Tuesday, February 05, 2008

Why I bought yet more First Marblehead

After the most recent First Marblehead release, the market gave me an offer I couldn't refuse. According to my calculations, the current liquidation or run-off value of the company is $9.80 a share. That number assumes shares will be diluted 20% according to the Goldman Sachs deal. Then I calculated a conservative guess of the company's value assuming it is able to return to some sort of stable business. I'm guessing the company is worth $38 or more if they are able to convert some of their loans on the balance sheet into earnings. Note that I'm not assuming they will get the same sort of securitization deals they received a year ago—just that they find buyers or financing to turn their loans into earnings at some point.

Personally, I think this whole crisis will blow over in a year or two and Marblehead and Sallie Mae will survive as a bunch of competitors will disappear. As survivors, their earnings power will dramatically increase and $38 will seem laughably cheap. But for the sake of argument, let's use that number. I also expect survival has a better than 90% chance, since Goldman Sachs has a stake in the company. But to prove the point, I'll assume the survival odds are 50%. My expected price, therefor, is $24 and my Kelly ratio is 39%. So I bought more shares at $14.95 to boost my First Marblehead position and reduce it's cost basis.

In my opinion, First Marblehead will be able to continue as a going concern whether or not it is able to securitize loans. Those loans will provide consistent, high-return cash flow to someone over the next few decades, so someone will buy them or finance Marblehead to keep them. It's not dissimilar from Microsoft shifting from selling shrink-wrap software to collecting service reviews. Either way they are selling something valuable and it's just a matter of how to collect profits. So this purchase is not a bet on the securitization market, but a bet on First Marblehead's business.

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