Thursday, 27 December 2012

Leucadia National and Jefferies to Merge - An Analysis

Several weeks ago, an admirable case study in the history of value investing came to an end - at least the long and satisfying first part did.  Leucadia National, long stewarded by the two-man team of Ian Cumming and Joseph Steinberg, merged with Jefferies, a leading mid-sized investment bank.  Technically, Leucadia swallowed Jefferies - at least the 71% that it hadn't already digested - but in some ways it feels like the reverse.  After all, not only will Jefferies become the anchor company in Leucadia's collection of businesses, Jefferies' chief executive Richard Handler will become CEO of Leucadia, as well as remaining at the helm of his own firm.  Ian Cumming will retire from his day-to-day role, while remaining a director, though Steinberg and the rest of Leucadia's senior management will remain on board.
Why the change?  Clearly, succession played a large part in the move.  Leucadia's aging masters weren't going to be around forever, after all.  In fact, Cumming had already signaled his intention to retire by declining to extend his contract past 2015.  Steinberg, however, will remain with Leucadia, both as Chairman and as an active executive, and has (to this writer's knowledge) not made public when he plans to move on.  Evidently, the opportunity to hand over the CEO role to a young and able manager with many years ahead of him was one that Cumming and Steinberg couldn't pass up.  Leucadia shareholders can take comfort in the fact that they've worked with Handler and his team for many years.  Indeed, they've enjoyed a personal relationship for more than 20 years, and an active business relationship for more than a decade.  Handler, for his part, regards Cumming and Steinberg as valued mentors.  Given that Leucadia's wholly owned operating businesses are run at the company level, and most of the company's senior managers will remain, Handler should be able to manage his newly expanded role.
How will the two businesses fit together?  Many mergers are sold on the basis of "synergies" that often fail to materialize, but Handler actively downplayed this motivation.  However, there are several areas where this merger could make 1+1 equal more than 2.  First, the deal flow that Jefferies is involved in will unearth opportunities for Leucadia that would otherwise not be available.  In fact, this has already happened in the past - Leucadia's investment in Fortescue, for example - thanks to the longstanding relationship between the respective companies and management teams.  Second, Leucadia has a large net operating loss, an asset that it can't quickly capitalize on without more operating earnings.  The new company, however, is expected to fully utilize the NOL over the next several years, which will turn it from a theoretical balance sheet item into cold, hard cash.  Finally, being part of a large and strong company such as Leucadia may allow Jefferies to escape the vicissitudes of the market, such as the one it suffered from in 2011, where the company looked to be in mortal danger for a short period of time, despite being fundamentally sound.  For a smaller investment bank, the mere perception that it's suffering financial distress, however false, can quickly create that very reality.  This will be less likely to happen as a part of Leucadia, though not impossible. 
While Leucadia will look very different in the future than it has in the past, the company has always been evolving, never staying the same for very long.  (Surprisingly, Handler stated only that he hoped that Jefferies will remain a part of Leucadia for the long-term, whereas many shareholders might have assumed that the two companies would be permanently married; this is a notable difference from Berkshire Hathaway, to which Leucadia has often been compared, which makes a promise of forever when it acquires a business).  What has remained constant, though, is a superb management team with the knowledge and temperament to take advantage of opportunities to create value for shareholders, in whatever form they arise.  Only time will tell if Handler is up to the challenge, but the ongoing presence of most of Leucadia's top brass is likely to mean a continuity of values, philosophy and process, even if the Leucadia's next chapter has a few unexpected plot twists in the future.
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