Goldman Sachs on FMD

4Q2007: Richer mix offsets the impact of an uncertain environment
August 10, 2007


What's changed

First Marblehead reported 4Q2007 diluted EPS of $0.83, higher than consensus of $0.81 but lower than our forecast of $0.87. 1. Management signaled concern about triple-B market receptivity for the transaction anticipated this September; we believe that their concerns may be warranted, and we assume (as we have done since our April 18th note entitled “Potential implications of the proposed Sallie Mae transaction”) an earnings model for upcoming securitizations similar to those reported in FY2006 (pre triple-B tranches). Such a structure should be characterized by lower upfront cash, higher residual fees, and lower blended yields (relative to most recent transactions). 2. Given the current (and anticipated) widening spread environment, we raise our discount rate assumption (forecast for residuals) to 12%, up from 11.59% which the company currently uses. 3. We were surprised by a stark mix shift demonstrated this quarter towards the more-profitable direct-to-consumer (DTC) channel.

Implications

We raise estimates by 2% in FY2008 to $4.03 and FY2009 to $4.57; the benefit of a (presumably tenable) mix shift towards the more-profitable DTC channel more than offsets the impact of a higher discount rate assumption. We introduce our FY2010 EPS forecast of $5.02.

Valuation

We maintain our $41 DCF-derived 3-month price target, implying 29% upside; however, given ongoing uncertainty regarding top line sustainability, we retain our Neutral rating.

Key risks

New legislation and loss of business from customers involved in the SLM transaction pose the biggest threat to our forecasts and price target.