Sussing Out a Sallie Mae Split

 | Oct 16, 2013 | 1:00 PM EDT  | Comments
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Sometimes the market dishes up numbers that are actually worth more than they may otherwise appear. That is the case with SLM Corp. (SLM), better known as Sallie Mae. It is to student loans what Fannie Mae and Freddie Mac are to the housing market. Originally known as the Student Marketing Association, Sallie Mae was set up in 1972 with the intent to originate, service and collect student loans. With more than 10 million borrowers, Sallie Mae manages a student loan portfolio of approximately $150 billion.

Sallie Mae recently announced plans to split itself into two entities. Shares in SLM trade for around $25, with a trailing price-to-earnings ratio of 8 and a yield of 2.4%. The intended split (which SLM will provide details of when it reports earnings after today's market close) could create two parts that are worth more than the whole. While Sallie is expected to report a nice jump in quarterly profit, the more interesting news may be what the entity will look like in the future.

The plan calls for two companies, each with its own attractive characteristics. One company will hold old loans along with loans made under the Federal Family Education Loan Program. This business will consist of the $150 billion in loans that Sallie currently services. Sallie has exited this business altogether; it no longer makes such loans but merely services the portfolio it currently holds. Little or no profitable growth exists from trying to grow this loan portfolio and the business is declining because of defaults or repayment problems. In fact, it's likely the $150 billion portfolio shrunk considerably during the third quarter.

But, according to estimates, this loan pool will provide cash flows for 20 years or more. So, this part of Sallie's business will be your slow-growth, cash-cow division, which could prove very attractive to income-seeking investors.

The other business is the fast-growing private student-loan market. This new Sallie Mae Bank will focus on private student loans. These are very high-quality loans. Despite lacking a federal guarantee, the credit scores of the borrowers are much higher than the legacy loans, and the vast majority of loans are co-signed by parents.

In this case, holders of SLM shares will ultimately get two different businesses, and it may be wise to hold on to both. The legacy business will likely maintain a stable dividend, while the new bank will seek to grow profits by making attractive private student loans. A single share that is now worth $25 may turn out to be worth much more when both businesses begin to conduct their own affairs.

The split may cause some shareholders to prefer one business over the other -- likely the growth business -- in which case the orphaned business may experience a sell-off, thus creating an even more attractive buying opportunity.

Put SLM shares on your watch list and stay abreast of developments. It may be a golden opportunity hiding in plain sight.

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