Navient Corp. [Nasdaq: NAVI] – Market Cap as of 28/02/2019  $3.07B

Introduction:

On February 18, 2019, student-loan servicer Navient rejected a $3.2 billion takeover bid from two investors, the hedge fund Canyon Capital Advisors and the private-equity firm Platinum Equity Advisors, as it believed the offer undervalued the company. Navient’s board voted to reject the $12.50 per share offer, that represented a 6.6% premium over Navient’s closing price of $11.73 a share on February 15 from the two potential investors.

About Navient Corp:

Founded on November 7, 2013 and headquartered in Wilmington, DE, Navient Corp. focuses on education loan portfolio management, servicing and asset recovery.

Navient was established in 1973 as a Government-Sponsored Enterprise (GSE) called Student Loan Marketing Association (notoriously nicknamed Sallie Mae). The company was created by Congress to support the student loan program established by the United States’ Higher Education Act of 1965.

The company provides asset management and business processing solutions for education, healthcare and government clients at the federal, state and local levels. It operates through the following segments: Federal Family Education Loan Program (FFELP) Loans, Private Education Loans, Business Services, and Other. The FFELP Loans segment acquires FFELP loan portfolios which are insured or guaranteed by state or not-for-profit agencies. The private Education Loans segment acquires, finances, and services private education. After the acquisition of financial technology and refinancing lender Earnest in October 2017, Navient’s private education refinances loans to its clients prevalently through the new fintech branch of Earnest. The Business Services segment deals with servicing, asset recovery, and other activities. The other segment consists of repurchase of debt, corporate liquidity portfolio, unallocated overhead, restructuring and other reorganization expenses, regulatory-related costs, and the deferred tax asset remeasurement loss. Navient funds most of its operations through student loan asset-backed securities or SLABs; bundling loans and selling them to investors as financial instruments.

Navient went public on April 21, 2014, along with its separation from parent company Sallie Mae (NASDAQ: SLM) and became an independent company. Navient shares have since gone through a rather rough patch. Navient’s year on year earnings growth rate was negative over the past 5 years. Earnings have been deteriorating even more, from an original 30% profit margin, to an 11% last year, suggesting that Navient has been ramping up its expenses. Navient’s ROE of 14.08% for the three months ending December 2018 is down from a 26% ROE in 2014 and a rather high debt to equity level (even considering the type of institution) of 27.89 are supplementary indicators of the company’s less than adequate financial health.

About Canyon Capital:

Canyon Capital Advisors, LLC, a $23bn hedge fund, was founded in 1990 and is based in Los Angeles, California with additional offices in New York and London. It operates as a subsidiary of Canyon Partners, LLC. It is a privately-owned investment manager, and primarily provides its services to pooled investment vehicles. Canyon specializes in value-oriented special situation investments for endowments, foundations, pension funds, sovereign wealth funds, family offices and other institutional investors. The company invests across a broad range of asset classes, such as distressed loans, corporate bonds, convertible bonds, securitized assets, direct investments, real estate, arbitrage, and event-oriented equities. The company manages separate client-focused equity and fixed income portfolios. It also manages investment partnerships and hedge funds for its clients. The firm invests in the public equity, fixed income, and hedging investments markets of the United States. It typically invests in value stocks to create its equity portfolios.  Canyon Capital Advisors’ top industries are ‘Food & Kindred Products’, ‘Depository Institutions’ and ‘Insurance Carriers’, whereas its top holdings are Vici Properties Inc (NYSE:VICI) , MGM Resorts International (NYSE:MGM) , Caesars Entertainment Corporation (NASDAQ:CZR) , Berry Plastics Group, Inc. (NYSE:BERY) , and Navient Corporation (NASDAQ:NAVI).

About Platinum Equity:

Platinum Equity, LLC is a private equity firm that was founded in 1995 and is based in Beverly Hills, California. It is a global investment firm with $13 billion of assets under management and a portfolio of approximately 40 operating companies that serve customers around the world. Platinum Equity specializes in mergers, acquisitions and operations – a trademarked strategy it calls M&A&O – acquiring and operating companies in a broad range of business markets, including manufacturing, distribution, transportation and logistics, equipment rental, metals services, media and entertainment, technology, telecommunications and others. The firm focuses on investments in North America and Western Europe, and prefers to have a majority stake. Platinum Equity has pragmatically procured a plethora of portfolio companies. The firm is currently investing from Platinum Equity Capital Partners IV, a $6.5B global buyout fund. In July of 2018 the firm announced the close of capital raising for Platinum Equity Small Cap Fund, L.P, its inaugural fund focused exclusively on investment opportunities in the lower middle market, freeing new capital that now is waiting to be invested.

Industry Overview:

Every 28 seconds a student loan borrower in the US defaults. To some, this number sounds like the real American crisis. To others, it signals business as usual in the tumultuous world of student loans.

Since the 2008 financial crisis, the student loan industry has faced policy changes that fundamentally reorganized the way it functions. While student loans are nearly always provided by the federal government, the ways students can access them tends to vary with administrations. Prior to 2008, the federal government paid large financial institutions to provide student loans, thus making the bank a middleman in the lending process. But following the financial crisis, and the collapse of several important financial institutions, the Obama administration cut these middlemen out of the process. To do this, the Department of Education took on over $100bn in existing student loans and began to lend out money directly to individuals. However, the Department of Education was never meant to be a bank. Lacking the infrastructure necessary to handle the collection schedules, defaults, and paperwork of nearly 44 million clients, the federal government turned to the private sector for help. But rather than returning to the old system of middlemen and banks, the new system became composed of the federal government providing loans and “student loan servicers” managing them. As of 2019, nearly $1.5tn in outstanding student debt is held by the federal government, but student loan servicers handle everything from defaults to paperwork for a small fee. 

While many businesses attempted to capitalize on this policy change, few managed to become one of the new “student loan servicers”. Only 3 players—Navient, Nelnet, and AES/FedLoan Servicing—currently populate the space. Despite 2 of these companies being less than a decade old, they collectively manage payments from 30 million borrowers, representing nearly $950bn (or 93%) of the outstanding government owned student loans. Nelnet represents the largest player in the industry, accounting for 40.58% of total debt outstanding. This is followed by AES/Fedloan servicing with 31.07% of the total, and Navient, with 20.95% of the total. The grip these 3 companies have on the federal government’s student loan portfolio is unlikely to change anytime soon, as recent acquisitions by the top players have consolidated the industry even further. For instance, prior to 2018 Nelnet was the smallest of four players in the industry, but rose to the top after acquiring the second largest company in the sector—Great Lakes—in a $155m deal. Such deal making has prompted others, such as Navient, to remain relevant through acquisitions of smaller competitors, like that of Fintech lender Earnest. The remaining 7% of total outstanding student debt is collected by five not-for-profit companies that operate in specific states such as Utah and New York.

Some students also choose to take on private loans from institutions like SallieMae, but they constitute the minority of loans taken out and are not handled by student loan servicers. However, the vast majority of students prefer federal to private loans because of their favorable fixed interest rates and term agreements. As of 2019, the average undergraduate borrower is given a 5.05% interest rate, while graduate or professional students receive a 6.6% rate. Once a year this rate is updated by the US department of Education based on market conditions.

Deal Rationale:

In late 2018, Canyon Capital and Platinum Equity approached Navient with an inquiry into a potential acquisition. By early 2019 the ongoing deal’s rhetoric had changed from neutral to harsh, as Navient rejected a $3.2bn “unsolicited offer” from Canyon and Platinum. This dramatic development, as well as the deal itself, can be better understood by examining the rationale behind the buyers’ actions.

Canyon Capital, a longtime shareholder of Navient, is the key buyer behind the deal. Therefore, with a 9.9% stake in Navient, Canyon also acts as its largest equity holder—no small coincidence considering the timing and narrative surrounding this proposed acquisition. Canyon Capital is known for relying on activist strategies in its investments, as highlighted by their 2016 proxy fight with Ambac Financial Group. Considering Canyon’s willingness to involve itself in matters at the student loan servicer, Navient seems to be no different.  Over the past year, Canyon Capital has expressed a desire for greater input in Navient’s strategy, which was further demonstrated by their request for an additional board seat in February of 2018.

From an activist point of view, there are a variety of factors that could be contributing to Canyon’s interest in buying Navient. Primarily, Navient is facing external pressure from legal and industry sources; both of which threaten to destabilize its market position and financial success. In recent years Navient has faced multiple lawsuits from state attorneys and the Consumer Financial Protection Bureau accusing them of misleading student borrowers. Many of these lawsuits have developed poorly for the firm and continue to distract executives from the even larger problem: losing their position within the market. In the middle of 2018 the Big 4 of student loan servicing (Great Lakes, AES, Navient, and Nelnet) were cut down to the Big 3 with Nelnet’s acquisition of Great Lakes. Acquisitions of companies large and small by these top players have led to an industry with a different landscape, one that is arguably worse for marginalized players like Navient. Despite its own attempts to join in on industry consolidation, with purchases like that of JP Morgan’s $6.9bn student loan portfolio and fintech lender Earnest, they still lag significantly behind many of their competitors. These external issues are compounded by the fact that, internally, Navient seems incapable of honing in on specific strategies to resolve these issues in a timely and efficient manner. As a whole, the young company seems to be struggling against a variety of factors, with little internal direction to guide them through the storm.

From this perspective, Navient seems like a decent target for an activist investor with a plan to stimulate operational and strategic change. Whether they, or this acquisition, will be successful is another story entirely.

Veto & Reasoning:

Navient rejected the proposed deal or ‘expression of interest’, on the grounds that the proposed deal would supposedly undervalue the company and it would not be in the best interests of Navient’s stockholders. The company further remarked that Canyon and Platinum have not provided substantive information on how they would address the change of control provisions in the Navient’s outstanding unsecured debt and warehouse financing facilities or how they would address the litigation and regulatory matters Navient faces. Canyon seemed to be surprised and quite puzzled by the veto, considering the two companies had rather friendly prior talks about the take-over. Since Navient was seen to previously announce that it would consider any ‘bona fide’ fully financed deal that would adequately reflect the fair value of the company and had a viable path to completion for a deal it seems that Canyon and Platinum have rushed the talks proposing a very low price (only 5% premium) triggering a strong public response by Navient.

Market Reaction:

Navient rose as much as 10% on February 19, 2019, which was the biggest gain the company witnessed since November of 2016. The shares went as high as $12.81, which was a 9.2% increment in New York trading. This positive reaction may partly be attributed to news and rumors about the potential for reconsidering the deal, given that the student-loan servicer had recently run into trouble with regulators over its business practices. Further, upon clear indication from Canyon that the hedge fund had fully withdrawn its expression of interest, the student loan servicer’s declined 5.4% on February 21, 2019, to $11.98.

Advisors:

Morgan Stanley & Co. LLC acted as financial advisor to Navient and Skadden, Arps, Slate, Meagher & Flom LLP acted as legal advisor.


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