What Happens When Your Competitors Quit?
Nelnet and the Changing Student Loan Servicing Industry
Everyone, and I mean everyone, has been talking about the shocking events in the last three weeks in the student loan servicing industry.
I’ve literally seen no one comment on the remarkable news that two student loan servicing companies, Granite State Management Services and Pennsylvania Higher Education Assistance Authority, which had been servicing approximately 10 million student loans have called it quits and are walking away from servicing 20% of all student loans in the U.S. by the end of the year.
It was just one short year ago that Nelnet, an industry leader in student loan servicing, was buffeted by news that it was losing its student loan servicing contract under mysterious circumstances. Let’s just say that the competition having connections to the previous administration led to some funny business that was so egregious that the contract was reversed shortly after being awarded.
All of this caused investors including myself to question the value of Nelnet’s loan servicing business or to place much value on it at all. In my research report on Nelnet, I wrote the following:
Another reason Nelnet has been so beaten down is that investors have placed an undue emphasis on its student loan servicing business, which has historically driven earnings and short-term results. And Nelnet, which is the largest student loan servicer just inexplicably lost two key contracts for the long-term servicing of millions of student loans. Nelnet has a strong reputation in this space but there appears to be some funny business around the award of the contracts, and Nelnet and First Data have protested the award after a small, less well-regarded company appears to have won the award.
Given the history of this loan servicing RFP, I believe Nelnet still has a good chance to participate. But as I will highlight below, Nelnet is so significantly undervalued that one can value this business at zero and it doesn’t matter, as the company still sells for less than half of fair value and well below book value.
So, imagine my surprise now as the industry is left with gaping holes in the competitive landscape. As is often the case in business, size and scale matter. Nelnet’s smaller competitors likely could not make money and walked away from their contracts. The only companies who can realistically service student loans are Nelnet and Navient (NASDAQ: NAVI) and a few small non-profits. And what becomes interesting is that the government appears to understandably not love Navient. Senator Elizabeth Warren has specifically called on the Education Department to stop working with Navient.
So, now a division of Nelnet that I had valued at little or nothing is suddenly almost the only game in town and will probably grow this business as it likely ends up servicing some of the 10 million student loans that will need servicing starting in January. Overall Nelnet is well regarded, invests in its technology and its people, and has the least complaints of all the servicers.
Nelnet has been earning approximately $90 million of EBITDA from the servicing business. With more student loans being serviced plus the Wells Fargo private student loan service book recently won, it is not inconceivable that next year Nelnet with scale could be earning over $100M EBITDA or more. At six to 8 times, this “worthless” division is worth $600 to 800 million and could ultimately be worth considerably more. All this on a $2.8 billion market cap.
But remember, I was not even counting on this segment for value as it is Nelnet’s technology businesses and investments that have me excited, including the Company’s education payments company, fiber optic strategic investment and valuable stake in youth sports startup, HUDL (a side note, with the monetization of high school and collegiate assets, HUDL becomes potentially an even more valuable asset).
All this means that I now believe that Nelnet has a net asset value today of at least $130 per share and growing, 75% higher than its current price.
Nelnet won’t be talking this up as management keep things close to the vest and are about as anti-promotional as a company could be. But with a diminished competitive landscape and surging cash flows, I’m happy to take the promotional banner and share the good news!
And don’t look now, but Nelnet is starting to rapidly expand into renewable energy projects as well. Nelnet is suddenly looking like a very exciting stock with a remarkably low valuation.