Wednesday, 23 May 2012

Leucadia National - A Mini Berkshire Hathaway?

Leucadia National (LUK) is sometimes referred to as a "mini Berkshire Hathaway," and indeed the two businesses share many important qualities in common.  Leucadia is among the very few companies with a track record nearly as long and glorious as Warren Buffett's investment vehicle.  Berkshire's (BRK.A) per share increase in book value from 1965-2011 was 19.8% per annum; LUK's performance by the same standard was 18.5% from 1979-2011, despite a large one-time dividend in 1999 that significantly reduced book value.
Aging Masters
Both institutions owe much of their past success to the superb two-man teams than run them.  Berkshire's Warren Buffett and Charlie Munger are the greatest and most influential investing combination of all time; though not famous, Leucadia's Ian Cumming and Joseph Steinberg have an investing record that isn't far behind.  All four super-investors share a similar philosophy: they search for well-run businesses with a solid competitive position, a high return on capital, selling for a reasonable price.  Not surprisingly, Berkshire and Leucadia have similar corporate structures, with each owning a collection of publically traded stocks, as well as wholly-owned subsidiaries that generate cash for the parent company. 
The two companies share a similar style, as well.  They both feature no-frills websites, neither employs an investor relations staff, nor do they host quarterly conference calls with analysts.  This is not to suggest an aloof attitude toward shareholders, though; in fact, just the opposite.  The leaders of both companies craft lengthy, informative letters to shareholders each year, outlining for investors their broad philosophies, as well as significant business developments.  Though Berkshire's annual meeting is an over-the-top capitalist carnival, Buffett and Munger do answer shareholders’ questions for many hours.  Leucadia's managers field questions just the same, though their meeting is a completely low-key affair. 
Unfortunately, these aging legends won't be around much longer.  Though neither has ever expressed an interest in retirement, Buffett is 81, Munger, 88.  While young and sprightly by comparison, the end is now in sight for Leucadia's Chairman Ian Cumming.  At the end of the 2011 letter to shareholders, he quietly announced that he will not work past the end of his current contract, which expires in June, 2015, around the time of his 75th birthday.  There was no word from the President, whose contract expires on the same date, though he is 68 years old.
Bigger, Stronger and Slower or Smaller, Less Strong and Quicker
Given the giants in charge, Berkshire's loss of talent will be greater, but their successor will at least inherit a formidable infrastructure of wholly owned subsidiaries that throw off cash to the parent company.  In the past, Berkshire's value rested largely on its stock portfolio, but over the last decade, the company has focused on buying businesses outright.  In the 2010 annual report, Buffett estimated Berkshire's "normal" earnings power at $12 billion after tax, a figure that must now be well in excess of $13 billion.  The downside of such size is, well, size.  With a $200 billion or so market cap, Berkshire is simply too large to grow quickly.  A nimble elephant, after all, is still an elephant.
Leucadia has a much smaller and less attractive array of wholly-owned businesses.  Berkshire is a cash flow machine, but Leucadia's ragtag collection of operating businesses - including a timber company, a vineyard, and a supplier of plastic netting - has generated only modest profits relative to the size of the parent company.  This may change before the existing management retires, though.  The company recently made its largest ever acquisition, paying $868 million for 79% of National Beef Packing, which commands a 14% share of the US-fed beef market.  Better still, Leucadia paid a price that values the business at just four times 2011 operating cash flow of $273 million.  On the plus side, with a market cap of just $5 billion, Leucadia remains small and nimble enough to grow quickly.
To Buy or Not to Buy
Though they're difficult to value, both companies appear cheap.  Historically, Berkshire has tended to trade at a 50-70% above book value, though that premium has narrowed considerably in recent years, likely due to fears about what happens after Buffett is gone.  The company recently initiated a share repurchase program, pledging to buy back stock only if it fell below 110% of book value.  In the few months since the announcement was made, the shares have rarely fallen below that threshold.  But it is barely above it at present, suggesting a cheap stock.
In the past, Leucadia's stock has deviated wildly from book value, sometimes trading for less than half of equity, other times more than twice book.  It currently trades at around the value of its equity.  There is no similar "floor" underneath Leucadia's stock, either in the form of historical precedent or a firm commitment to buy back stock when it falls below a certain metric.  However, given the company's proven ability to grow book value over time, buying in at today's prices likely represents a sound investment.
Leave it to the pros, or do-it-yourself?
When studying investment holding companies, active investors will naturally be tempted to pick and choose the best ideas for themselves.  Indeed, copycat investors have long coat-tailed Warren Buffett by buying into the same stocks that he does, after his investments have been made public.  But a "do-it-yourself" Buffett portfolio is not a proxy for Berkshire, since it can’t reproduce the massive amount of free "float" provided by the company's insurance operations, nor the large and growing cash flows from 70-odd operating businesses.  However, investors could more readily create a "make-your-own" version of Leucadia, since much of its value is currently tied up in the stock of Jefferies, Mueller Industries and Inmet Mining.  Most investors would be wise, though, to leave it to the masters, even if they won’t be around forever.

Sources: Berkshire Hathaway annual reports, 2011; Leucadia National 2011 annual report, 2012 first quarter filing
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