Value Investing

Leucadia National 2015 Annual Meeting Notes

Leucadia National 2015 Annual Meeting Notes thanks to a reader for sending – looks like was also posted on The Motley Fool

I recently attended the Leucadia National Annual Meeting in New York City. These are my raw notes, posted so that those willing to wade through it all can draw their own conclusions. Apologies for anything unpolished. Because of my less than stellar transcription skills, these should be considered to capture the rough meaning of the statements rather than direct quotations.

Good hunting!

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Leucadia National
Annual Shareholder’s Meeting

[I counted approximately 108 people in attendance, which includes employees and those on stage.]

Joe Steinberg (JS) began with some introductions and announcements. He acknowledged the recent retirements of Tom Mara, Joe Orlando, and Phil Cannella, who he described as our “tax guru, his job was to make sure we didn’t pay any more taxes than we needed to.” He extended a welcome to Teri Gendron, the new CFO, who isn’t really so new anymore. “When I asked her if she could reduce our 10-K to a few short paragraphs, she said it wouldn’t be a problem.” Introduced all the membrers of the board, all were present (they were having a board meeting directly after the meeting). In addition to the board, he noted that attending were Mike Sharp, general counsel, Teri Gendron, Barbara Lowenthal, and Rocco Nittoli, the treasurer.

The reading of the proxy votes was next, with 324M shares out of 366M, or 88%, being represented. All nominated directors were elected and all proxy proposals were ratified.

Rich Handler (RH), gave an overview in which he had an updated organization chart from the 10-K. [It was very similar to that given in the 10-K, so I won’t try to reproduce it.] Parent capital was $11.8B. In the last 2 years, we sold about $2.5B worth of assets. In a world where it is very hard to find value, we deployed about $2.5B in investments. He noted some recent changes, including Justin Wheeler becoming CEO of Berkadia and some additional investments in existing platforms of the operating businesses. We are striving to provide more transparency and communication to shareholders, so as to give a roadmap to our way to create long-term shareholder value. Behind each box that you see is a thriving organization with a team of people working to create value opportunities. This is a team effort, not just the Joe, Rich, and Brian show.

Now I’ll talk about he core business at Jefferies, where I just had my 25th anniversary on May 4; my wife threw me a very nice surprise party that I was happy about. We had about 5 quarters of near double-digit return on equity. The 4th quarter of last year was relatively challenging, and the 1st quarter of this year remained slow. But it looks like we are back on track, including on underwriting and other areas of the business. We are seeing opportunities to take advantage of our non-bank holding company status. We decided in the 4th quarter to transfer Bache to Satyem and that is on track to close, and should help overall return on equity and will simplify the balance sheet. At Jefferies Finance, where we partner with Mass Mutual, we believe that is a business we can scale and see it as a core business. At Jefferies LoanCore, we’re undergoing the registration process so I can’t talk about it too much.

With regard to the investment in Knight securities, we sold assets and raised capital for them, underwriting a stock offering.

I’ll also talk about Harbinger, now known as HRG Group a bit. We took a stake, consistent with our goal of trying to find value. We believe we had a very good entry point, with a sum of the parts valuation being substantially higher than what we paid. This investment is representative of how we think. It is important how we get into a company; that we have an ability to influence decisions and to create value is important to us. They had two jewels, Spectrum Brands and FGL; they had some other assets that are not as valuable, but also had a business strategy involving a lot of overhead. We recent put FGL up for sale, and believe we will receive a full valuation for that. Spectrum recently acquired Armorall; they have an ability to create a world-class consumer products company.

[Next, various managing directors at Jefferies/Leucadia who work with the different business units presented on collections of operating businesses.]

Nick Daraviras presented on National Beef. It operates two processing plants with good access to cattle. It also provides value-added products which improve margins, including beef and pork consumer-ready products, a tannery, and Kansas City Steaks which you can check out online. The main story of 2014-2015 has been availability of cattle, which had been declining for years due to drought. In 2014 into 2015 we have seen more favorable weather and good grazing conditions. This led to greater heifer retention and a period of herd rebuilding; this in turn reduces the amount of beef available for sale. But, if this process continues, it could have beneficial effects later.

Next I’ll talk about the asset management business at LAM, where our strategy is to partner and sometimes seed. Topwater Capital is a hedge fund of funds that pioneered a unique model; managers put up 10% as a first-loss provision. In 2014 they outperformed their comparable index with no down months and with a low market correlation. Structured Alpha uses a strategy involving merger arbitrage; this was an outgrowth of strategies developed within Jefferies. Mazama is a long-only manager that has performed very well over a long period. Folger Hill is a multi-manager, long/short model. They raised over $1B at launch, with $400M from us.

Idaho Timber has 7 plants and 3 sawmills. They have faced headwinds since the housing market collapse, but saw a 60% increase in EBITA in 2014 off of a 19% increase in volume. Their strategy is to focus on operations and opportunistic purchasing.

Jimmy Hallac presented next. FXCM is a leading provider of trading services for foreign exchange. They had $1.5B in capitalization when the Swiss franc was revalued. Their clients lost more than $200M that they needed to collect from the clients and because of that had run out of sufficient regulatory capital when they . contacted us. On the next day, that $200M was funded by Leucadia. We have confidence in their management team. The investment is structured as a senior security; the coupon increases by 1.5% each quarter. We have been repaid a total of $88M in cash, and have $228M in remaining principal, for which we expect payback on schedule. That investment managed to stabilize FXCM, and as well as paying us back, they are focused on reinvigorating their business. That investment is marked to market on a quarterly basis; in the last quarter it had a $947M mark using a 3rd party model. There are many inputs to that model, the most important of which are FXCM’s stock price and the volatility. Just as an example, a $0.30 change in their stock price could result in a $51M loss on the mark. Since that last report, we’ve seen a $131M loss on the mark since FXCM stock is down $0.70.

Linkem is a fixed wireless provider in Italy. Italy has no cable TV system, and wired broadband is only available via DSL. They have substandard legacy networks. Linkem acquired spectrum via auction; it is very good for data, not good for cell. They have been putting up antennas on existing cell towers. Up to 2013, they were using WiMax covering 30% of the country. In December 2014, they switched to LTE and have an expanding footprint. Subscriber growth is increasing rapidly, along with low churn. We invested $238M to get 42% of the common stock, and have 55% on a diluted basis. We hold it on the books at $145M.

Conwed is a manufacturer of extruded oriented knitted netting, used in pipelines, soil erosion, etc. It has been a steady modest grower. Last year Conwed acquired 80% of Filtrex and 100% of Weaver. Filtrex is a sock manufacturer. Weaver is an installer of the sock. We have received from them $150M in excess of our investments. It is held on the books at $117M.

Golden Queen we invested in as a joint venture. We invested $71M, the Clay family invested $34M. Roughly speaking, we own 1/3, the Clay family owns 1/3, and the public shareholders own 1/3. It is the first mining company to be approved in CA since they changed their rules in 2002. It is on time and on budget. We expect to be pulling gold early next year. The county where it is located is reliant on oil revenues and is going through an emergency due to the low oil price, so we’re viewed positively for creating jobs locally. There will be a top-up investment in the summer to complete construction, which we knew about going in.

David Severn presented next. Berkadia is a 50/50 joint venture with Berkshire Hathaway. It has grown to become an industry-leading real estate originator and servicer. It is the 3rd largest servicer. Last year, it did $128B in originations. It was the largest originator for Fannie, Freddie, and HUD in 2014. It puts two teams together: origination and servicing. The servicing portfolio runs off each year. The low cost servicing platform allows us to enter sub-servicing agreements. We serviced about $236B last year. We can offer customers a better product today than previously. We have the ability to have debt refinanced, so we have repeat customers. We do several $1B+ deals each year. A lot of debt was originated prior to the financial crisis, that will be coming due for refinancing soon.

Garcadia is the 12th largest auto dealer in the US. New unit volume saw a 20% increase, which is a same-store sales equivalent. We are gaining our unfair share because the overall market averaged only 6% growth. The strategy is focused on creating life-time customers through the service platform. On acquisitions, the market is still very fragmented, so there remain opportunities to acquire individual dealerships. But we are being very cautious as we look at individual dealerships.

We have two lending companies. Foursight is a near-prime focused auto lender. It was jump-started by Garcadia dealers, but most of the growth is coming from 3rd party dealers, which we expect to continue going forward. It currently has a small footprint. The majority of volume comes from only 10 states, so there is an opportunity to expand.

Chrome offers first-time leases on Harley Davidson motorcycles. It gives a two-year lease to allow customers to “test-ride” without the risk of depreciation. It also allows Harley Davidson enthusiasts to move from bike to bike over time.

Oregon LNG; we have been working since 2007 to permit a pipeline. It has been a painful process. We recently got a scheduling notice from FERC, which set the environmental review and gave March 12, 2016 as the federal authorization deadline.

George Hutchinson presented next on the energy businesses. Vitesse Energy is led by Bob Gerrity and Brian Cree. It is essentially a financier funding operating leases in the core of the Bakken. They have 22,000 net non-operating acres. Currently producing 21,000 barrels per day from 900 gross acres, 25 net wells. Those wells are operating at $15 per barrel net costs. There are opportunities for more than 200 horizontal wells. The majority of opportunity is in these undrilled wells, so will benefit from improvements in horizontal drilling and split-water fraks. The lower rig count has reduced costs. Our comparatively low entry price gives us confidence that it will create value in the future.

Juneau Energy is led by management that has been in the industry for 30 years, which gives us an edge in assembling core acreage in non-conventional fields. Juneau owns 25,000 acres in the East Eagle Ford. The company has met all development agreements to hold the acreage but will defer drilling. We expect it to be very profitable in 2016 and beyond. Also has acreage in Houston. Has a joint venture in Oklahoma, which has drilled 5 Mississippian wells; 3 of 4 of the operating wells are producing a daily volume of 1,000 barrels per day, and they are looking at expanding that joint venture. The returns at current oil prices are quite robust.

Brian Friedman (BF) wrapped up the presentations. We realize we are a complex company. We are trying to be transparent without giving away trade secrets. The goal is value creation, which comes in current earnings and in growth. I think about our companies in two buckets. One is a group of companies with current earnings and opportunities to grow those earnings. The most notable of these is Jefferies, where we aim to improve margins and take market share; we continue to see a lot of opportunity in Jefferies’ business.

LAM is in its early days; today we manage several billon dollars and have opportunity to scale. Folger Hill has about $1.1B under management with an opportunity to have several billon in AUM. Structured Alpha has about $1B today. It is a 20 person team, so we see opportunity to grow that. Topwater has an opportunity to grow to $80-90B in outside AUM. We own almost all the equity in the general partners and managers. We do share with the managers but keep most of the equity. We have a significant margin in LAM.

I also include in this bucket Berkadia, Conwed, and Idaho Timber. These are what I refer to as “whip with an H” companies, we whip them to drive earnings.

In the other bucket are our WIP – works in progress – companies, where there is a gap of book value to current value. We have about $2.4-3B devoted to these companies. FXCM and HRG have been talked about. KCG has a tender offer that will shrink its capitalization. HomeFed, it is public that the other half of the Otay property is on the market, we hope we might be the buyer. The value is meaningfully in excess of what is on the books. Beef I include here because we are not currently getting the earnings. We think we are through the trough and are willing to be patient. Golden Queen is in its early days. Linkem is a WIP but on steroids. It has a technology aspect, not because we think we’re developing some new technology but it takes advantage of existing developments. This group has possibilities for meaningful value creation. For example, at FXCM it will be getting back to business as usual and business to be.

We also have the $1.1B deferred tax asset. Today that earns nothing. As we generate earnings, the DTA turns into cash that we can put to use.

What we hoped when we put together Leucadia and Jefferies has come true. Jefferies is a contributor of ideas; for example it seeded HRG and FXCM.

[They opened it up for questions.]

Q: I am a shareholder. I own exactly 1 share, so I guess this is my $24.70 question. The company is complicated. Can you talk about risk management, surveillance of risk, how that can be acted on? I know that across the companies, there are people thinking about this, but that looks like risk management in silos. How can it be coordinated to anticipate problems? (He mentioned an FGL investment in RadioShack that took a loss.)

BF: At the top level, diversification creates security but also creates complexity. We think only as shareholders. At the holding company, we operate with almost no leverage. In Jefferies there is a 60-person risk department. To a deep degree in every company, the risk management is knowing who your people are and who the risk-takers are. To be fair, the investment in RadioShack was done long before our investment in HRG.

RH: I would add the culture. The business is complex. Things have gone wrong in the past and will go wrong again. Surround yourself with people who will elevate risk, are willing to raise their hand when there is a problem.

Q: The reworking of Union Station looks like a massive project. Is there anything you can say about that, even though I may not live long enough to see its completion?

RH: I just visited it. It is one of the most valuable pieces of real estate I have ever seen. The problem is we have to inconvenience 60,000 people who commute there every day. It will take decades. It is a monster project with huge upside but will take a very long time to realize.

Q: Accounting question with respect to FXCM. It seems aggressive to value it at almost $1B when the market cap of FXCM is around maybe $100M.

BF: It is not easy to value. First, $300M is the loan. In our view, the loan is worth the loan and we start there. Then there are two $175M pieces. One $175M is to us, a second $175M is to the convertible. Then there is a 90/10 split (he actually said 80/20 and was corrected). You have a $2 stock on 100M shares representing the 10. We’re getting multiples on that. It is discounted due to volatility or it would have been higher. After 10 seconds into the deal, we were down to $280M due to a fee that came back. Our sense is that we are sitting on $100s of millions.

RH: The market cap today is only half of the market cap because the owners hold ½ in a limited partnership. The company did nothing wrong, they were struck by lightning.

BF: A big piece is coming from sold assets that were not meaningful contributors.

RH: This investment shows the mindset that we have. Using expertise from Jefferies, we can look at situations and protect our downside. We could commit very quickly. It shows the philosophy and power of the combination of the investment bank and the merchant bank. At the end of the day the numbers will be what they will be.

Q: Given that the atmosphere and environment at National Beef today is different from when the investment was made, does it still fit?

BF: We believe it will become something of significant value to all of us as shareholders. It may not have been a timely investment. It does appear to be on the upswing and having persevered, the shareholders deserve the benefit.

Q: Why have you been so reluctant to buyback? And given the success of Berkadia, why is your joint venture with Berkshire so small? Why don’t you partner more with Warren Buffett?

RH: I suspect that nothing would make Warren happier than us bringing him a big deal we like, but it is hard to find in this environment. On the buybacks, I manage much of this personally. I like to do buybacks when not just our stock but both we and the world are on fire. With two reporting periods (from Leucadia and Jefferies) we are almost constantly in a blackout period. We will be patient and opportunistic.

Q: I represent 380,000 shares, so I guess this is my $10M question; for that, I’ll ask two. How does a rate increase impact Jefferies? And what vision do you have for the Jefferies private client group?

RH: A rate increase will cause dislocations of the bond market. One of the benefits of merging with Leucadia was that we kept our entrepreneurial culture without become a bank holding company. When the world shakes, people have the worry that Jefferies will not be secure. We can never say never, but this is a large reason that we did the merger. In fixed income, ½ of Europe already has negative interest rates. Portfolio managers are afraid to buy because everything looks overvalued, but they are afraid to sell because they can’t replace it. People aren’t transacting. We have to try to make money as a market maker in the middle of that. We expect a slow rate increase because the world can’t handle a fast one. On the private client group, I would love to expand it. Would like to have 100-200 people, it is hard to get them without a large guarantee that many of our competitors are offering.

Q: What is Ian Cumming’s involvement? Can you say whether he is still a shareholder and does he have any advisory role?

RH: He is a current shareholder. He has sold some but still holds shares. He will always be a personal advisor for me. He is doing investments with his family and he is happy and doing well.

Q: I refer to this as Leucadia 2.0. We used to be able to look at book value per share and see that as it went up, the stock price went up. Now things are more complicated and there doesn’t seem to be that relationship. Is there a simpler way to show us the value?

BF: Not sure there is a simpler way. A regularized world will be better for our business. We are just seeing the Volker Rule coming to full bloom for the banks; that is creating some opportunities for us. We are a different company.

RH: Just keeping true to the concept of increasing book value per share over time.

Q: (Directed at Joe Steinberg) With this portfolio, what is a reasonable expectation for annual compound growth?

JS: I haven’t a clue. (Q responds: Yes you do.)

Q: Thank you for passing on your bonuses. The stock has been dead flat. It is a nice collection of assets and people, but when my clients ask me why we’ve underperformed this past year, I tell them it is because we own Leucadia and we didn’t own Apple.

RH: We like to make money for shareholders. Our results will dictate the stock price. I can tell you that there are 3 big stockholders on stage that did not enjoy not participating in the rally. But the Apple decision was on your own; that’s not my fault.

Q: Something about progress on HomeFed’s Otay and Finita projects.

BF: Otay, there are bulldozers on the property.

JS: Finita is in the final planning stages. It is like watching grass grow but will get done.

Q: What is the risk and expected returns on LAM? It can be attractive if the underlying firms grow, but depends on the sunset clause. What is the risk of the firms not scaling up?

RH: Our vision of a combination of asset manager, investment bank, and merchant bank excites us. One way to get into asset management is to make an acquisition, but you pay a high price, take lots of goodwill onto the balance sheet, and have to pay retention bonuses. And you’re buying when the asset managers who know the business best are sellers. What we’re doing is building with people we know. Instead of trying to buy, we put in our own capital. We own a good portion of the general partner on each; we haven’t disclosed the portion. If Sol and his team have good returns then Folger Hill could scale to be very large, as could Topwater, Mazama, etc. Margins are high, we have a significant general partner interest. There are costs, but they are measured in the tens of millions.

BF: Our capital is almost entirely going into the asset, so capital is coming back to us. On seeding and sunsets – the sun doesn’t set at Leucadia. There are no sunset provisions. Inside, some mangers may have a sunset but not on the overall business.

Q: Regarding the energy investments.

BF: At Juneau, we try to see more than others see and do more than others do. We feel good about what we have. We are looking at opportunities. If there is an opportunity, the sense is that it still may be early. There hasn’t been capitulation or blood on the street. We are watching the sector. The Fall will be telling as banks go through the re-valuation cycle.

RH: There is a lot of money chasing energy. It will be interesting to see what banks do in the Fall when they reclassify loans.

Q: I represent 1M+ shares. Can you describe your circle of competence outside of financial services? How should we judge your ability to cast a wider net over time?

RH: This is the luxury of having over 4000 people in various industry groups throughout the Jefferies platform. That is combined with a large deals team at Leucadia. We have information we can leverage over a wide variety of opportunities. We need to make sure we can access all of that knowledge.

Q: Jefferies, repo, cyclity? (Didn’t fully catch this question.)

BF: Repo availability mostly goes to investment managers and funds. At Jefferies, we give a lot of information on this. In the period of early fall and winter, there was lots of attention on Fed moves, coupled with a Fannie court decision. That slowed down strategic decision making at companies. On average, a deal occurs 4-7 months after it is conceived. We have seen a return to normalcy on the investment banking side. The long-term rate is so low that there is not a lot of room; not a lot of folks transacting. The opportunity to take market share is still there.

RH: It is just us and the trillion-dollar bank holding companies. We have a different model from our competitors. We look at a lot of distressed situations. Frankly, there was some bad luck with Bache. Whatever can go wrong does go wrong, but you power through it.

Q: (From a Fidelity analyst) Serving as the financier of last resort is interesting but it is a hard way to go through life. Is that the primary model? Are there examples where you said no to those in need?

RH: Our business model is not to lend to those who’ve blown themselves up. We focus where management did nothing wrong and where replacement of capital will solve the problem. This crystallized for us in 2011 where we knew we did nothing wrong and needed to get the truth out and be transparent. With Knight Capital Group, it was clear that their clients wanted them to stay in business, they just needed capital. The bad computer was unplugged and the business recovered. With MF Global, they were 40:1 levered but also had a large off balance sheet asset. We wanted them to sell that asset but management chose not to do that. It became too late. There can be arrogance in terms of denial of what has to be done. With FXCM, talk about a group doing nothing wrong! It is a pure riskless business, but a G7 country changed the rules, which they said they wouldn’t do, and it left a big smoking hole. We make sure our downside is protected and we find that the upside takes care of itself because we can structure it favorably. With KCG and FXCM, the managements were very appreciative. They didn’t view us as taking advantage but as the only solution.

Q: I view Joe and Ian as old-time entrepreneurs and more risk-takers. As you said, a few years back you guys had to make the call to Leucadia. You’re battle-scarred and therefore more conservative. I view you as trying to create an unassailable company that never has to make that call again. Am I wrong?

RH: That’s an interesting way of looking at it. I would say we are battle-tested. We have scars but remain optimistic at having been given the opportunity of a lifetime to build a very special company. Anyone who knows Joe and Ian knows they are not risk-takers; they will take a calculated risk but only as great long-term value investors. We are trying to create long-term wealth. We recognize that the world today is a scary place. It would be simple to go out, deploy lots of capital and boost ROI, but that may not be the right thing to do long-term. We are being cautious.

BF: I would also distinguish that we have more flow, that because of Jefferies we see more than Leucadia ever did.

JS: You don’t have to worry about Rich and Brian being risk-takers in the prudent sense. It was a bittersweet moment for me that they jumped on FXCM and figured it out and I wasn’t involved at all, except on the board. They figured out HRG and acted. They are battle-tested, and focused on long-term value creation for shareholders.

Q: I have found with the new company it is harder to get information. Can you become more investor-relation friendly, maybe by creating an IR department? (RH asked him to clarify what information he was having difficulty getting.) It was difficult to get on your first conference call and there was only one analyst on the call and no questions.

RH: You are 100% correct on that conference call; we had a technology glitch that we were really mad about. We had 20 people from Jefferies ready for the call and the operator completely screwed it up. But you can contact Richard Khaleel at Jefferies IR and he will be responsive.

Q: Can you give us any color on Joe’s employment contract? In the proxy it says it will end in June.

JS: I’m here until they throw me out.

RH: And we like having him around.

Q: (missed the question)

BF: We didn’t wake up with a hunger for foreign exchange, but we do have a hunger for opportunity. In Beef, we feel there is a big margin for upside.

Q: Congrats on handling difficult circumstances. Is there a level of cash you want to have at the holding company?

BF: We have committed in writing that we’ll hold $400-500M. You can look at where the cash comes from. The FXCM loan is being repaid. That will be about $260M coming back over 12-18 months. Our net free cash is well over $500M. We have a cushion and investment opportunity as the DTA converts into cash.

Q: Have you thought about buying an insurance unit?

RH: Well, we’re in the process of selling one – that’s FGL. The right time to buy was when HRG bought FGL. There will be opportunities again, but the world will be upside down.

Q: I almost feel that the market cap is about what Jefferies would sell for, so it is like I am getting everything Joe and Ian had done for free.

RH: I can tell you that Joe never comes for free. A lot of the value is tied up in financial services; we will execute but it will take time.

Q: What is your thought process on buying distressed assets when the world is on fire versus platforms that you can build?

BF: It is both. Waiting for value and the world to end as a singular strategy is not enough to build value. Platforms like Berkadia and Garcadia are low risk and have good value. It is a different way to get the same result. Over the last 30 years, distress cycles are getting shorter and less attractive because there is more capital for arbitraging down opportunities.

Q: Are you still building out the investment banking team in other countries?

BF: We have over 900 people in Europe. Europe was a modest star performer last year. It has worked and will continue to work for us.

Q: You mentioned it is a good environment to sell insurance. What is a full price? Is it book, premium to book, or some other multiple?

RH: I think a premium to book is a reasonable expectation given the way the world works now.

Leucadia National
Leucadia National