The Oracle of Lincoln

Praise for Michael Dunlap, the Chairman of Nelnet

Billionaire founder CEOs with phenomenal track records of shareholder value creation are rightfully lionized by the media and investors. Over time the performance of these great CEOs and the management teams they assemble develop followings. People watch what they invest in and weigh the words they communicate. But somehow Nelnet and its executive Chairman, Michael Dunlap, has yet to enter these conversations and due to its quiet, non-promotional style Nelnet has not yet caught on with investors. I think this is about to change.

Michael Dunlap and the management team (including the wonderful CEO Jeff Noordhoek) of Nelnet (NYSE: NNI) deserve praise and attention from students of business and leadership. For a primer on Nelnet, I wrote a report on the company in June (Nelnet Research Report).

Here is a snippet of what attracted me to Nelnet from my original June report:

Nelnet has quietly built a phenomenal technology company and simultaneously compounded its book value by over 17% for almost 15 years. Despite this performance, Nelnet trades not only well below book value, but less than half of its fair value. There may be no better performing technology company with such a low valuation that is publicly traded and has over a $1 billion market cap.

At a time of such high technology company valuations, how is it possible that Nelnet’s valuation is so low? Nelnet’s enormous legacy student loan portfolio disguises just how fantastic its technology payments division, fiber optic network and venture investments are.

With its stock stuck in the mud, virtually no analyst coverage and a quiet management team, few have heard of Nelnet and even fewer understand that Nelnet’s run-off student loan portfolio is winding down and is poised to deliver over $10 per share in cash over the next seven quarters, or close to a quarter of the current market cap and will enable Nelnet’s true technology colors to emerge.

Very quietly, the company has been wasting no time and has been aggressively buying back its shares as the cash flow tsunami starts. Typical of its non-promotional style, Nelnet has reported in SEC filings and not press releases that it bought back over 2% of the company’s shares in just six weeks in April and early May, and I believe by the time the quarter is finished it’s possible the company will have bought back 4% of its stock in one quarter alone.

How long until growth and technology investors recognize that Nelnet is not a complex financial services company but a technology payments company, that investors can buy for free, excluding its government-guaranteed student loan portfolio? With the company buying back plenty of shares, and the cash flow spigot about to be turned on, Nelnet’s shares are set to re-rate substantially higher.

What drove me to write this updated post is that due to the quiet nature of Nelnet and its management team, no one is calling out the exceptional performance of the company, especially on a risk adjusted basis.

And nowhere was this more evident than last week’s announcement regarding Allo, its fiber network division. Nelnet announced it was selling a majority stake in its fiber network division to SDC Capital for a total consideration of $571 million. Why is this so good?

Nelnet saw that high-speed internet was underserved in its hometown of Lincoln, Nebraska and other smaller communities. They deployed capital to grow the fiber division even though it drove losses through its balance sheet, complicated its story and confused investors. Fast forward to today and the company earned an attractive return from its investment and now gets to own a 45% stake with experienced operators who are going to grow it much faster.

And this goes to a point about the leadership of the company. Nelnet knows how to allocate capital and compound value. They have been compounding value at a 17% clip for over fifteen years. But if we look at intrinsic value, the growth rate has been even higher (I believe intrinsic value is at least $100 per share right now).

With this kind of performance, you would expect the stock to have done extremely well. However, the company went public at eight times book value (again a great capital decision) and it has taken awhile for the stock to catch up to that very high initial valuation.

The company is about as quiet as can be and doesn’t trumpet its results. But I want to tout the company for an even more important reason.

There are lots of companies that have had great returns in the last ten to twenty years, but what makes Nelnet special is when you look at the risk that they took to achieve those returns. I would argue that Nelnet took below market risk and yet achieved above market returns. And this is why I would call Michael Dunlap, the Oracle of Lincoln (Nebraska). Nelnet and Dunlap are a 59-mile drive from the Oracle of Omaha (Warren Buffett) and the similarities are canny.

Warren Buffett used capital earned from insurance to grow a book of public and private investments. Michael Dunlap has been using student loans to do the same thing, but with a focus on technology. Allo is one example, but the gem of the company is its Nelnet Business Services, which is an education payments company with strong market share and 32% operating margins. The company also owns a chunk of soon to be technology unicorn, HUDL.

And in March of this year, Nelnet received an ILC Bank Charter, which offers another source of upside that is not appreciated. New ILC bank charters are extremely rare, as there hasn’t been a single one issued in over a decade, until Nelnet and Square (NYSE: SQ) both received one. Square for many reasons has been soaring and trades at nosebleed valuation levels.

As to Nelnet the stock, it has performed well since my report came out thanks to a great recent earnings report and the realization that the company will be a prime beneficiary of low interest rates. But Nelnet still has 50% upside to my estimate of intrinsic value of $100 per share despite several improvements in the story, including what happened last week.

I think investors are starting to wake up to the Nelnet story and particularly to management’s performance. And it helps that Nelnet’s investment story is simplifying. First, Allo, which many investors didn’t appreciate, generated losses that masked Nelnet’s profitability. This will end after the transaction with SDC Capital. Second, Nelnet’s massive student loan book is slowly rolling off, bringing on hundreds of millions of cash back onto Nelnet’s balance sheet. Add in the Allo transaction and Nelnet could see upwards of $700 million, or $18 per share of cash return to the company’s balance sheet.

What will they do with that cash? I’m not sure, but I’m investing alongside the Oracle of Lincoln. I know that they are going to be great stewards of that capital and I expect to keep compounding at an above market rate with lower than market risk.