JEF - Jefferies Group

[jay21]

Just an article link...

 

The Stock I Like Best: Leucadia National Corp. (LUK): Valuation Analysis

 

http://www.valuewalk.com/2015/12/the-stock-i-like-best-leucadia-national-corp-luk/

 

 

 

As of this posting I have no position in Leucadia.

 

Pretty sure this is benhackers writeup.

 

Thanks ben!

[scorpioncapital]

What incentive does LUK have to renegotiate the FXCM loan / participation rights terms? The only incentive is reduced mark to market volatility each quarter due to the way they treat the derivative rights. But is that temporary gain or loss worth giving up the fact that they effectively own 90% of the company? The easiest solution is just buy out the whole thing - 100% and consolidate it and remove the public shares which is a circus. Or keep some sort of dividend paying preferred with a rights kicker for say 50% of the company. I just can't see why they'd loosen the noose so to speak.

 

Depends on key man risk.  If there are key guys who have shares and can see all their hard work accruing to Leucadia, they might either leave or just not work hard.

 

The management bankrupted the company. The risk is keeping them, not letting them go, I'm surprised Leucadia as the effective owner didn't just install new management. Probably they thought it wasn't their fault but then again is it ever anybody's fault when a company goes bankrupt if it wasn't just for that lack of funds in the bank? :)

 

 

[Guest roark33]

The problem with these SOTP analysis is that the writer rarely understands each individual business well enough.  For example, FXCM is almost certainly not worth 759m-1.0B.  That's a company I know well, and looking at that valuation makes me skeptical of all the other numbers. 

 

Just my two cents.

 

[benhacker]

Roark, would love to hear your thoughts on the FXCM valuation.

 

Post LUK-FXCM deal I was short FXCM and got what I felt was a fairly decent feel for a range of what I thought the business was worth, but would love to hear another perspective.

 

Given the EV of FXCM prior to the CHF move was >$1.5B, would you say that:

1) That EV egregiously overvalued FXCM's enterprise?

2) That EV was materially impaired post CHF move?

3) Something else (and/or a combo)?

 

Always love other thoughts.

 

Thanks,

[Picasso]

roark, I'll have you know that the guys on Twitter think FXCM is going back to $150.  Something about filling a gap...

[Guest roark33]

Ben-

I think it is a combination of both. 

TTM ebitda before the crisis was around 90m, valued the company at about 15 ebitda, but this was "ex-cash", which I think the SNB event has showed that FXCM needs that cash (and more) to operate without going bust.  FXCM still talks about excess capital, but I think they probably don't have enough now. 

 

TTM ebitda now is around 35-40m for ongoing and discontinued businesses.  Assuming they recut the deal with LUK and get the keep all the operations, what's that worth going forward?  600m?  15x?  155m goes out the door to the converts, so LUK is left with around 450m. 

 

The operating leverage in this business requires a high level of volume, but I think lower leverage standards and credit card rules will continue to bring these numbers down, in addition to competition.  Also, FXCM is switching its model to "Dealer's Desk", which was one of its main selling points pre-SNB. 

 

LUK will do fine in this deal and make money, maybe even 600m on its 310m investment, but thinking the low end is 759m struck me as aggressive right off the bat.  Also, my focus is more on whether FXCM is still a good short at these prices.  I was short after the LUK deal got signed when the stock spiked up to 5 and stayed around 3 before drifting down to 1.  If LUK wants mgmt to stick around, they might have to re-cut the deal. 

 

Are you long FXCM now or thinking about a short?  I posted to this board a few weeks back after Niv hinted about re-cutting the deal when the stock was at $6.  day traders have pushed it up to 19 now, which I think is insanity, but happy to hear other opinions. 

 

Picasso--I am waiting for the double-top head and shoulders or some other brand of shampoo to start my short position (technically, have started a small short already)...

 

[benhacker]

Thanks Roark,

 

No, I am most certainly not long FXCM, hahah... the common is toxic (at current prices) IMO... not necessarily that's crazy overvalued, but it is really high risk and converts would be a better way to invest in FXCM thesis I think. 

 

I would re-short assuming the deal doesn't get recast (as the implicit value to LUK stake according to common is already above or at the top end of my range of value) probably, although recasting the deal is an uncertainly I wouldn't / don't want to take on an illiquid / high-borrow short at this time.

 

Ok, you answered my next question already which was if you think my LUK stake valuation is aggressive, you clearly agree that FXCM is a hard $0 so shorting makes sense.

 

I don't have a super strong opinion, but I appreciate your points and your valuation thoughts.  Just hard for me to say the market is so wrong, unless I am willing to short FXCM here... and if so, then I can stub out the value in my SOTP right now by shorting FXCM, so either way I'm not so sure my valuation is off depending on how you think about it.

 

But your bearishness will have me poke back at FXCM a bit more in the coming weeks.

 

Side note, you said that LUK invested "$310m" but cash out for that was <$280m  it was bought below par and JEF made deal fees (pretty sure, don't have my notes in front of me).  Perhaps not relevant here, but thought I would mention.

 

I'll revisit my valuation which does need to change as the term loan gets paid down, but again, if this particular piece of LUK is offensive, it can be stubbed out above my estimated value, but that does come with borrow risk and deal recast risk....

 

Thanks for your thoughts at any rate, and the way I do these values, each range has a 20% chance of being wrong (that's at least how I try to think about it, 10% on each end) in the end, so maybe this will be one of those.

 

I totally agree with you on the problem in general of SOTP evaluations BTW...

[Picasso]

Not a lot to add here, but I think the FXCM deal is an example of the ability of management to show competence at managing shareholders capital.  A couple more savvy deals and you can easily trade at book value.  That said there are a ton of stocks trading at large discounts to SOTP.  I think the best SOTP stories are ones where you are temporarily under earning a long-term attractive franchise.  Otherwise it's just another story in a long list of cheap stocks that show low returns on capital.  I'm still undecided on whether LUK is temporarily under earning, but I like their long-term bonds at 8-9% yields.  This is one of those stocks where you'll get 90% of the returns in a short period of time, people jump in the stock, and it flat lines again.  Patience is key here but there's a lot of opportunity cost if you're wrong.

[scorpioncapital]

Under-performance can usually be attributed to 1) management mis-allocation of resources and 2) lack of a moat. In financial services, you have some moat and some commodity aspects - probably more of the latter. But it's a muddy mix of management and moat dynamics. I hold a small stake in LUK now (down from a pretty big stake before) but it has not performed to my expectations for a long many years and it is hard to believe it is just the environment. When I played Bridge I learned an important lesson - you don't need the best hand, you don't even need a good hand. You can have any combination of cards, the key is how you play them and isolating the skill component. Yes, it's easier to win with a great hand but then, anybody with that can do well (that's Buffett's genius by the way - play a good hand and play it better than others so you have a double gain effect). What's really scary is when someone has a great business and still manages to lose due to inattention or inexperience (say like using margin)! That is also not unheard of in the investment business.

 

 

[undervalued]

Sinking like a rock. Is it time to back up the truck yet?

[scorpioncapital]

It's the only stock I follow that seems to be approaching it's 2008 financial crisis lows that isn't in energy or bankrupt, that is kind of troubling...

 

 

[bookie71]

I was in LUK for many years, but haven't been able to get comfortable with the new management.

[twacowfca]

I was in LUK for many years, but haven't been able to get comfortable with the new management.

 

It's the same MO, but their sweet spot is being ready to write  a check to buy the whole company quickly when there is an otherwise good financial company in short term distress.

 

:)

[petec]

I was in LUK for many years, but haven't been able to get comfortable with the new management.

 

Interesting - I'm the other way round.  I was uncomfortable with the prior management's commodity investments (some of which worked out great, but I didn't want "value" managers getting on the commodity "higher for longer/ever" bandwagon.  The new guys have done a good job of compounding in a tough business (Jefferies) and have tidied up Leucadia dramatically.  I'm back in after a 5-year hiatus and I'm excited about the long term compounding possibilities.

[Spekulatius]

I assume the ~$460M in energy investments (Juneau, Vitesse ) are probably zeros. National beef seems permanently impaired and Jefferies profitability has been subpar for years.

 

 

I know we had this discussion before, but why is owning this stock better than GS? GS tangible book is about $162/share, so you can buy this stock for tangible book. Wee know that GS marks tend to be conservative and they own a huge wealth management business that is certainly worth more than tangible book. Buying GS right now is buying a dollar for 80c or better - and they do have a reasonable overall return  on equity (~10%) which LUK does not, due to so much dead weight.

 

I would so argue that being a TBTF bank has it perks, as your customers won't be running from you if there is a hiccup in the financial markets. I am not so sure about how Jefferies will be viewed in such a case.

[scorpioncapital]

new LUK is knee-deep in commodities like old LUK. Jefferies is an I-bank with a very large concentration in energy and junk bond trading and lots of their profits are linked to commodity companies vs other banks. In terms of their other businesses, I'm hard-pressed to name one that isn't a real commodity business. Linkem? the money given to hedge fund managers (what are they doing?)

[thepupil]

I assume the ~$460M in energy investments (Juneau, Vitesse ) are probably zeros. National beef seems permanently impaired and Jefferies profitability has been subpar for years.

 

 

I know we had this discussion before, but why is owning this stock better than GS? GS tangible book is about $162/share, so you can buy this stock for tangible book. Wee know that GS marks tend to be conservative and they own a huge wealth management business that is certainly worth more than tangible book. Buying GS right now is buying a dollar for 80c or better - and they do have a reasonable overall return  on equity (~10%) which LUK does not, due to so much dead weight.

 

I would so argue that being a TBTF bank has it perks, as your customers won't be running from you if there is a hiccup in the financial markets. I am not so sure about how Jefferies will be viewed in such a case.

 

LUK trades at 73% of tangible capital. JEF's IB is 44% of that. I don't think the two are really comparable. 

 

If we write off National Beef, Vitesse, Juneau, Golden Queen, Linkem, 1/2 of the DTA, 50% of FXCM, and mark JEF at 85% of tangible, you get to the stock price.

 

I think at this point (and I recognize I've said this at higher prices) the issues are priced in and the optionality is very high. Taking the above steps to impair the assets is probably overly harsh, but leaves you at a good starting point in terms of owning the other stuff.

 

- Berkadia, maybe worth 8-16% of the market cap as a good, albeit cyclical, business that is easily monetizable given the other side of the JV is Berkshire. It's not worth $200MM.

 

-Garcadia and being a landlord to garcadia seems like a decent business worth more than its mark

 

- Harbinger pro-forma for the closing of the FG&L sale in Q2 (which has some China risk) will be a no net debt owner of Spectrum Brands so that's 10% of the market cap that's in a relatively easy to understand/ get comfy with business (making George foreman grills and other crap).

 

-Homefed is marked well below its market value and is monetizable

 

Leucadia is my biggest $ PnL loser of all time due to combination of a 30+% drawdown and big sizing (think it was maybe 15% or so at peak). It was a mistake at $24 and a bigger mistake not selling in the low $30's when I thought it was getting a bit ahead of itself but was trying to be all "let the winners run".

 

That being said, I see a ton of levers to pull to convert non-earning assets into more obvious forms of value.

 

Side note: I thing buying HRG and shorting out the FG&L deal risk and SPB MTM may be a nice way to play a Harbinger simplification/restructuring. Steinberg is highly incentivized to close the NAV discount for LUK's sake. Haven't run the exact numbers though, just spitballing.

[plato1976]

I am wondering why LUK is esp strong in this pullback

 

I assume the ~$460M in energy investments (Juneau, Vitesse ) are probably zeros. National beef seems permanently impaired and Jefferies profitability has been subpar for years.

 

 

I know we had this discussion before, but why is owning this stock better than GS? GS tangible book is about $162/share, so you can buy this stock for tangible book. Wee know that GS marks tend to be conservative and they own a huge wealth management business that is certainly worth more than tangible book. Buying GS right now is buying a dollar for 80c or better - and they do have a reasonable overall return  on equity (~10%) which LUK does not, due to so much dead weight.

 

I would so argue that being a TBTF bank has it perks, as your customers won't be running from you if there is a hiccup in the financial markets. I am not so sure about how Jefferies will be viewed in such a case.

 

LUK trades at 73% of tangible capital. JEF's IB is 44% of that. I don't think the two are really comparable. 

 

If we write off National Beef, Vitesse, Juneau, Golden Queen, Linkem, 1/2 of the DTA, 50% of FXCM, and mark JEF at 85% of tangible, you get to the stock price.

 

I think at this point (and I recognize I've said this at higher prices) the issues are priced in and the optionality is very high. Taking the above steps to impair the assets is probably overly harsh, but leaves you at a good starting point in terms of owning the other stuff.

 

- Berkadia, maybe worth 8-16% of the market cap as a good, albeit cyclical, business that is easily monetizable given the other side of the JV is Berkshire. It's not worth $200MM.

 

-Garcadia and being a landlord to garcadia seems like a decent business worth more than its mark

 

- Harbinger pro-forma for the closing of the FG&L sale in Q2 (which has some China risk) will be a no net debt owner of Spectrum Brands so that's 10% of the market cap that's in a relatively easy to understand/ get comfy with business (making George foreman grills and other crap).

 

-Homefed is marked well below its market value and is monetizable

 

Leucadia is my biggest $ PnL loser of all time due to combination of a 30+% drawdown and big sizing (think it was maybe 15% or so at peak). It was a mistake at $24 and a bigger mistake not selling in the low $30's when I thought it was getting a bit ahead of itself but was trying to be all "let the winners run".

 

That being said, I see a ton of levers to pull to convert non-earning assets into more obvious forms of value.

 

Side note: I thing buying HRG and shorting out the FG&L deal risk and SPB MTM may be a nice way to play a Harbinger simplification/restructuring. Steinberg is highly incentivized to close the NAV discount for LUK's sake. Haven't run the exact numbers though, just spitballing.

[wachtwoord]

Btw, does anyone else think the 6 5/8% of 2043 @ $99 are cheap?

 

390 or so over the 30 yr seems like decent compensation for the credit risks of this business.

 

Compare the financials heavy i-shares preferred stock index at 5.6% and vanguard long term investment grade @ 3.76% and the vanguard long term corporate bond @ 4.2%.

 

I know some of you may scoff at this, but for the right buyer (like a retiree) this seems like decent relative value.

 

at the risk of being laughed out the room for accepting a low rate of return, I have recently purchased some more of these at 89 3/4% of par for a YTM of 7.5% for both my and my parents account (in an IRA for them).

 

these are 440 over the 30 year and are well collateralized by $7.6B or so of tangible equity (half of which is NOT  Jefferies). There is about $1B of holdco debt. So you are writing insurance on the bottom $1B of of Jefferies and other LUK equity and getting paid a reasonable equity rate of return to do so ( I don't believe the S&P or Russell will return anywhere close to 7.5% at current valuations over the next say 5-10 years). A further back up in rates only increases your rate of re-investment (<---this is a cop-out way to dismiss the duration risk).

 

I also own LUK stock, which I think is very cheap given the changes in the assets that are occurring, but the bonds are obviously a different set of risks/reward.

 

$83.5, 8.12%, 515 spread to the 30 year...I am hoovering these in.

 

I purchased some at 80.26 (8.47% yield) 575 spread over the 30 year. Thanks for the tip! (my limit order stood for a few weeks).

[scorpioncapital]

What happens if 30 years treasuries go to 10%?

 

[wachtwoord]

What happens if 30 years treasuries go to 10%?

 

Nothing good for this bond. It's 3.5% of my portfolio though.

 

If long term treasuries go to 10% I probably should consider buying bonds exclusively Very different from today's situation. In my short investing career (5 years) this is the first bond I ever purchased).

[thepupil]

What happens if 30 years treasuries go to 10%?

 

What happens if the S&P multiple goes to 6X?. 10% on 30yr is probably just as likely.

 

these bonds have duration of about 11. whether it's through spread widening or rates backing up, you'll lose a little less than 11% for every 100 bps of additional YTM. As it declines in dollar px, duration obviously decreases on the way down. I'm satisfied with the carry comfortable with the credit risk. if rates back up and my bonds lose value, so be it.

 

I see spread tightening as a more likely scenario (no strong view on rates), but am also comfortabl holding and just clipping coupon if there is no tightening. 

 

But to answer your question more directly, if spreads were to stay constant and the 30 yr went to 10% and these traded to about a 16% yield, then the bonds would be in the low 40's and you'd be down 50% from price return, less the carry you clipped along the way. Other asset classes would likely do no better. What has more duration, a 30 yr bond at 8.5% yield (actually a 27 yr bond) or the S&P at 19X earnings or a high multiple growth stock or real estate etc.? An increase in the cost of capital of that magnitude would kill lots of risk assets.

 

[scorpioncapital]

Indeed, such a scenario does sound like holding cash until the rates rise would provide some juicy opportunities.

[Picasso]

Agree with pupil.  If anything you're reinvesting your coupons at higher rates of return on a fixed return asset.  You'll actually make more even though the market value drops, you just don't realize it when it happens.

 

I'm probably the only guy who likes to see bonds drop in price if I'm comfortable with the credit risk.

[Mungerish]

Thought this might be of interest. LUK and Jeff Price to TBV