Tuesday, January 23, 2007

Trading student lenders SLM ($45.0) and FMD ($52.89)

With Morgan Stanley having tactically changed its recommendation to equal weight its target price to $53 (from $55) following the sharp heavy volume selloff and dramatic underperformance versus the sector, yours truly thought it worth revisiting the short call on SLM ( first made here on September 6th anonomously) given the fact that I consider him the most competent sector analyst out there. I came away unconvinced that my own target price of $35 should be altered uness we go push out the time horizon to 2010. Then, the price target would rise to the low forties. It's clear that the relative value versus the S&P financial sector is now somewhat enhanced by virtue of its own dismal performance. (Hence I believe his tactical call.) It's a twisted way of seeing opportunities through the lens of hedge fund investors, whom, for the most part, are happy to pick at an idea if it provides some relative performance through to the March quarter. And as investment opportunities go, this stock is as likely as any financial for a short-term rebound; bonds are a bit oversold; banks have given up substantial ground since late December, and the yield is now above 2% and competes with the S&P yield. What struck me was the analyst's conviction that the real story was the growth in "private loans" (30% potential and worth $30 of the $53 a share!!!!). In my humble opinion, giving credit to a stock trading at this unusually high premium/book on the basis of "growth" in private loans is tantamount to "credit suicide". Even under the base-case scenario for 2010 of a 29% ROE, the stock would deserve a price/book of closer to 2.5 to 3x (depending on yield curve shifts) and prospective ROE assumptions beyond 2010. In fact, I would hazard a guess that the p/e will fall to the single digits like FNM and FRE did after their mercurial rise in the Nineties (and subseqeunt fall out of favor) along with SLM'a unsustainable high ROE business model. So to sum, up, if you are going to go long this idea (SLM) for a trade this quarter, short FMD ($52.89) in the interim, a short opportunity of historic proportions (more on this in past and future posts)