the company (partly through Class B shares) and insiders own 45%.
· NNI went public in late 2003 at $21/share. Book value in 2003 was $5.70/share and has compounded at 18.2% since to $58.02/share in 2019 Q1. The only down year in book value was -1.6% in 2007. Tangible book value is $51.47/share.
· The company is comprised of 4 segments: Student loans – a $40/share portfolio of student loans that are 97% federally guaranteed and in runoff, Loan Servicing – a business that services student loans, Education Technology – a software business that services K-12 and university markets, and Communications, a fiber business in the Midwest that passes 153k homes in the Midwest, mainly servicing Lincoln, NE and a smattering of rural communities. In addition, there is a portfolio of investments mainly comprised of real estate, VC, and odds and ends, the main asset being a 20% stake in Hudl, a fast growing private software company that services high school and college athletic markets.
· I think the company is conservatively worth $80/share today based on a SOTP, compared to a $60/stock price, and the value is growing. In five years, the loan book will produce over $20/share in cash cumulatively, and the software business should be worth $50/share. The rest of the business should produce several dollars in FCF per share as well annually over that time.
· SOTP valuation:
· One way to think about it is that NNI trades slightly above book value. Most of the book value is in government-guaranteed student loans, other assorted investments, and cash, and then there is an asset light business (Education Technology) that is worth far more than book value which comprises most of the $20-30/share value in excess of book value. The software business is growing and highly profitable and unrelated to the education lending businesses.
· The company is a bit complicated with unrelated segments with very different financial and operating characteristics. I think this largely explains the mispricing, as well as some segment-specific issues discussed below. The margin of safety is that there is a lot of firm value, management has an excellent track record, and management owns a ton of stock. They think the stock is cheap. Management are straight-shooters. The two co-founders had a portrait of Buffett over their fireplace in their college dorm in Lincoln, NE.
· Management does not have quarterly conference calls and they don’t speak to the sell-side, but they do care a lot about shareholder value. Shareholder letters are available back to 2006 and are excellent.
Overview (Company segment name underlined then my description after that)
Asset Generation & Management = Student loan portfolio = almost entirely FFELP (“Federal Family Education Loan Program”) loans which are 97% federally guaranteed = $21.7 billion FFELP loans and $401 million private education and consumer loans. Mostly in runoff, 75% of value converts to cash in next 7 years, very conservative loans. Value = $40/share, broken down into $37/share value of current portfolio and $3/share in equity value of loans they have not yet securitized.
Loan Servicing= Loan servicing of mostly education loans = 13.1 million borrowers and $420 billion loans. NNI is one of 3 players. There is some contract risk here as government rebids program, but I think status quo outcome or one favorable to NNI is likely. Value = $9/share or 4x EBITA due to contract risk. That is a conservative valuation, upside could be $20/share.
Education Technology = Payment processing, tuition management, and other administrative services/software for schools, both K-12 and Higher Education. Great software business, unrelated to lending/servicing. EBITA margins are 32% and revenue has grown 16% CAGR last 5 years. If this was public, it would trade north of 30x earnings. At 25x 2019 earnings, value = $32/share
Communications = Allo = Residential fiber network mainly in Lincoln, NE, 153k homes passed in total. Business is ramping up as capex completed this year. I think this was a very favorable contract due to local connections. Value = $6/share = the capex they have spent building out network.
Investments & Cash = NNI has a number of small investments: real estate, stake in Hudl (leader in sports software analytics for high school and college market), and various other small investments = $5/share.
Corporate OH = - $6/share
Total value = $85/share.
The company had 52.6 million shares outstanding in 2006 and has 40.4 million shares outstanding today. Management has opportunistically repurchased shares over time.
Asset Generation & Management
· NNI started out as a servicer of student loans. Over its history, it has made most of its money from holding a portfolio of federally guaranteed student loans, in addition to servicing both government-owned and privately-owned student loans. In 2009, the federal government changed the rules for its student loan program; it would no longer guaranteed privately owned student loans (FFELP) and would henceforth make the loans directly. This meant that NNI’s main business, owning student loans, would go into runoff. Since then, the major banks have largely exited the business, and NNI has purchased $19 billion of loans and the loan portfolio has stayed largely constant: $24.0 billion in 2010 to $22.0 billion today. Nevertheless, this portfolio will eventually run off, mostly in the next 7 years. NNI provides a table with undiscounted cash flow projections in each quarterly filing.
· These loans have very attractive characteristics. Principal is 97% guaranteed by the federal government, accrued interest is 100% guaranteed. The following table is based off information provided in the NNI 10-K. The loans are almost entirely match-funded.
· Student loans have historically been serviced by four main players: Navient, NNI, PHEAA (Pennsylvania Higher Education Assistance Agency), and Great Lakes. NNI acquired Great Lakes, a for-profit company owned by a non-profit entity, in early 2018 for $150 million. Navient is the 2nd biggest player after NNI and is a 2014 spinoff from Sallie Mae that contains most of its loan servicing business and student loan portfolio. PHEEA is a quasi-governmental agency based in Pennsylvania.
· Historically, government loans for servicing have been allocated out to these 4 players (and subcontracted to them by other middlemen) through a reasonably complex government process. NNI’s revenue in this segment has grown modestly over time, but underlying that is a big mix shift, as FFELP loans are in runoff and government-owned loans have been growing.
· NNI’s current contract with the Department of Education runs through 12/15/19. In April 2016, the Obama administration announced that it was going to undertake a new contract procurement process wherein it would select a single servicing system platform with multiple customer service providers to manage different pieces. On 8/1/17, the Department of Education, now under the Trump administration, announced they were cancelling that plan and were going to select one master system and dole out the pieces vertically (separate contracts for database housing, system processing, and customer account servicing). The winner was supposed to be announced in June 2019, but that deadline has been extended and is likely to get extended several more times.
· Either Navient or NNI could win the bulk of the contract and take share from the other two players. I think it’s likely that NNI comes away with terms at least as good as they have now. NNI has the best reputation of the players, and Navient sold most of the upside in this business to First Data, as it is bogged down with lawsuits. The status quo is likely to drag out for a few more years. Even in a scenario where NNI loses the contract, the segment will still have earnings and will make money in the next few years.
· NNI has $511 million revenue and $93 million EBITA TTM in this business. I value this at $36million, or roughly 4x EBITA, and think this is fairly conservative.
· This is a fantastic business and completely separate from lending and loan servicing. NNI sells a number of administrative software solutions to the education market. These include solutions for tuition payment plans, financial needs assessment service, online payment and refund processing, and school information system software. It’s basically software for the education market that helps schools automate administrative processes and collect and process data. This is a very sticky business and they have thousands of customers. NNI has made a few tuck-in acquisitions over time in this segment which have turned out very well.
· Net revenue has grown from $48 million in 2008 ($14 million EBITA, 29% margins) to $179m TTM ($60 million EBITA, 34% margins). I value it at 25x earnings on 2019, or $1,280 million. In public market, this would easily trade way above that.
· I think the company is very cheap, especially adjusting for the amount of cash that is coming to come in over the next few years, with little debt at the parent level. Management owns a huge stake, has a terrific track record, and has demonstrated the ability to invest capital in new businesses at high returns. In addition, they have intelligently shrunk the share count over time. They see book value as a floor and think the business is worth far more, and I agree.
· Key to future value is management investing the large cash inflows in the next few years wisely.
· Risks are some kind of change in terms or government appropriation of the legacy student loans. That would have to happen at materially below book value to hurt NNI. Another risk is a loss of the loan servicing contract, which has more headline risk as the segment is ~11% of total value.
· If management continues to invest and earn, say 12% ROE on investments over the next 5 years, then the stock would have a high-teens CAGR over that period if it traded up to fair value. I also see very little downside here, as there is a significant NAV cushion to soften any unexpectedly negative outcomes.
Continued growth in software business, shriking of loan book, and favorable outcome in loan servicing.
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