Description

Overview:

Homefed(HFDC.OB) is a San Diego Savings and Loan that went bankrupt in the
early 1990's. Leucadia(LUK), whom I'm sure many of you are familiar with,
gained control of the company through its reorganization. In 1995 the
company emerged from bankruptcy and in 1999 Leucadia distributed the
Homefed common stock to the shareholders of Luecadia. As a result, Joseph
Steinberg and Ian Cumming, who collectively run LUK each own approximately
13% of HFDC.

At first blush HFDC looks like a ridiculous shell of a company. While this
is true further inspection reveals a company that has several key assets
that should eventually be realized by the market and be worth much more
than its present stock price indicates. As I will get to later the
current P&L is completely irrelevant.

Current Valuation:

At the current stock price of $0.90 per share Homefed has a market equity
value of $51 MM with Net debt of $22 MM giving it an EV of approximately
$73 MM. At the present time there are no meaningful metrics on which to
value the company so I will move on to the thesis.

Investment Thesis:

There are several critical pieces of info that make HFDC appealing:

1) HFDC has $275 MM of NOL's from its days as a bankrupt company. As a
result, it is unlikely HFDC will ever pay any material amount of taxes.
It does note in the documents that despite these NOL's they may still
be liable for the Alternative Minimum Tax of 20%. All of my calculations
going forward incorporate this conservatism. The NOL's expire in various
time from 2001 - 2015.

2) HFDC manages the San Elijo Hills property that is owned by its parent
company LUK. As a result, HFDC is guaranteed some fairly healthy fee
income over the next several years. In fact, as of the latest K HFDC
provides conservative assumptions for the expected fee income over the
life of the management contract. It says that HFDC should expect at
least $118 MM in cash flow from the management of this property. Again,
this should be tax free except for the ATM. In the K it states that HFDC
plans to receive these cash flows over the course of 9 years.

3) HFDC owns the Otay Ranch through their interest in the Otay Land Company.
The Otay Land Company purchased 4,800 acres of land located within the
larger 22,900 acre Otay Ranch master planned community south of San Diego,
CA. HFDC acquired this land for $19.5 MM in October of 1998.

The San Diego area is a great area to own real estate. There is little
developable land and most of it is happening at Otay. A local real estate
expert has said that Otay Ranch is possibly the largest master plan
under development in the world right now! HFDC has the Otay Ranch on
its books for about $23 MM. Considering that they bought the land for
$19.5 MM in 10/98 that's probably a fairly conservative estimate. In
fact, considering the tight-lipped nature of LUK management it is
probably fair to assume its worth much more. One local real estate
expert has been quoted publicly saying that it is probably worth several
times over its initial valuation. Basically if you want to build a major
apartment building or condo in San Diego it has to be in Otay.

4) HFDC owns a 10-acre site at the Paradise Valley project in Fairfield,
CA. As of 12/00 the book value of the site was $1 MM.

5) The small management team that is managing the day-to-day operations at
HFDC have options with strike prices of around $0.75 per share. As a
result, they make very little money if the stock stays were it is.

6) HFDC is effectively run by LUK employees and is owned in large part by
LUK top management. Steinberg and Cummings have a long history of
investment success and are often considered a "Baby Berkshire Hathaway".
That being the case you can be assured that LUK will do what is
necessary to maximize value from HFDC's assets. Very much like Buffett,
LUK has a long history of under promising and over delivering. As a
result, most of the above mentioned financial assumptions are probably
very conservative and leave a lot of room for upside. LUK has every
incentive to utilize every cent of NOL HFDC has on its books and I
would not be surprised if at some point did not do some type of
creative transaction to utilize those assets even more.

7) There is no risk of HFDC going bankrupt. It clearly states in the K's
that if HFDC at any point needs funds that LUK will trigger a sale of
a property to generate management fees for HFDC. HFDC's only debt is
issued by LUK. As a result, LUK will in no way do anything to damage the
assets at HFDC.

Outcome Scenarios:

I have looked at the investment from a NPV perspective to try to get an
accurate measure of the value. Below I have laid out a Conservative,
Reasonable and Optimistic scenarios:

Conservative Scenario:

Assuming you get the $118 MM from the San Elijo fees spread evenly over
9 years and the Otay Ranch property at present book value in year 9 and
discount at 10% you get about $0.85 per share. Again this is a super
conservative scenario. It assumes the San Elijo fees will be perfectly
even over nine years which is probably very unreasonable. It also assumes
that the Otay Ranch does not appreciate in value for 9 years. Again, as
mentioned above all this is taxed at 20% for the AMT which they may or
may not have to pay in full. So this basically says that investors could
expect to earn 10% a year with these very conservative assumptions, not
bad for the worst case.

Reasonable Scenario:

Assuming you get more of the San Elijo fees in the first half of the 9
year period and less in 2nd half and assume you get the Otay Ranch in year
9 at 4x book value and discount at 10% you get about $1.40 per share. This
makes more sense that HFDC would try to extract more fees in first 5 years
than in the last 4. Furthermore, 4x book for Otay in 9 years seems very
reasonable considering that it's probably worth more than that right now.
Again these numbers are taxed at the AMT.

Optimistic Case:

Assuming you double the San Elijo fees to $236 MM and front load more of
it in first five years and assume you get the Otay Ranch in year 9 at 10x
book and discount at 10% you get about $3.50 per share. I think it is very
plausible that the San Elijo fees estimates are very conservative estimates.
Given the track record of LUK management there is no way they would put an
estimate in the K that they were not certain they would get. I think this
leaves a lot of room for upside. Assuming the Otay ranch at 10x book in
year 9 is not outlandish at all from what I have heard about the potential
for the Otay properties. Again these numbers are taxed at the AMT.

Catalyst

The catalyst would be any upcoming management fees announced that would
draw attention to the situation and make people realize that HFDC will
indeed be paid. When people see $20MM + fees being paid to this over the
counter stock people will start to notice. In addition, the eventual
rationalization of the Otay property. You are basically buying an option
with very little downside and massive upside.

Finally, I suspect LUK will try to extract more of the NOL from HFDC by
shifting some assets to HFDC or some other creative way which would make
the optimistic case very reasonable.