Leucadia National - 2012 Letter to Shareholders

The end of an era at Leucadia National was announced late last year and made official earlier this year when shareholders voted in favor of a merger with Jefferies, a leading mid-sized investment bank.  Alas, the long-time duo at Leucadia's helm recently penned their final letter to shareholders.  Warren Buffett's annual letter is the gold standard in the corporate world, but Ian Cumming and Joseph Steinberg's co-written communication is not far behind.

This year's piece strives to do two things: make the case that the new incarnation of the company will be a success, and recap what's happened over the past three and a half decades.  Cumming and Steinberg met Rich Handler, Jefferies' CEO and the incoming chief executive of Leucadia, more than 25 years ago, and have been doing business with him ever since.  Jefferies returned an exemplary 22% per year for the 23 years ending in 2012.  Importantly, not only did Jefferies survive the recent financial crisis, it flourished, using the upheaval as an opportunity to almost triple revenues between 2008 and 2011.  Put simply, Jefferies is in sure hands, and it’s likely that Leucadia is too.

Rather than merely discussing the year that was, though, the CEO and President recap their 35-year run, which investors would be wise to read.  Starting at a small firm, ironically named Carl Marks, they navigated booms and busts, invested in a wide range of businesses, suffered some failures and hard luck, enjoyed some great good fortune and came through it all far ahead of where they were at the beginning.

Leucadia's future will almost certainly not be as dazzling as its past.  There's an unfortunate Catch-22 in investing: every year of above average gains makes it more difficult to outperform the market in the future, because increased size shrinks the number of potential investments.  In 1979, Leucadia's book value was $22 million; by the end of 2012, it had grown to $6.8 billion (and now stands at $9.8 billion).  Cumming and Steinberg note that good investments have become harder to find these past few years, but blame increased competition from hedge funds and private equity, rather than the constraints of being an elephant.

Still, there's a good chance that Leucadia 2.0 will be able to outperform the market for years to come, though by a narrower margin.  Handler and number-two Brian Friedman will likely continue their very fine work at Jefferies, and Leucadia's handful of long-serving senior executives, minus only the retired Ian Cumming, remain on board.  It's worth noting that Leucadia has successfully navigated the pitfalls of global investing, rather than focusing only on the US.  This brings many risks, but also greatly increases the pool of possible investments, which should somewhat counteract the "Elephants-can't-dance" problem.  Now may not be a bad time to buy, either, since Leucadia's share price is trading at less than book value.

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

 

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.

 

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

Leucadia National and the Commodities Supercycle

The recent world economic slowdown has included the developing world, which largely escaped the severe 2008-09 recession.  The prominent BRIC nations, too, have showed surprising weakness, with India reporting disappointing growth figures, Brazil already cutting rates, and Russia sure to slow if the price of oil continues to fall.  But the "C" is more important than the "BRI": not only is China larger than all three countries put together, it's growing faster.  However, even the Chinese juggernaut has begun to slow.  First quarter GDP fell to 8.1%, which is still robust, particularly given the Middle Kingdom's $7 trillion-plus economy.  However, second quarter growth may be still lower, which was likely what prompted the government's recent decision to cut interest rates.

Given the short-term mindset that prevails among financial commentators and investors alike, the end of the commodities "super-cycle" is already being declared.  Perhaps it will indeed slow; only time will tell.  But two of the finest investors of the past few decades don't appear to believe the newfound hype.  Ian Cumming and Joseph Steinberg, the superb two-man team at the helm of Leucadia, state their case on commodities simply in their 2011 annual report: "We continue to believe that as citizens of historically poor countries get richer they will demand higher quality items – and more of them" (1).  Accordingly, they have most of the firm's capital invested in companies that stand to prosper only if commodities remain priced at relatively high levels.

They hold a large position in Inmet Mining, a Canadian firm whose production is centered on copper, along with a few other minerals.  While Leucadia has sharply reduced its common stock position in Fortescue, a miner of iron-ore, it holds a significant royalty interest in the Australian company's production.  Most significantly, Leucadia recently closed its largest ever acquisition by purchasing National Beef Packing, paying $868 million for 79% of the company (2).  Though the company is based in the US, a mature market for beef, the global trade in meat is growing significantly, a market the company will tap into.  As poor people in developing countries grow wealthier, one of the first changes in consumption is a move to add more protein to their diet, mostly by eating more meat.  Only if this trend continues is National Beef Packing likely to grow.

Cumming and Steinberg increased Leucadia's book value 18.5% per year from 1979-2011, despite a large one-time dividend in 1999 that significantly reduced shareholders equity (3).  Over that three-decade-plus time span, these super-investors saw many trends come and go, but they remain confident that the rise of the developing world is a secular change, and the commodity boom that began more than a decade ago will likely continue.  They could be wrong, but bet against them at your own risk.

Sources (1), (2), (3): Leucadia 2011 AR

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.

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

Disclaimer: The host of this blog shall not be held responsible or liable for, and indeed expressly disclaims any responsibility or liability for any losses, financial or otherwise, or damages of any nature whatsoever, that may result from or relate to the use of this blog. This disclaimer applies to all material that is posted or published anywhere on this blog.