Nelnet

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Nelnet, Inc. is a diversified financial services company primarily engaged in loan servicing, technology solutions, payment processing, and education services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Nelnet operates in several segments with varying profitability and competitive dynamics:

  • Loan Servicing & Systems: This segment is responsible for the core part of the business: student loan servicing and payments. Nelnet services both federal and private loans.
  • Education Technology, Services, and Payment Processing: This segment offers technology and services for K-12 and higher education, including payment solutions and software systems.
  • Asset Generation and Management (AGM): A smaller segment, this handles the company’s investments, including a portfolio of federally insured loans.
  • Corporate and Other Activities: This segment includes corporate assets, liabilities, activities, and a small amount of other non-core business units.

Revenue Distribution

Based on the recent SEC filings (Form 10-Q and 10-K), The Loan Servicing and Systems, as well as their education and technology solutions, are the main drivers of total revenues. The financial services that Nelnet provides are generally spread out between providing servicing for student loans, financial payments, and investment opportunities.

  • Loan Servicing & Systems: Provides payment processing and loan servicing services
  • Education Technology, Services, and Payment Processing: Provides educational software and technology to schools.
  • The education loan servicing sector is experiencing increased scrutiny from government regulators and consumer advocates, focusing on transparency, accountability, and affordability. This heightened scrutiny has the potential to increase compliance costs and could potentially lead to changes in operating procedures.
  • The transition to digital financial platforms has seen an increase in online learning. New entrants are now trying to disrupt the market.
  • The education industry is always having an increased number of institutions and more government-backed financing programs, which can reduce prices for the borrowers.
  • The payments and financial services market is experiencing a technological transition. New technologies including blockchain, crypto, and AI threaten to take over the traditional methods of financing.

Competitive Landscape

  • Loan Servicing: The loan servicing industry, especially for federal student loans, is highly concentrated, with a few large players like Nelnet, Navient, and MOHELA, dominating the market. These incumbents operate with a certain level of regulatory backing, making it extremely difficult to break into the industry.
  • Educational Technology: The educational technology sector is more fragmented than loan servicing. Nelnet competes with a variety of companies with different specialties. For example, for school software, competitors might include companies like Blackboard. For payment processing, they are competing with companies like Nelnet Campus Commerce (previously FACTS) and others. This makes it very difficult to compete, because they don’t have an advantage in all the segments of the educational industry.
  • Fintech: The fintech sector is one of the fastest-growing sectors and therefore extremely competitive. There is cut-throat competition between giants, start-ups, and traditional businesses. Competitors include Stripe, Block, PayPal and other payment processing companies.

What Makes Nelnet Different?

  • Established Presence: Nelnet is one of the biggest players in student loan servicing, giving them established processes, infrastructure, and market familiarity to operate in this difficult environment.
  • Integrated Technology Platform: The company also operates and integrates their loans with their educational software services. This provides an added advantage.
  • Diversification: Nelnet’s diversified portfolio of businesses, including technology solutions, payment processing, and education, makes the company relatively more stable in times of uncertainty.
  • History: Nelnet has been in operations since 1978 (when it was U.S. Educations Inc.), has made several acquisitions and partnerships throughout the years. Having an experience of almost half a century in the industry is a major advantage.

Financials

Revenue

Nelnet’s operating revenues have increased consistently over the past years. But this has come along with increased operating expenses. The company’s revenue is highly dependent on loan servicing and the interest income from these loans and securities. Other important factors are the amount of processing and subscription revenues from technology and payment services.

Profitability

  • Historically, the operating margins for Nelnet have been stable, at approximately 20-25% from 2020 through 2023. While the gross margin has been very high, operating costs (like personnel and administration costs) have reduced the overall profit margins.
  • The company’s performance varies based on the type of sector. For example, for the financial services part of the business, higher-yielding loans lead to higher margins, but come along with a high degree of volatility. On the other hand, a company’s subscription services in the technology sector can give more stability, but are less profitable in general.

Cash Flow

Nelnet’s cash flow can be somewhat tricky to predict, since it is dependent on various economic conditions and repayment behavior. Usually, the company has healthy cash flow from operating activities.

  • Liquidity: The company is in good health in this regard as cash, and other marketable securities are more than sufficient for the company’s operational purposes, therefore, has a lot of leeway.
  • Total current assets are $3.6 billion
  • Current Liabilities are $1.7 billion
  • Debt: The company has total long-term debt of $1.6 billion, which it manages using a staggered repayment plan. While debt servicing can take up a decent portion of revenue, it allows them to operate more efficiently.
    • Total liabilities: $9.4 billion
    • Shareholder equity: $5.5 billion

Recent Concerns and Problems

  • Regulatory Scrutiny: The ongoing review of the federal student loan programs can bring more challenges and reduce profit margins. As of now, there isn’t a clear picture about what changes are to be adopted.
  • Competition: Increased competition in student loan servicing and other segments is pressuring revenues and profit margins, since the company does not have a distinct competitive advantage in any individual segment.
  • Economic Uncertainty: Economic uncertainty can bring about a reduced number of opportunities in the market, along with more defaults. Therefore, it will take more time to gain high profits.

Moat Rating: 3/5

Nelnet’s moat is not particularly strong. Their moat is primarily based on switching costs and to some extent a long operating history in a regulated industry, although they are still vulnerable to competition and are not necessarily a monopoly.

  • Switching Costs: The main component of a moat is how difficult it is for a customer to change to another provider. There is a moderate amount of switching cost involved in the loan servicing business as this can involve complicated and lengthy procedures. The same is true for educational software and other subscription based services.
  • Regulation: Regulations in the financial sector can lead to a moat. But regulatory scrutiny can also lead to potential future changes. Therefore, the regulatory moat is not extremely dependable.
  • Brand Value: Nelnet doesn’t have any particular brand value in the consumer market and the B2B sector is a very fragmented market, with new competitors always trying to capture market share using promotions and by offering various features. The company’s brand strength does not protect it from the competition.
  • Network Effect: Only a small part of the business, where they offer payment systems, can be considered to have some level of network effects. This is because the more people use the system, the more valuable it becomes. For the rest of the business, network effects is nearly non-existent.
  • Cost Advantages: Nelnet does not possess a superior cost advantage, unlike companies in the low-cost airline business. They source from various third-party providers, which their competitors can also take advantage of. Their operation might be streamlined but isn’t necessarily a unique component.
  • Intangible Assets: Some minor intangible assets can be attributed to the company’s licenses. But overall, they do not have proprietary technologies, patents, brands, or other such intangible assets to create a moat.

Legitimate Risks That Could Harm the Moat and Business Resilience

  • Increased Competition: New entrants in all the segments, might take market share and force prices lower, therefore reducing profitability. New disruptors might come along and create a better, more optimized offering.
  • Regulatory Risk: Changes in government regulations could significantly impact the company’s operating model, particularly in the loan servicing and payment processing segments.
  • Economic Slowdown: An economic slowdown could lead to higher credit risks, reduce revenue and increase defaults.
  • Technological Changes: Rapid changes in technology, such as blockchain and AI, could disrupt existing services and potentially reduce the value of the company’s current products.
  • Cyber Security: Breaches of data and other cyber security problems could affect the company’s reputation and could also lead to penalties from regulatory bodies.
  • Mergers & Acquisition Risks: When the company acquires, it has to go through a lengthy process of restructuring and integration. During this process, there may be a high chance of missteps and lower-than-expected returns.

Business Resilience

Although the company has risks, it also exhibits several resilient characteristics:

  • Diverse Business Portfolio: Their diverse operations in loan servicing, education technology, and payments processing provide some safety and are a hedge against some volatility.
  • Long Standing Relationships The company has been in the education and financial sectors for many years, giving it solid long-term relationships with clients that are difficult to replicate.
  • Stable Operating History: The company has consistently operated for many years, thereby having an experienced team and processes. This experience is a good asset and reduces the risk.
  • Strong Balance Sheet: The company maintains a solid financial structure.

Understandability: 3/5

The company’s business is a bit complicated to understand fully. While the basic concept of student loan servicing might seem easy, when the various segments are taken into account it makes it complicated. The company has expanded and diversified to many different segments, making it difficult to properly value the business.

Balance Sheet Health: 4/5

Nelnet displays strong liquidity and reasonable debt, which is a sign of good financial management. There are some slight concerns about long-term debt obligations, but overall the balance sheet is strong. A small number of the investments carry some degree of risk, but are generally well-hedged.