Sometimes the best investments are hidden gems, or what some might call "boring" businesses. These unloved companies are continually passed up by investors who typically prefer trending software or technology stocks. These companies can put up outstanding returns for your portfolio if you buy and hold for the long term, especially if they have adept capital allocators at the helm.
Nelnet (NNI 0.44%) fits this description really well. The small-cap conglomerate is building a Berkshire Hathaway-like business with a strong track record and a diversified set of investments in its portfolio.
Nelnet reported solid first-quarter earnings results on Tuesday, May 10. Is now the time to buy some shares? Let's take a look.
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The student loan cash cow
With Nelnet, it's best to start with its student loan portfolio. It holds billions of dollars in student loans that it has either originated or acquired and those loans generate steady cash flow for the company as borrowers pay back what they owe. Over the next 15 to 20 years, management says payments will generate $1.83 billion in revenue from its securitized loan portfolio. Of that $1.83 billion, roughly $800 million will be paid in the first four years, giving management a steady cash cow to reinvest or give back to shareholders.
You might be asking: What happens to this loan portfolio if the federal government cancels student loan debt, a topic of discussion among politicians recently? The answer is a bit complicated, but likely a positive for Nelnet. According to its financial forecasts, if all of its student loans were pre-paid today (which is what would happen if the government canceled the debt), it would get $1.1 billion in cash. This is less than the $1.83 billion it is projecting over the next 15 to 20 years, but it would be available immediately and create lots of flexibility over what to do with it. It would account for a little over one-third of Nelnet's entire market cap of $3 billion right now.
Nelnet no longer originates new student loans after the federal government took the process in-house around a decade ago. To transition this business, it has started or invested in numerous other businesses to keep growing value for shareholders.
A steadily growing education/payments business
The second-largest business within the Nelnet empire is the Education software/payments division. This unit sells software and payments services to administrative offices at K-12 and secondary schools, mainly focused in the United States. In the first quarter, this division generated $112 million in revenue and $33 million in operating income, up from $95 million and $31 million, respectively, in the year-ago period.
Nelnet doesn't report how much cash, if any, this segment generates for the company each year. Making an educated guess based on close to $100 million in annual operating income, if you assign a price-to-operating income (P/OI) of 10 to the business, this division is likely worth around $1 billion to Nelnet today. Like the student loan book, this should make up around one-third of Nelnet's market value today.
New projects are becoming more important
With the student loan book slowly (or maybe quickly) going to zero, more and more of Nelnet's value will be derived from the other projects it has invested in. I won't go into every segment today, but I will focus on two: the investment portfolio and Nelnet Bank.
Since 2018, Nelnet has started investing heavily in venture capital, real estate, and solar energy projects, building up an investment portfolio now valued at $1.65 billion. There is not much insight right now into the nature of these deals, other than the fact that management has accelerated its investment rate each of the last three years.
Last year, it deployed $726 million just in the division, or around half of Nelnet's total capital deployed. Clearly, management sees something promising here. Investors should look for results to come over the next few years.
Nelnet Bank was given a charter in late 2020 and is focused on (you guessed it) student loans. Right now, its main products include student loan refinancing and private student loans. At the end of the first quarter, the bank had $547 million in customer deposits and a $368 million loan portfolio, and it had just started generating positive net income. It is hard to put any value on this business at the moment, but it has grown quite rapidly for Nelnet in less than two years of operations.
Returning capital to shareholders
Nelnet is finding plenty of ways to reinvest capital. But with the student loan book being so lucrative, it still has room to give dollars back to shareholders through share repurchases and dividends. Its dividend yield currently sits at 1.2%, and in the first quarter, it repurchased $33 million worth of its common stock.
Nelnet has a growing set of diversified business units, a strong track record of growing investors' capital, and is steadily returning cash to shareholders through repurchases and dividends. At a market cap of $3 billion, or less than the company's current book value of $3.08 billion, the stock looks like an easy buy at these prices.
