Leucadia's Unmined Potential

Barron's(12/8) Leucadia's Unmined Potential
(From BARRON'S) By Andrew Bary
Leucadia National may be the closest thing to what Berkshire Hathaway was 20 years ago,before Berkshire became so large that Warren Buffett needed investments of severalbillion dollars to move the needle. Run for 30 years by a secretive duo, Ian Cumming and Joseph Steinberg, Leucadia hasinvested in a wide variety of stocks and a diverse group of businesses. It has generatedvery impressive returns and developed a cult-like following among value-orientedinvestorswho like its investment style -- and results. Buffett is a fan of Leucadia,although Berkshire doesn't own the stock. Leucadia's book value, which stood at$23 a share on Sept. 30, is up from just 11 cents in 1979, an annual growth rate of morethan 20%. Leucadia (ticker: LUK), however, has fallen 60% since Sept. 30, to about 17, leaving itway below its May peak of 57 and slashing its market value to $4.3 billion. Investorsfear that Cumming, 68, and Steinberg, 64, have lost their touch, owing to declines inmany of Leucadia's key equity holdings, including Australian iron-ore producerFortescue Metals Group (FMG.AU), securities firm Jefferies (JEF), Canada's InmetMining (IMN.T) and auto-finance outfit AmeriCredit (ACF). Many of the company's other investments are suffering, including Cresud (CRESY),an Argentine agricultural and real-estate company, and Leucadia's 10% stake in ahedge fund run by William Ackman of Pershing Square that owns a single stock, retailerTarget (TGT). Leucadia probably has lost half of the $200 million it put in the fund lastyear. Fans argue that Leucadia is oversold, noting that it rarely has traded below book inthe past decade and in recent years typically has commanded 1.5 to two times book. Thestock could hit $30 in the next year if the company's equity holdings turn aroundand if Steinberg and Cumming take advantage of the current financial distress to displaytheir old stock-picking magic. Says one Leucadia holder: "I don't think thatthey suddenly took stupid pills." Given market declines since Sept. 30,Leucadia's book value has now probably fallen closer to $20 a share. Steinberg and Cumming, who couldn't be reached for comment, focus on minimizingLeucadia's tax bill. The company now has $1.6 billion of deferred tax assets,indicating that it expects to shield some $5 billion of future profits from federalincome taxes. Strip out that tax asset to reflect no future gains, and estimated bookfalls to around $14 a share. "That's a worst-case assumption. You're notpaying much above that for the stock," says a recent Leucadia investor. Book value also may be understated because of conservative valuations for real estateand other assets the company owns, plus a potentially lucrative agreement with Fortescuethat pays Leucadia 4% of net revenues from its Australian iron-ore mine for more than adecade. The deal could produce more than $100 million of annual profits for Leucadia,assuming ore prices don't collapse. Leucadia's operating businesses, including plastics, wood products, pre-paid phonecards, as well as a Napa Valley winery and the Hard Rock Hotel & Casino in Biloxi,Miss., don't generate much profit. Investors tend to value the company on bookvalue, rather than earnings, because most of its worth lies in investments. Leucadia also has invested about $100 million for an 87% stake in a medical start-upcalled Sangart, which is developing a blood substitute now in clinical trials. There havebeen many failures in this field, but Leucadia hopes that Sangart's product,Hemospan, is a winner. Many holders simply view Leucadia as a play on Cumming and Steinberg's investmentacumen. Both intend to stay on the job for a while; their employment contracts run into2015. Some Leucadia watchers believe the company will be liquidated or sold when Cummingand Steinberg leave the scene. Like Buffett, Cumming and Steinberg believe in a strong balance sheet. As of Sept. 30,Leucadia's $8.4 billion in assets significantly exceeded its $2.6 billion in debtand other liabilities. Leucadia had about $500 million of cash and equivalents on Sept.30, down from $1.4 billion on Dec. 31. Dividends certainly aren't a drain on itscash. This year, there will be none; last year, the payout was only 25 cents a share.
Unlike Berkshire, Leucadia lacks significant operating businesses; its focus tends tobe on more speculative companies. It has paid $405 million for 32 million shares -- a 28%stake -- in AmeriCredit, which provides auto loans to those with weak credit. Reflectinga tough economy and tightness in the credit markets, AmeriCredit shares are 40% belowLeucadia's cost.
Cumming, Leucadia's chairman, and Steinberg, its president, may be thelowest-profile leaders of any sizable public company. Outside of their annual shareholderletter and appearance at the annual meeting, they stay out of public view. There are noearnings conference calls, no investor presentations and no financial guidance. There areno photographs of Cumming or Steinberg in the annual report. Hardly any analysts coverthe company because of its complexity and minimal communications. Leucadia invested in Fortescue in 2006, when founder and CEO Andrew Forrest neededmoney to build a giant mine in a remote area that would compete with Australian iron-oretitans Rio Tinto and BHP Billiton to supply the voracious Chinese steel industry.Leucadia, which initially invested $400 million, now owns 9.9% of Fortescue. Theminer's shares got as high as A$13.15 in May, at the height of the commodity boom,making Leucadia's stake worth $3 billion and pushing up Leucadia stock. Since then,Fortescue has slid to A$2.50 still more than double Leucadia's cost. Leucadia also has a close relationship with investment firm Jefferies, reflecting inpart Steinberg's friendship with CEO Rich Handler. Last year, Leucadia took a 50%stake in Jefferies junk-bond trading unit, in return for $350 million, even thoughsecurities firms rarely sell outsiders parts of their trading operations. This year,Leucadia has accumulated a 30% stake -- 48.6 million shares -- in Jefferies itself, at anaverage cost of $16. But the stock has dropped to around 10, less than 80% of book value.

Jefferies isn't immune to Wall Street's troubles -- it laid off about 10% ofits staff last week -- but its losses have been relatively modest because it doesn'ttake big trading positions. Still, its high-yield trading business has lost more than $80million this year. Jefferies, a scrappy niche firm, focuses on equity trading and junkbonds, as well as investment banking. Leucadia now looks like an attractive play on its depressed investments and on theability of Cumming and Steinberg to find new opportunities. Unless the pair has indeedtaken "stupid pills," investors could do well taking a ride with them.
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