Value Investors Club / LEUCADIA NATIONAL CORP (LUK)

Description

Leucadia is well known among members of VIC. Due to uncertainty around a recent announced merger plus a spin-off of its wine assets, the stock has become cheap.

In Nov 2012, Leucadia announced a merger with Jefferies Group. Leucadia plans to swap 0.81 of its shares for each Jefferies share. Leucadia plans to spin off its California wine business, with a book value of $197 million, or 81 cents a share, to its holders before the deal closes.

With the memory of the near-death of Jefferies (due to the collapse of MF Global) still very recent in their minds, Leucadia shareholders initially reacted negatively to the news. Leucadia's stock price dropped to 20 and change, even when the book value per share of the post-merger will be 24.69. Recently, the stock has come back to 27.

Post-merger, Leucadia will be in the business of merchant investing and owning Jefferies, an investment banking firm. Jefferies wil continue its over 50-year focus in the capital markets and maintain a highly liquid balance sheet. Future acquisitions and investments will leverage the knowledge base, opportunity flow and execution capabilities of Leucadia and Jefferies' management team and businesses. Management will consist of: Richard Handler, Jefferies’ CEO, and Brian Friedman, Executive Committee Chairman, will serve as Leucadia’s new CEO and President, respectively, while continuing as hands-on leaders of Jefferies. Joe Steinberg, Leucadia’s current President, will serve as Chairman of the Board of Leucadia. Leucadia’s senior operating team, including Justin Wheeler, Chief Operating Officer, Tom Mara, Executive Vice President and Joe Orlando, Chief Financial Officer, will remain in their roles and manage Leucadia’s existing assets under the leadership of the new CEO and President from Jefferies. Ian Cumming will be retiring (he is 71).

LOGO

The non-Jeffereies assets of post-merger Leucadia are the following:

National Beef
-4th largest beef processor in the US, with significant operations in hide tanning, direct-to-consumer beef sales, retail package preparation and logistics
-Major exporter to foreign markets, including Asia and the Middle East

Inmet Mining (Publicly listed – TSX: IMN)
-Global exploration, development and mining of base and precious metals. Copper mine development currently underway in Panama

Premier Entertainment (Hard Rock Hotel & Casino Biloxi)
-325 room hotel with 50,000 square feet of gaming
-Currently constructing a 154-room tower addition to hotel

Berkadia
-One of the largest non-bank owned commercial mortgage servicing and origination platforms
-50/50 joint venture with Berkshire Hathaway

Garcadia
-Acquires and operates auto dealerships, with current operations in lowa, Texas and California
-Joint venture with Garff Enterprises

Conwed
-Market leader in lightweight oriented and extruded plastic netting
-Partners with customers to customize core technology into innovative solutions

Linkem
-Start-up wireless broadband services provider in Italy

Idaho Timber
-Wood product manufacture and distribution
-Operations in primary milling, clear boards and dimensional lumber remanufacturing

HomeFed
-Developer of residential real estate projects

Leucadia's CAGR Growth in Book Value Highlights

From Leucadia’s 2011 Annual Report:
	Leucadia National Scorecard
			Book Value Per Share		Book Value % Change		% Change in S&P 500 with Dividends Included			Market Price Per Share		Market Price % Change			Shareholders’ Equity			Net Income (Loss)		Return on Average Share- holders’ Equity
	(Dollars in thousands, except per share amounts)
	1978	($	0.04	)	NA		NA		$	0.01		NA		($	7,657	)	($	2,225	)	NA
	1979		0.11		NM		18.2	%		0.07		600.0	%		22,945			19,058		249.3	%
	1980		0.12		9.1	%	32.3	%		0.05		(28.6	%)		24,917			1,879		7.9	%
	1981		0.14		16.7	%	(5.0	%)		0.11		120.0	%		23,997			7,519		30.7	%
	1982		0.36		157.1	%	21.4	%		0.19		72.7	%		61,178			36,866		86.6	%
	1983		0.43		19.4	%	22.4	%		0.28		47.4	%		73,498			18,009		26.7	%
	1984		0.74		72.1	%	6.1	%		0.46		64.3	%		126,097			60,891		61.0	%
	1985		0.83		12.2	%	31.6	%		0.56		21.7	%		151,033			23,503		17.0	%
	1986		1.27		53.0	%	18.6	%		0.82		46.4	%		214,587			78,151		42.7	%
	1987		1.12		(11.8	%)	5.1	%		0.47		(42.7	%)		180,408			(18,144	)	(9.2	%)
	1988		1.28		14.3	%	16.6	%		0.70		48.9	%		206,912			21,333		11.0	%
	1989		1.64		28.1	%	31.7	%		1.04		48.6	%		257,735			64,311		27.7	%
	1990		1.97		20.1	%	(3.1	%)		1.10		5.8	%		268,567			47,340		18.0	%
	1991		2.65		34.5	%	30.5	%		1.79		62.7	%		365,495			94,830		29.9	%
	1992		3.69		39.2	%	7.6	%		3.83		114.0	%		618,161			130,607		26.6	%
	1993		5.43		47.2	%	10.1	%		3.97		3.7	%		907,856			245,454		32.2	%
	1994		5.24		(3.5	%)	1.3	%		4.31		8.6	%		881,815			70,836		7.9	%
	1995		6.16		17.6	%	37.6	%		4.84		12.3	%		1,111,491			107,503		10.8	%
	1996		6.17		0.2	%	23.0	%		5.18		7.0	%		1,118,107			48,677		4.4	%
	1997		9.73		57.7	%	33.4	%		6.68		29.0	%		1,863,531			661,815		44.4	%
	1998		9.97		2.5	%	28.6	%		6.10		(8.7	%)		1,853,159			54,343		2.9	%
	1999		6.59	^(b)	(33.9	%)	21.0	%		7.71		26.4	%		1,121,988	^(b)		215,042		14.5	%
	2000		7.26		10.2	%	(9.1	%)		11.81		53.2	%		1,204,241			116,008		10.0	%
	2001		7.21		(0.7	%)	(11.9	%)		9.62		(18.5	%)		1,195,453			(7,508	)	(0.6	%)
	2002		8.58		19.0	%	(22.1	%)		12.44		29.3	%		1,534,525			161,623		11.8	%
	2003		10.05		17.1	%	28.7	%		15.37		23.6	%		2,134,161			97,054		5.3	%
	2004		10.50		4.5	%	10.9	%		23.16		50.7	%		2,258,653			145,500		6.6	%
	2005		16.95	^(c)	61.4	%	4.9	%		23.73		2.5	%		3,661,914	^(c)		1,636,041		55.3	%
	2006		18.00		6.2	%	15.8	%		28.20		18.8	%		3,893,275			189,399		5.0	%
	2007		25.03	^(d)	39.1	%	5.5	%		47.10		67.0	%		5,570,492	^(d)		484,294		10.2	%
	2008		11.22	^(e)	(55.2	%)	(37.0	%)		19.80		(58.0	%)		2,676,797	^(e)		(2,535,425	)	(61.5	%)
	2009		17.93		59.8	%	26.5	%		23.79		20.2	%		4,361,647			550,280		15.6	%
	2010		28.53	^(f)	59.1	%	15.1	%		29.18		22.7	%		6,956,758	^(f)		1,939,312		34.3	%
	2011		25.24		(11.5	%)	2.1	%		22.74		(22.1	%)		6,174,396			25,231		0.4	%
	CAGR
	(1978-2011)^(a)						11.1	%		26.4	%
	CAGR
	(1979-2011)^(a)		18.5	%			10.9	%		19.8	%				19.1	%

The following chart shows Jefferies' business:

Jefferies' business consists of:

-Investment Banking (40%)
-Equities (21%)
-Fixed Income (38%)

Jefferies' recent Income Statement


Financial Summary
($ Millions)	Fiscal Year 2011		Nine Months 2012
Equities	$	594	$	466
Fixed Income		715		897

Sales & Trading		1,309		1,363
Other		74		13
Equity		187		141
Debt		385		310

Capital Markets		572		451
Advisory		550		392

Investment Banking		1,123		843
Asset Management Fees and Investment Income		44		11

Net Revenues	$	2,549	$	2,230
Adjusted Net Revenues ⁽¹⁾		2,476		2,220
Adjusted Operating Earnings ⁽¹⁾		366		395
Adjusted Net Income ⁽¹⁾	$	232	$	221

With the exception the global financial crisis in 2007-2008, Jefferies has not had a single loss quarter dating back to 1990.

Jefferies 10 year highlights:

INCOME STATEMENT: 10-YEAR SUMMARY

DATE	SALES	EBIT	DEPRECIATION	TOTAL NET INCOME	EPS	TAX RATE (%)
11/12	3.87 Bil	491.80 Mil	52.80 Mil	282.41 Mil	1.22	34.30
11/11	3.53 Bil	419.33 Mil	45.10 Mil	284.62 Mil	1.28	31.70
11/10	2.80 Bil	396.67 Mil	36.00 Mil	223.67 Mil	1.09	39.40
12/09	2.63 Bil	507.75 Mil	39.80 Mil	275.28 Mil	1.35	38.60
12/08	1.67 Bil	-888.16 Mil	29.30 Mil	-540.92 Mil	-3.30	0.00
12/07	2.72 Bil	245.73 Mil	27.00 Mil	144.67 Mil	0.92	37.90
12/06	1.96 Bil	348.65 Mil	18.90 Mil	204.14 Mil	1.41	39.40
12/05	1.50 Bil	268.41 Mil	15.56 Mil	157.44 Mil	1.16	38.80
12/04	1.20 Bil	226.99 Mil	13.78 Mil	131.37 Mil	1.03	37.00
12/03	926.72 Mil	144.53 Mil	14.75 Mil	84.05 Mil	0.71	36.60

WHY THE DEAL IS BENEFICIAL

Before, I delve into the price and valuation, I will first explain why the outlook of this deal is net-net positive. For Leucadia, it solves a leadership-succession issue because the the current duo that have led Leucadia since the 1970s, Joe Steinberg and Ian Cumming, are 68 and 71, respectively whereas Richart Handler is only 51. The deal gives Jefferies access to a strong liquid balance sheet outside its own. Leucadia also benefits because it's buying a profitable firm and thus should be better able to make use of $1.4 billion of deferred tax assets that might otherwise have to be written off. Leucadia's current businesses don't generate a lot of profits, netting about $100 million in the first nine months of 2012 (Cumming and Steinberg is more interested in increasing book value than in reported profits). The combined companies will have $9.3 billion in book value. Leucadia has a liquid balance sheet with cash and public securities of $2.4 billion, offset by $960 million of debt. Leucadia presumably will continue to make investments and buy businesses. Handler's stake of $235 million dollars in Jefferies will be converted to Leucadia stock and should put himself aligned with Leucadia shareholders going forward. Leucadia will leverage Jefferies' 700 investment bankers across 8 industry verticals in offices worldwide, as well as Jefferies' research and trading platforms. As a subsidiary of Leucadia, Jefferies will have greater balance sheet resilience and flexibility to guard against, and take advantage of, market dislocations and other opportunities especially during this time when competitors confront regulatory, operational and market pressures. The current chairman will retire in mid-2015, handing the reins to the Jefferies CEO; this leaves the company with well-regarded management and a stable of well-financed businesses with mostly high return on capital. With an expanded capital base and an enhanced earnings base, Leucadia could experience better growth in its book value in the coming years, providing attractive returns to investors. Examples of opportunistic intermediate term (six months to two+ years) marketable securities investments emanating from Jefferies’ trading flow and market knowledge in the past include the recent investment in Knight Capital.

WHY EXECUTION RISK IS MUTED

Jefferies and Leucadia’s relationship has been built over twenty years. Leucadia owned 28% of the firm prior to the merger deal and held about half of one of Jefferies' best businesses, its junk-bond trading desk. It's rare for a Street firm to take a partner for a trading operation. Jefferies and Leucadia have worked together and partnered on countless financings and strategic transactions, including Jefferies High Yield Funds (2000 – 2007), Jefferies High Yield Holdings joint venture (2007 – ongoing) and the Fortescue investment (2006 – 2012). Furthermore, Rich Handler will continue to own over $230 Million worth of stock in Leucadia. This will align him, Cumming, Steinberg with the shareholders.

LOGO

Valuation

Leucadia is paying less than book value for Jefferies. At $27, Leucadia is now trading at less than 1.1 times the book value of the post-merger. Included in this market cap is a stake in the wine assets, that will be spun-off to shareholders. The wine asset is carried in the balance sheet at $197 million. Leucadia has never traded this cheaply to its book value in many years. In fact, the stock is down sharply, from its 2007 peak of $56, as the price/book multiple has collapsed. I actually estimate that because of access to Leucadia's capital and Leucadia's NOLs, Jefferies should be able to help the combined company compound book value faster than its CAGR rates in the past 10 years. Once the recent memory of MF Global becomes more distant in the past, a company that can compound at 15% starts getting revalued with a higher price-to-book multiple by the market. Suppose you use $27 per share as cost and we use 13% as the CAGR for the company for the next 5 years, and the company gets valued at 2 times book at any one point in time for the next 5 years, then you are looking at a CAGR return in the stock price that is in the 27% range. Now if you value the wine asset at a midpoint between different methods of valuation, you can easily take another $1 per share in your cost basis in the stock. This means your cost basis is $26 and not $27. Suppose you use $27 per share as cost and we use 13% as the CAGR for the company for the next 5 years, and the company gets valued at 2 times book at any one point in time for the next 5 years, then you are looking at a CAGR return in the stock price that is in the 29% range.

I end this report with a little discussion on the wine assets (Crimson Wine Group) that are being spun-off and how I arrived at around $1 of value ($1.17 to be exact) for each Leucadia share.

Crimson Wine Group, due to list 2/26, owns high-end wine brands (e.g. Pine Ridge) that sell for $15 to $100; 180 acres of prime Napa vineyards (Stag’s Leap, Rutherford,
Carneros); and about 900 acres elsewhere. Each Leucadia share will receive 0.10 share of Crimson Wine Group. The firm has struggled since consumer luxury demand collapsed in 2008, but it treated falling land prices (35% in Napa, more elsewhere) as a chance to increase acreage, harvest and case production by 70%, 120% and 150%, respectively. Crimson earned just 2% on equity in 2011, and not much more in 2012 -- but Leucadia reports the firm has only now reached efficient scale, and will henceforth be more sustainably profitable, subject to the usual uncertainty of an agricultural firm. More speculatively, Crimson would benefit from consumer recovery and a falling dollar (exportable product with few foreign inputs). Crimson controls approximately 1,166 acres of vineyards and approximately 706 acres are planted (newly planted vines take approximately 4 to 5 years to reach maturity). The company bought Seghesio Family Vineyards in 2011 and Chamisal Vineyards in 2008. The company paid around $105 million that is equivalent to $4.30 per Crimson Wine share versus the current total book value at $8.10 (as a reference the company recently sold a non-strategic vineyard for approximately 1.8x book value). If you take the price/book of comparables like Constellation, Willamette Valley adn Treasury Wine Estates (traded in Australia), you can arrive at $11.70 per share in value for Crimson. That equates to about $1.17 per Leucadia share in Crimson Wine Group.

I hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Just cheap as investors have a near-term memory of the negative events that surrounded Jefferies Group, the company that is becoming a subsidiary of Leucadia. The pending spin-off of Crimson Wine Group will give investors an opportunity to pick up Leucadia at a further discount.

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			2013	2014
Price:	27.00	EPS	$0.00	$0.00
Shares Out. (in M):	378	P/E	0.0x	0.0x
Market Cap (in $M):	10,206	P/FCF	0.0x	0.0x
Net Debt (in $M):	-1,500	EBIT	0	0
TEV (in $M):	8,706	TEV/EBIT	0.0x	0.0x