First Marblehead Unfairly Battered

It’s been a lousy year for First Marblehead, and the last two-month span has been the worst time of all. It’s not hard to see why. That’s the time period when the entire financial services sector came under fire from sub-prime fallout.

FMD has no exposure to sub-prime, but it is in the debt securitization business. Instead of packaging mortgages, it packages student loans. Analysts are worried that as buyers of mortgage securitizations become gun shy, the entire asset category will lose its appeal. That could mean that FMD will have trouble securitizing student loans this quarter and possibly next.

Last week, FMD was downgraded by FBR. Yesterday, it was downgraded by Sandler O’Neill analyst Michael Taiano. Mr. Taiano said that a prolonged liquidity crunch could threaten FMD’s business structure by limiting its alternatives and compressing its profit margins. Other analysts, even those who haven’t downgraded the stock, have lowered earnings estimates for next year.

Longtime FMD bullish analyst Tom Brown disagreed with FBR’s recent worries.

A look back at FMD’s stock price history is instructive. The company has experienced a boom-bust cycle that’s now clear. From November 2003 to February 2005, the stock rose 248%. It then fell 71% to give back all the gains by October 2005. From there, it rose 296% by January of this year and then again fell 65% to today’s close at $19.93.

That’s quite a price history. The rising times were characterized by an interest in the firm’s impressive control of 20% of the student loan securitization market, strong growth, and solid profit. The down times, oddly, were characterized by the same healthy business attributes but one kind of worry or another.

The first plunge came when the company’s former CEO Daniel Meyers was caught up in a scandal where he’d exchanged $32,000 in gifts with Kathy Cannon, who at the time was a senior vice president in Bank of America’s student loan division. Mr. Meyers resigned and BofA chose to not automatically renew its contract with Marblehead, presumably to distance itself from the scandal.

A Goldman Sachs analyst said that the non-renewal was a huge negative and that “the visibility on FMD’s outlook is poor.”

The company, however, never missed a beat. The scandal disappeared, BofA renewed, and the stock price got back to climbing on the high rates of growth.

In August 2006, FMD reported a 65% surge in profits. CEO Jack Kopnisky said, “Fiscal year 2006 was one of the strongest years in First Marblehead’s history, as revenue, earnings and EPS all exceeded our expectations.”

That positive trend continued, even to this day. Good news has been plentiful this year: FMD authorized a stock repurchase in April, boosted its dividend 67% in June, announced a $1 billion securitization in June, was called a “screaming value” by Motley Fool analyst Philip Durell in August, and beat earnings estimates that same month.

However, in the background were worries that some of Marblehead’s clients would get into the student loan securitization business themselves, thereby lowering the firm’s profits. None of the clients did so. All said that they would not.

Now, we face the third time FMD shares have been battered by analyst worries about something that may or may not happen. There have been no business hiccups. Not one. Analysts are making projections about business trouble ahead, as they’ve done in the past, but they were wrong before and could well be wrong again.

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