Conglomerates like Berkshire Hathaway are popular among the investment community due to their long-term track record of outperforming the market. Long-term shareholders of the company managed by Warren Buffett have seen their investment grow by a compound annual growth rate of 20.1% since he took the helm in 1965, which crushes the broader market's average of about 10%.
Of course, all that growth is related to past performance. Can investors today find a small-cap conglomerate with the potential to put up long-term returns similar to Berkshire Hathaway going forward? Enter Nelnet (NNI 0.06%). Here's why this wildly undervalued small-cap conglomerate is a perfect buy for your portfolio in 2023.
Nelnet: A base of reliable cash flow
Nelnet started its business a few decades ago as an originator of student loans. Its business model was financing and securitizing loans to create highly reliable streams of cash flow. There are two characteristics of student loans that make them great for lenders like Nelnet. First, they last a long time, sometimes earning interest on a loan for decades. Second, they have bankruptcy protections from the U.S. government, making them a lot less risky than other consumer loans. Over the years, Nelnet built up its loan book to over $10 billion, a book that generated over $100 million in cash flow each year.
But then, 10 years ago the U.S. government banned the private origination of student loans, making it illegal for Nelnet to make new loans to customers. Luckily, this wasn't all bad news. Since a student loan has a long duration, Nelnet has been able to generate cash from its existing loan book ever since this ban was put into place. Even today, it expects to generate $1.66 billion in cash flow over the life of these loans and over $100 million every year from now until 2027.
With all this cash, Nelnet reinvested in a variety of other projects to diversify away from the student loan market.
A strong track record of growing asset value
For a financials-based conglomerate like Nelnet, the most important metric to follow is growth in book value per share. Book value is calculated by taking the assets minus the liabilities on a company's balance sheet, and the "per share" value comes from taking book value and dividing it by the total shares outstanding.
Since going public in 2004, Nelnet has compounded its book value per share (including dividend payouts) at 17.2% a year, even with its student loan origination business winding down. This is highly impressive and close to what Buffett was able to achieve at Berkshire Hathaway in its early years. How did Nelnet do this? By taking all the cash generated by its student loan portfolio and making smart investments.
These include things like an investment in Allo Communications (a fiber internet company), real estate, venture capital, and a burgeoning solar energy financing/construction subsidiary. At the end of Q3, Nelnet's investments outside of its student loan book were valued at over $2 billion, up from just $477 million two years ago. At a market cap of just $3.45 billion, all these new investments will be the key to driving shareholder value for Nelnet shareholders this decade. Combine them with the future cash flow coming from the student loan book, and one could argue that Nelnet is wildly undervalued at today's market cap.
Management also continues to return cash to shareholders through dividends and share repurchases. Shares outstanding are down 20% in the last 10 years, which is a direct input to growing book value per share.
NNI Shares Outstanding data by YCharts
Are there some hidden gems on the balance sheet?
The downside for a conglomerate like Nelnet is that investors don't know the exact details of what it owns. However, there is one investment I think has plenty of promise, and that is its 20% stake in Hudl. Hudl sells film and analysis software programs to over 200,000 sports teams, according to its website. It is unclear what Hudl's revenue is today, but with the average high school team paying $1,600 a year for its software, the company is probably doing $500 million in annual revenue, if not much more given its prevalence among professional teams.
Software companies usually get valued at mid-to-high single digits of their revenue bases, meaning that it is possible that Nelnet's 20% stake in Hudl is worth $500 million on its own. Today, Nelnet carries this private investment at $83 million, which is just holding all the dollars it put in at cost. This is just one of the potential hidden gems on Nelnet's balance sheet today.
Add up the durability of student loan cash flow, a great track record of growing book value per share, and the potential of the Hudl investment, and the future looks bright for Nelnet shareholders.
