First Marblehead A Buy?

Ryan writes:

You wrote about First Marblehead (FMD) a while back. The stock got killed yesterday by the TERI bankruptcy and I’m wondering if you think it’s worth picking up shares.

Yes, it did get killed yesterday, and that wasn’t the first time, either. It’s down to less than $5 from more than $40 a year ago. I sent a report to Kelly Letter subscribers last night, from which the following is adapted:

It’s too late to sell. The time for selling this stock was a year ago. That narrows the options to initiating a position, holding a current position, or adding to a current position.

This is a maddening situation of seeing a great company smacked down for having done nothing wrong. There are no accounting irregularities, no failure to find new business, no product delays, no lack of due diligence as we saw with sub-prime lenders. All was going swimmingly for Marblehead until the credit market closed. Through no fault of its own, the doors to its store are locked shut.

The loans that it packaged and sold as bonds are performing well, according to Marblehead. It hasn’t needed to rely on TERI. Of course, just when things are dicey enough that it would be nice to have a strong backer, Marblehead’s backer fled the scene. I suggest turning to Warren Buffett’s Berkshire Hathaway for future financial backup.

We could analyze the situation a hundred different ways but what it all really comes down to is this: First Marblehead is hostage to the credit market.

If that market gets going soon, Marblehead will be fine and the shares should rocket higher. They could erase recent losses in a single week.

If that market remains closed for too long, Marblehead is doomed. It could go the way of Bear Stearns, acquired by a bigger company for a buck or two and then seeing that company go gangbusters with FMD’s profits when the credit market wakes up.

Now, lest you think all is lost, remember that a lot is going on behind the scenes in financial markets these days. Just as those investing in Bear Stearns saw their $2 stock become a $10 stock with one announcement from JPMorgan, so could we see good things come to FMD out of the blue.

Remember that Goldman Sachs invested $261 million in Marblehead last December. Some $60 million bought FMD at $11.24, and the remaining $201 million is slated to buy at $15. That deal puts Goldman Sachs down pretty far at the moment, and I have a feeling Goldman isn’t happy about that. It’s good to have Goldman on your side.

If you’re looking for somewhere to take some risk, I think buying Marblehead at these prices will work. Don’t use your lunch money, of course. Use the money you set aside for just such moments when you think it could really pay, or really disappear — but not ruin your life by doing so.

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