The Stock I Like Best: Leucadia National Corp. (LUK) by Remick Capital

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Summary:

From time to time the market hands investors an apparent opportunity in which the facts on the ground about what a business is worth, seem to deviate from market price driven estimates so much that you will find yourself looking around in confusion, asking “what am I missing?” Leucadia National is, for me, one such investment at today’s price.

There are many reasons which I believe cause the stock market to discount future possibilities at Leucadia, but the pessimism which permeates Leucadia’s valuation seems short term, and overdone; missing the many positives of the company. Also, I believe there are non-fundamental, emotional and short-sited reasons many legacy holders of Leucadia are throwing in the towel – maybe because they are sad the old leaders are half out the door, or perhaps because they need to realize tax losses this December. I believe their lack of fortitude in combination with Leucadia’s many cyclical business lines currently under earning their potential, is creating a once in a generation opportunity to buy a quality business with great management at a large discount to tangible net assets.

Leucadia History:

In 1978, Joe Steinberg (JS) and Ian Cumming (IC) took over Talcott National, a 125 year old (mostly) factoring business, which was a struggling company with a negative net worth at the end of 1978. By mid 1979, JS and IC had completed a restructuring of Talcott and subsidiaries by extinguishing approximately $160m in debt with $130m in capital that was raised primarily by selling financial subsidiary assets. Through this move and a few others, Talcott moved from negative $8m in equity in the business at the end of 1978 to nearly $30m in equity by the end of 1979. From that auspicious beginning, IC and JS took Leucadia National, newly renamed in 1980 with the sale of the factoring business, on a run of acquisitions, divestitures, restructurings, and various business deals that would culminate in a company at the end of 2012 with one of the great capital allocation records during that timeframe of any public business; compounding shareholders equity per share at greater than 18% / year (including dividends).

Characterizing IC and JS’s style of management during this 3 decade run is not hard. They tried to buy cheap, distressed, and sometimes mismanaged assets. They would clean out and restructure these assets, take care of them for a time, and then when the time was right, sell to a buyer when the fog of war was gone and the assets were no longer as distressed.

They did hold some of their businesses for the long term, but in general, they excel(ed) at buying what no one else was willing to pay up for, seeing value where others didn’t, buying where others feared to tread completely, and importantly, leveraging extensive knowledge of the tax code to ensure Uncle Sam’s profit share was reinvested as long as possible.

During this time, JS and IC didn’t have conference calls, rarely were captured in the media, and largely flew below the radar in the investment community and Wall Street. Once each year, Leucadia published a short and informative investor letter with their annual report, and had a short annual meeting with shareholders. They attracted a loyal following of shareholders who profited from their eclectic vulture-like approach to capital allocation and mostly stuck to their knitting.

A sampling of transactions from 1980 to around 2010 is captured below; I provide this only for clients who don’t have a good idea of the scope of activities Leucadia has been involved in over the decades, I’m sure many pertinent items were missed:

1980-1982 – Sold Talcott Factors, bought AIC (insurance), sold roughly half of consumer finance receivables for $200m, bought 57% of TFI (building products and meat product distribution), and sold a ton of company owned real estate.

1983-85 – Repurchased $4.5m in stock, entered into partnership with Jordan company (PE firm), bought Columbia National Life, received bank license (Utah), bought Conwed (for $45m) via TFI, bought leasing services via Ch 11, bought stake in Brae Company (leasing), bought minister, GATX, and Prudential.

1986-88 – Bought back $20m of LUK stock, sold $140m in bonds, added $25m bank line, sold consumer finance operations, sold Ministar, sold 1/3 interest in Carmike via IPO (owned via Jordan Company investments), bought back $10m more in stock, bought Phlcorp (trading stamps and other assets), reached $2B in assets, began to temper expectations of returns, and highlight complexity.

1989-1993 – Sold railcar leasing biz (basically all of Brae) for a gain of $47m, bought back $37m in stock, cuts loose legacy traditional life biz, realizes $17m loss, bought Colonial Penn for ~$130m, Colonial Penn earns $191 pre-tax income 3 years later, sold $125m of notes, rated investment grade for the first time (Jefferies handles the deal), floated $100m convertible notes, resolved El Savadoran electricity subsidiary, realized gain via cash and bonds from El Salvadoran government of $8m, realized $13m gain in Bolivian Power IPO (gained shares from Barbados Power & Light).

1994-1999 – Began a RE buying spree (two Ch11 transactions, buying HomeFed, etc), entered into Wine business, invested $25m in Russian driller, grew and then started winding down insurance business as it was unprofitable, acquired some pre-Inmet assets, liquidated / sold all manufacturing assets except Conwed, had a failed investment in Russian Pepsi bottling operations, repurchased $50m face of preferred stock for $40m, added real estate via Home Fed in San Diego and Washington DC, and paid a large one time dividend.

2000-2006 – Acquired FINOVA in partnership with Berkshire Hathaway (Berkadia), entered into Jefferies credit hedge fund partnership, acquired WilTell and then sold to Level3 for large gains, warned of housing market mortgage problems in 2003, bought Symphony Health, warned about supposedly AAA rated companies having issues with Fraud in 2004 (cited MBIA, AIG, Fannie Mae and Freddie Mac by name), acquired Idaho Timber, MK Gold stake upped and converted into Cobre Los Cruces investment in Inmet, and made Fortescue investment + follow on purchase while discussing that China was driving much of their recent commodity exposure.

2007-2010+ – Took stake in Goober Drilling, bought into Premier Gaming, wrote off tax asset, and then later wrote it back up, invested in Lake Charles Gasification project and Oregon LNG, started Berkadia Commercial Mortgage with Berkshire Hathaway, invested heavily in a 25% stake in AmeriCredit (subprime auto lender) and a 29% stake in Jefferies during the financial crisis, and sold out Inmet and Fortescue stakes near peak of commodity market cycle.

And many more items followed recently.

Jefferies History:

Jefferies namesake, Boyd Jefferies, ran the smallish firm dealing in niche after-hours and off market equity trading for much of the 1970’s and 80’s. In 1987, Mr, Jefferies was convicted of parking stock (essentially holding accumulated stock on his company books to make it look like the real owner doesn’t yet control it) in 1987 for Ivan Boesky (the infamous corporate raider and arbitrager). Frank Baxter took over Jefferies from its namesake and in a seemingly odd choice, kept the firms name in defiance of the charges. Three years later, Baxter brought over 60 junk bond traders from Drexel Burnham Lambert (Michael Milken’s firm) after its leader was sent to

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