As I’ve noted in previous articles, my portfolio has not changed since the start of the year; as of Monday, that is no longer the case. My first trade of the year was a sale - I disposed of my entire stake in Leucadia (NYSE:LUK), which accounted for roughly 3% of my portfolio prior to the sale. I first discussed Leucadia in a value contest submission back in April 2012. In the year and a half since that time, the stock has returned about 20% to equity investors (including dividends and the proceeds from the spin-off of Crimson Wine Group); the increase in the share price plays a part in why I decided to part ways with LUK.
At the time, the stock traded at a small discount to book value (which I pegged at about 0.9X); at the end of the most recent quarter, Leucadia reported $10.1 billion in shareholders’ equity against 367.7 million shares – with book value per share at $27.50, and the current price/book multiple at a slight premium to 1x. That’s not much of a change – and it wasn’t the primary factor in my decision. There are three things that happened in the past year that made me uncomfortable with continuing to hold Leucadia looking forward: Fortescue, National Beef, and Jefferies.
As noted in the original write-up, I believed that Leucadia’s book value at the time materially understated the value of certain assets; the primary driver behind that was Fortescue – with that changing in the fourth quarter of 2012, as outlined in this note from the 10-K (bold added for emphasis):
“During 2012, the Company sold its remaining common shares of Fortescue Metals Group Ltd (“Fortescue”), and recognized aggregate Corporate securities gains of $543,713,000. The Company’s initial investment in Fortescue also included a $100,000,000 unsecured note of Fortescue’s subsidiary, Chichester Metals Pty Ltd (“Chichester”), that accrued interest at 4% of the revenue, net of government royalties, invoiced from the iron ore produced from certain project areas (the “FMG Note”). During the fourth quarter of 2012, Chichester redeemed the FMG Note for aggregate cash consideration of $715,000,000, resulting in the recognition of a pre-tax gain of $526,184,000, and the parties agreed to settle all pending litigation and disputes without any additional payment. The Company has received aggregate cash proceeds in excess of its investment of $2,313,272,000, which reflects all sales of Fortescue common shares, interest collected on the FMG Note (net of withholding taxes), the redemption of the FMG Note, expenses and the cost of its investment.”
This was the most understated asset on the company’s balance sheet (in dollar terms), and among the easier to put a directional value on (the same cannot be said for Sangart, as an example – it could prove to be worthless despite continued investments in R&D; with new management shutting down operations as of Q3, that is now the case); with the unsecured FMG note redeemed, this hidden value was realized (it proved worth much less than I had expected, but was also realized over a much shorter time period than would’ve occurred had it been held).
Leucadia purchased an 80% stake in National Beef, which holds a 14% share of the U.S. fed beef processing market, for $868 million at year end 2011. According to data compiled by competitor Tyson Foods (TSN), this 14% share makes National fourth in the industry – behind Tyson (26% share), JBS USA (23%), and Cargill (23%). After spending some time trying to get comfortable with the industry and gain a further comprehension of the underlying fundamentals, I still can’t get a hold of just what attracted Leucadia (the price appeared far from excessive, but it doesn’t jump out as a very attractive business either); in the most recent year, the pre-tax return on assets for the business was slightly above 3% (with Tyson reporting comparable results in the protein over the past decade). Simply put, I’m not comfortable with owning this business in the coming decades based on what I currently know.
Leucadia and Jefferies announced plans to merge in November 2012, with Jefferies becoming a wholly-owned subsidiary of Leucadia in March of this year. Without going into more details than necessary, here’s the critical statement from the 10-K: “Jefferies will be the Company’s largest investment, and will continue to operate as a full-service global investment banking firm in its current form.” Much like National Beef, I have little confidence in my ability to form realistic expectations about what the next decade will look like for Jefferies (particularly the “Capital Markets” segment); a great example was the fiasco surrounding the company’s exposure to Eurozone debt in November 2011, which was a large driver in the stock’s decline of more than 60% from the start of that year (eventually bottoming near 0.6X book). It’s not the fall in the stock that concerns me – it’s the inability to discern what is really going on and just how serious it might actually be. Others have the industry knowledge and expertise to do so competently (JEF would likely be a good place to look as the historical financials appear quite good); at this point in time, there’s no question I’m not one of those people.
I believe some of the other one-off pieces of Leucadia remain understated – but with the overwhelming importance of Jefferies - and National Beef to a lesser extent - to the pie as a whole (with the decision to hand the CEO role to Richard Handler speaking to that reality), the upside potential from eventually realizing the fair value of those assets no longer seems attractive enough to move the needle (as noted above, the Fortescue deal went a long way towards that conclusion anyways); at the end of the day, Leucadia is primarily those two investments, particularly Jefferies – and I don’t know anything about either of them that gives me confidence in holding LUK shares going forward.
I thought that might change with time – and maybe it will. If it does, then I’ll reconsider an investment in Leucadia; after a few quarterly filings since the start of the year, I can confidently say that is not the position I find myself in today. At this point in time, I will leave the proceeds from the sale in cash.
About the author:
As it relates to portfolio construction, my goal is to make a small number of meaningful decisions. In the words of Charlie Munger, "Patience followed by pretty aggressive conduct."
I run a concentrated portfolio, with a handful of positions accounting for the majority of my equity holdings (currently two). From the perspective of a businessman, I believe this is adequate diversification.