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This Small-Cap Conglomerate Just Put Up Another Solid Year

By Brett Schafer - Mar 4, 2021 at 11:14AM

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The Nebraska company has compounded its book value per share at 17% since 2004.

Nelnet (NNI 1.30%) is a little-known conglomerate based out of Lincoln, Nebraska. When looking at its 2020 annual report released on Feb. 25, you might get the impression that the company doesn't do anything special. But if you take a deeper look, you'll realize that the unique structure of Nelnet sets it up to grow -- with little downside -- for many years to come. 

Here's why investors should consider Nelnet stock as a potential addition to their portfolios.

Steady cash flow from student loans

Nelnet started out as a purchaser of student loans, and now owns a large portfolio of loan assets. With the government deciding to bring all loan origination in-house in 2010, Nelnet has struggled to grow its loan portfolio, only growing it by buying existing loans from other financial institutions. However, the existing loans still generate millions in cash for Nelnet each year. Management estimates it will get $2.3 billion in future cash flow from its existing portfolio, with $1.51 billion coming within the next five years.

A stack of dollar bills with a blue arrow laying on top of it.

Image source: Getty Images.

Cash generation from the loan portfolio is affected by interest rates, something management cannot predict or control. Specifically, rising interest rates may lower the estimated future cash generation, hurting Nelnet's ability to invest in its other businesses and future projects. You also might think Nelnet is at risk from rising defaults from the underlying loans in its portfolio, but the government guarantees 97% repayment of principal to creditors if a student defaults, shifting any default risk from Nelnet to the federal government. 

Other parts of the business

Over the last decade-plus, Nelnet has taken the cash it generated from its student loan portfolio and invested in other businesses (some wholly owned) and some as outside investors. There are many businesses under the company's umbrella, but I will highlight three here: Allo Communications, Education Technology and Payments Processing, and Nelnet Bank.

Allo Communications is a broadband and fiber communications business based in Nebraska. Nelnet owned the majority of the business until late last year, when it sold off a 48% stake to SDC Capital, recognizing a pre-tax gain of $259 million. Nelnet now owns 45% of Allo Communications, but holds it as an outside equity investment on its balance sheet and does not control the day-to-day operations of the business. 

Education Technology and Payments Processing is a Nelnet business segment that provides software tools to manage tuition payments, administrative work, and other things for schools of all sizes. The division had $282 million in revenue and $66.2 million in operating income last year, giving it a 23.4% operating margin. With good profit margins, minimal competition, and high switching costs, investors should expect this Nelnet subsidiary to consistently produce cash for many years to come.  

Nelnet Bank was launched on Nov. 2 of last year, almost immediately after Nelnet received an industrial banking charter and approval to provide federal deposit insurance. The bank is located in Utah, will have one physical office, and is already taking on commercial clients. In 2021, the bank plans to launch a K-12 student loan product for private schools. As you know by now, student loans are Nelnet's expertise, so don't be surprised if it crushes it with these private loan products.

Valuation 

With all the unique businesses under the Nelnet umbrella, price-to-earnings ratios or other traditional value metrics don't really do it justice. But when you look at the current market cap of $2.78 billion versus the $2.3 billion in estimated cash generation from loans, the market is letting you invest in Allo, Nelnet Bank, the education technology business, and everything else Nelnet owns for a relatively cheap price.

If you trust management (and why wouldn't you? It has only compounded book value per share at 17.3% yearly since 2004), this stock looks like it could grow at a high rate for many years to come.

 

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