JEF - Jefferies Group

[petec]

Major disappointment for me is actually the 5y lockup on the rest of NB.

[benhacker]

More than $800m for Garc (I like the biz though).

 

As for your more optimistic comments (note, I'm still very long, and think it's quite cheap, and was a heavy buyer recently...), I think Spek has represented the common view that the JEF part of the business is the wart, but with this announcement it is going to be getting more investment (either view buyback or overt hiring)... that portion of the business is looking better lately, but it's not doing well on an ROTE/ROE standpoint, and Handler has not clearly shown that he has a good handle on predicting the business.

 

I agree optically to the market the news is good (stock is up), to those of us following, I don't think the combined reveal of NB + Garc is surprising so perhaps the renaming news is really counterbalancing that for many here.

 

Just my 2 cents.  The news is "positive" for sure... but the incremental news to me is negative.

[scorpioncapital]

Maybe Jefferies should get into retail brokerage, like Schwab or IB. That business model is not bad. As long as they don't make the money on one hand, and blow it on some errors in merchant banking on the other hand, all should be good. They can take some lessons from IB...don't exceed your area of competence. Keep it simple.

[petec]

More than $800m for Garc (I like the biz though).

 

As for your more optimistic comments (note, I'm still very long, and think it's quite cheap, and was a heavy buyer recently...), I think Spek has represented the common view that the JEF part of the business is the wart, but with this announcement it is going to be getting more investment (either view buyback or overt hiring)... that portion of the business is looking better lately, but it's not doing well on an ROTE/ROE standpoint, and Handler has not clearly shown that he has a good handle on predicting the business.

 

I agree optically to the market the news is good (stock is up), to those of us following, I don't think the combined reveal of NB + Garc is surprising so perhaps the renaming news is really counterbalancing that for many here.

 

Just my 2 cents.  The news is "positive" for sure... but the incremental news to me is negative.

 

Thanks. FWIW:

- I had the Garc stake at $300m which is c. 6x recent annual distributions because I don't have a good way of handicapping how cyclical the business is. I could be pitching way too low but I wanted to be conservative.

- Jefferies may be the wart - I have no strong view here - but it is not nearly as leveraged as it was and has shown the ability to delever fast in the past. I value it at tbv. I wouldn't pay more but I don't see huge risk at that price.

- To me the value of Jefferies is in the deal flow which they can take advantage of using permanent capital. I don't explicitly value this because it is unproven but I like the optionality.

- This deal is far less significant than their "completes transformation" headline implies. There's still a lot of value outside Jefferies and some nice optionality there too.

- I won't be surprised if the HRG stake gets converted to cash soon. Adding the NB and Garc cash and they are staggeringly well capitalised - especially if they don't pay tax on the sales/convert some of that DTA to cash.

 

[petec]

Maybe Jefferies should get into retail brokerage, like Schwab or IB. That business model is not bad. As long as they don't make the money on one hand, and blow it on some errors in merchant banking on the other hand, all should be good. They can take some lessons from IB...don't exceed your area of competence. Keep it simple.

 

I'd actually be quite concerned by a change like that. Retail brokerage is great but saturated and it would be staggeringly expensive to break into when you consider that they don't have a retail network of any sort, fixed costs are quite high (great when you have volume, terrible when you don't), and they'd need to advertise like hell for sticky customers, which is a terrible combination.

[benhacker]

The headline is clearly an overstatement Petec, but now you have Vitesse, Berkadia, Linem, Golden Queen, and Homefed... HRG is getting sold, other businesses are financially related.

 

I'm not so sure that without the name change you wouldn't just say "they are selling some to buy back shares"... but with the name change, I think the character of the direction going forward is clear.

 

Again, I think JEF is a good business, but I've been wrong on the extent of profits I assumed they would make so my view is converging with the conventional wisdom that it is mediocre.

[Foreign Tuffett]

The headline is clearly an overstatement Petec, but now you have Vitesse, Berkadia, Linem, Golden Queen, and Homefed... HRG is getting sold, other businesses are financially related.

 

I'm not so sure that without the name change you wouldn't just say "they are selling some to buy back shares"... but with the name change, I think the character of the direction going forward is clear.

 

Again, I think JEF is a good business, but I've been wrong on the extent of profits I assumed they would make so my view is converging with the conventional wisdom that it is mediocre.

 

I also thought the auto dealer biz was more worth more. I had it marked in the $700 million range.

 

I don't understand why they aren't being more aggressive with share buybacks. They are shrinking their business, the pro forma holding company is overcapitalized, pouring money into Jefferies is (IMO) unlikely to produce a strong ROIC, so why not be very aggressive in shrinking the share count?

 

How is Jefferies a good business?* It has a massive balance sheet, yet ekes out a barely acceptable return on its net tangible capital. Maybe operating results will improve as interest rates rise and/or market volitility rises?

 

* I don't mean this to come off as rhetorical. I am open to being convinced.

[Liberty]

Am I missing something here? They've just sold most of NB for a fat profit, which few would have thought likely 2 years ago, and they've converted Garcadia to cash at (probably) the top of the auto cycle.

 

If they hadn't changed the name we'd all be saying it was a great day. But they changed it so apparently that chucks all the good work of the last 5 years in the bin.

 

Has anyone considered what would have happened if they hadn't done the deal? Lots of junk assets and with the executive team on the way to the door? I have no view on whether it was a good deal but I don't like the alternative much.

 

Kind of annoying, I was looking forward to adding at 1x tbv ;)

 

Edit: looks like p/tbv has actually fallen so I may have to retract my last sentence!

 

I can't speak for others, but my comment was strictly about the way that the JEF merger was described as a succession plan to keep Leucadia going after C&S (the name, the model, etc). I have no opinion on whether these moves are good financially for shareholders or not, as I've not kept track of LUK assets.

[benhacker]

How is Jefferies a good business?* It has a massive balance sheet, yet ekes out a barely acceptable return on its net tangible capital. Maybe operating results will improve as interest rates rise and/or market volitility rises?

 

* I don't mean this to come off as rhetorical. I am open to being convinced.

 

I clearly don't mean to say that it is historically or financially a "good business".  It's been decent to good in the past, but never blew away the competition.  I mean to say that I think it can be a better business primarily by benefiting from scale (augmenting a non-IB large financial).  I also think it can be a better business than has financially been the case in the recent past (rates, internal scale, reputational improvement)... nothing crazy, but mid-teens ROE kind of business.

 

Both my angles on why the biz is good have not yet come to pass, and perhaps I am wrong.

 

Side note, I would strongly agree generically that buybacks are a good use of capital here... I have noted as much to Handler, so I hope he's listening and I hope others are saying the same.

[racemize]

I held this one for a long while for many of the positive reasons listed here, but sold it when it approached book value last year (higher than current price).  Here are my issues with it:

 

1) Even in the good quarters, I'm not seeing Jefferies earning an ROE that gets you to over book value, and it appears that this is the main business these days (I agree the others were undervalued, but they aren't showing growth and are being sold off).  In other words, I get the reasons for the recent underperformance, but I'm having trouble seeing the normalized earnings being much more than 10% RoE?  When this deal initially happened, I liked it because Jefferies had actually increased book value faster than Leucadia over the prior decade, but as soon as it happened, Jefferies has just been a dog.  While the missteps recently masked earnings, I came to the conclusion that the secular IB stuff had just made it a tough business.  Maybe I'm wrong here and they will show something good, but every time I looked at a good quarter, it just didn't seem that great, even if they kept it up all year.

 

2) I liked the FXCM type deals, and I like cleaning up some of the junk.  The energy stuff and the AUM seeding didn't seem that good to me. 

 

3) Jefferies management likes to give itself a lot of stock, particularly when undervalued, all the while not really meaningfully buying back stock.  I'm not really seeing them as being on our side so much, which seemed more like the original two's style.  Or said another way, Handler sure did well while our returns were in the crapper...

 

I'd probably buy it again if it were at a big discount though.

 

Edit: I'm happy to be wrong here, and am doing this off memory, so please point out if my thinking is off somewhere.

[benhacker]

I held this one for a long while for many of the positive reasons listed here, but sold it when it approached book value last year (higher than current price).  Here are my issues with it:

 

1) Even in the good quarters, I'm not seeing Jefferies earning an ROE that gets you to over book value, and it appears that this is the main business these days (I agree the others were undervalued, but they aren't showing growth and are being sold off).  In other words, I get the reasons for the recent underperformance, but I'm having trouble seeing the normalized earnings being much more than 10% RoE?  When this deal initially happened, I liked it because Jefferies had actually increased book value faster than Leucadia over the prior decade, but as soon as it happened, Jefferies has just been a dog.  While the missteps recently masked earnings, I came to the conclusion that the secular IB stuff had just made it a tough business.  Maybe I'm wrong here and they will show something good, but every time I looked at a good quarter, it just didn't seem that great, even if they kept it up all year.

 

2) I liked the FXCM type deals, and I like cleaning up some of the junk.  The energy stuff and the AUM seeding didn't seem that good to me. 

 

3) Jefferies management likes to give itself a lot of stock, particularly when undervalued, all the while not really meaningfully buying back stock.  I'm not really seeing them as being on our side so much, which seemed more like the original two's style.  Or said another way, Handler sure did well while our returns were in the crapper...

 

I'd probably buy it again if it were at a big discount though.

 

Edit: I'm happy to be wrong here, and am doing this off memory, so please point out if my thinking is off somewhere.

 

I think this is the forming consensus view, and why LUK trades at a "discount" to a simple NAV.  HoldCo overhead + lack of pickup expected in ROE getting to "normal"... thus discount is warranted.

 

I don't mean consensus here as a subtle pejorative by the way!

[racemize]

 

I think this is the forming consensus view, and why LUK trades at a "discount" to a simple NAV.  HoldCo overhead + lack of pickup expected in ROE getting to "normal"... thus discount is warranted.

 

I don't mean consensus here as a subtle pejorative by the way!

 

Well, I'll end up being wrong one way or another: either initially for thinking the consensus was wrong or now for succumbing to it.  I guess I'd rather be wrong the second time...

[Mungerish]

I was just getting ready to give them hell at the annual meeting...Asking for patient LT investors is one thing, but like a beautiful young woman in her 30's, every investor has opportunity costs and a clock that's ticking.

 

I'm very happy with the sale and catalyst.

I think the name change is about revaluation.

There is only one IB that sells under 1.5X TBV and that is C

They have no earnings and are still in the crisis penalty box.

 

TBV today is over $24 with sale....So 1X TBV for a company that keeps churning out these merchant banking gains is kind of b bat sh*t crazy...No?

I have a chart on my office wall of the long term history of P/BV and P/TBV for both LUK and JEFF when it was independent...It paints a very different picture than 1x

[petec]

Unless I have missed something Jefferies has just become a smaller part of this. TBV is now over 9bn and JEF is still 3.8bn. What has become a bigger part is cash. The holdco is now net cash, and heavily so if HRG gets converted any time soon.

 

I would sell in an instant if that cash gets poured into Jefferies and I am wary of a buyback, despite the optics, for the same reason: I don't want Jefferies to grow in the mix.

 

What I do want is for cash to be put to use in great new ideas. I love what they have done with the portfolio they have inherited but I am underwhelmed by the number of new ideas they have generated. This may be because sorting out the legacy portfolio has taken a lot of time or it may be because they just aren't seeing the opportunities. I suspect and hope it is the former.

 

FWIW I like LAM - no harm giving your capital to smart people to manage, especially if you get a stake in the management company for free. Feels like a heads I win big, tails I don't lose much scenario. All the monster asset managers started somewhere. Obviously if it turns out all the fund managers are morons it will be a nasty experience, but that's true of just about anything I can do with my capital.

 

Mungerish - I have the same charts but I think  there is a way to go before we regain those lofty heights! Need a few home runs generated by this team rather than just realised by them.

[Snorky]

I was just getting ready to give them hell at the annual meeting...Asking for patient LT investors is one thing, but like a beautiful young woman in her 30's, every investor has opportunity costs and a clock that's ticking.

 

I'm very happy with the sale and catalyst.

I think the name change is about revaluation.

There is only one IB that sells under 1.5X TBV and that is C

They have no earnings and are still in the crisis penalty box.

 

TBV today is over $24 with sale....So 1X TBV for a company that keeps churning out these merchant banking gains is kind of b bat sh*t crazy...No?

I have a chart on my office wall of the long term history of P/BV and P/TBV for both LUK and JEFF when it was independent...It paints a very different picture than 1x

 

 

Would you mind to share pictures of the charts?

 

Best,

 

Ben

[scorpioncapital]

IB can be very good if inflation picks up. They carry lots of cash like assets which will earn more and their cost of capital will be partially funded by their customers and - hopefully locked in long term debt.

But I agree there is a risk that the new cash inflow will be squandered or not invested optimally. This is why I've seen many pools of cash and everything depends on the intelligence of the Prime Capital Allocator. I remember LMCA when they had split off and was just a pile of cash. It was trading below cash. You had a team known to make surprising and quality deals. A few months letter they bought Formula 1. This wasn't known at the time...but the point is that track record becomes more meaningful when someone has to make investing decisions , especially at a holding company.

[arcticfox]

As a longtime shareholder I am pleased with the actions taken to highlight some of the value in the company. I don't fully understand the name change but if it drives a higher multiple and they think the brand awareness is better, than great. One of the reasons I liked the company was that it wasn't a pure financial. The name change and direction signals an effort much more towards Jefferies traditional model, which I don't completely understand as Jefferies results have ben nothing special. I still struggle to understand why it doesn't trade North of $30. They are beginning to demonstrate again that value exist and they can grow book value. From a cycle stand point it feels a bit late so I hope they can continue to find the balance between occasional opportunities and holding cash for the downturn.

[petec]

The name change and direction signals an effort much more towards Jefferies traditional model.

 

Not necessarily. What they have said is that naming the holdco Jefferies will help Jefferies the operating company. I'm not sure I understand that. But they have not said they will be pouring equity into Jefferies (in fact Jefferies isn't even retaining its profits - it paid $200m to holdco in January), and they have said they are keeping the Leucadia for the merchant banking (i.e. investment) operations where it has a great brand. That's not such a big change.

 

They have also said that they have become a diversified financial services holding company. That does not mean they are moving back to the Jefferies model. The key word is diversified. Jefferies, Berkadia, LAM, and FXCM are clearly financial services, and so is merchant banking if you look at it as an activity rather than at the underlying holdings. However those underlying holdings are still mainly nonfinancials - HRG, Homefed, Linkem, Vitesse, National Beef, and others - and there is nothing to indicate they will not do more of these.

 

I expect Jefferies to continue to become a smaller part of the mix as the other businesses grow and as merchant banking compounds its capital over time.

 

So what's really new? We have all known a sale of NB was coming but the news is still welcome. The sale of Garcadia is a surprise but not a particularly bad or material one. The name change is more or less irrelevant unless it signals a change of direction. There is some confusion around that but actions speak louder than words and so far none of the actions point towards a greater reliance on Jefferies' traditional activities.

 

I think this is very much inline with the actions of the past 5 years. They are trying to build a business with ongoing cash generators (Jefferies, Berkadia, LAM, maybe Vitesse and FXCM) and optionality around deployment of permanent capital (merchant banking). What's new is that they have cleared the decks in the merchant banking portfolio, ready to go on to the front foot. That's not a change in strategy.

 

The proof will be in the next few actions: if they pour equity into Jefferies then I am wrong. If they do some great merchant banking deals then I am right. Here's hoping.

[arcticfox]

I probably wasn't clear enough. It sounds like they are trying to grow the less risky part of jefferies, investment banking. While I believe they are going to do merchant banking type investments it sounds like it will be closer to the Leucadia asset management focus, or fxcm versus a garcadia type. They do state that Jefferies is by far our largest business and our engine of opportunity. Peter, I hope you are correct. We will have to watch the next few investments. In the meantime I would think that stock buybacks are attractive and still think that dividending the hrg/spb position out makes sense.

[petec]

I read the comment about "engine of opportunity" as a reference to the fact that Jefferies sees a lot of deal flow that it can pass to the merchant banking side, not as a statement of any intent to grow Jefferies' investment banking arm. Was there anything specific that led you to that conclusion?

 

Ever since the merger the chat has been about how exciting it is to have the deal flow of an investment bank AND permanent capital. Now they've cleaned up the legacy portfolio and got some cash we will see how true that is.

 

I am not sure it is consistent to want Jefferies to be a smaller part of the whole and to want buybacks. If we want Jefferies to shrink in the mix we need that capital to be deployed, not used to buy back shares (and ideally we need HRG to be turned to cash internally and redeployed but that might be harder for tax reasons, I don't know).

 

 

[petec]

On deferred tax assets my reading of page F-90 of the 10K is as follows:

- the net deferred tax asset is $743m

- of this $600m is NOLs

- the total NOL is actually $2.4m, $1.2m of which can be used to offset the taxable income of any subsidiary and $1.2m of which can be used to offset the taxable income of specific subsidiaries. Given this wording around taxable income I assume it cannot be used to offset capital gains.

- the full $2.4bn is not recognised on the balance sheet as it is currently considered unlikely to be realised (expiry starts 2023) - they may be writing some of this back onto the balance sheet given the comments in yesterday's release but actually I think this wording probably refers to part or all of the $93m valuation allowance detailed in the table.

 

Does this look right? 

[Mungerish]

I think the share buybacks are symbolic in one sense. They came under significant criticism at the annual meeting on occasion since the merger for not buying back more stock when it was trading below TBV and BV. The answer was that they needed JEFF to be highly liquid and could not risk having problems during severe market volatility or crisis.....and they view those periods of crisis as a given in markets.

 

Now with the additional liquidity, they would be hard presses to make that argument and not look like they have no faith in what they are doing. 25mm shares would be 7% of the float without dilution at a cost of $25 per share or $625mm. They wont do it all at once or even at all....Not to mention these things are partially used to offset option and stock grants.

 

I think they would rather invest the capital in outside opportunities, but can't escape the elephant of undervaluation in the room.

[petec]

Funnily enough I would see retaining capital as signalling faith in what they are doing. If this thing is undervalued then it has been undervalued for a long time. That suggests the market doesn't get it. The way to fix that isn't to buy back stock at a small discount to tbv - it's to blow the doors off with a triple-bagger sourced from your supposedly well-positioned investment bank!

 

I'm not denying the maths of buying back below tbv but it would increase the weight of Jefferies and reduce their firepower. I prefer Jefferies getting smaller and lots of firepower. Each to their own.

[scorpioncapital]

"That suggests the market doesn't get it"

 

Usually the market is right say 70% of the time. Value investors make their fortunes in the 30% when the market isn't right or by just riding along in that 70% part, perhaps with slightly superior companies.

 

So the probability is the market is right about LUK. Namely, that it doesn't trust them to make good capital allocation decisions and hence the discounts. If evidence comes to the contrary, then I would expect the market to re-rate the share price upward - perhaps with some lag.

 

But one has to make an argument what they are doing that is so reformed and intelligent compared to the past.

 

 

[petec]

Sorry - my point wasn't that the market is missing something (though I think it is). My point was that the way to prove that the market is missing something is to do great deals, not to buy back stock.

 

I do think the market is missing something though - both these companies had good records before the merger and even if Jefferies is no longer the business it once was, the combination of its deal flow and permanent capital could lead to regular big merchant banking gains.