In their 2008 letter to shareholders of Leucadia National (NYSE: LUK), released on April 15th, chairman Ian Cumming and president Joe Steinberg describe 2008 as a year in which "everything came tumbling down." Leucadia reported a staggering loss of $2.5 billion on tax asset writeoffs ($1.7 billion), markdowns of investment securities ($700 million) and interest expense and other items.
Cumming and Steinberg explain the idiosyncratic nature of the tax asset writeoff by providing some color on how tax assets are accumulated in the first place and how they are monetized (hint: you need profits to derive any value from such intangible assets). The Leucadia co-heads state that in the past the company "bought assets and companies that were in extremis and as a result of shepherding them through Chapter 11 we acquired not only a good business, but also a tax loss carryforward or other tax benefit. One such company was WilTel Communications."
The letter discusses in some detail Leucadia's major investments, most of which suffered a disastrous year in 2008. Two of the more prominent investments are investment banking firm Jefferies (NYSE: JEF) and subprime auto lender AmeriCredit (NYSE: ACF).
While reflecting on the past and suggesting they might have quit after paying out a special dividend some ten years ago, Cumming and Steinberg remind shareholders about the continuity of Leucadia's business model over the past three decades:
We tend to be buyers of assets and companies that are troubled or out of favor and as a result are selling substantially below the values, which we believe, are there. From time to time, we sell parts of these operations when prices available in the market reach what we believe to be advantageous levels. While we are not perfect in executing this strategy, we are proud of our long-term track record. We are not income statement driven and do not run your company with an undue emphasis on either quarterly or annual earnings. We believe we are conservative in our accounting practices and policies and that our balance sheet is conservatively stated.
In addition to maintaining a value discipline, "a theme of [Leucadia's] investing [over the past several years] has been to make some investments in those things which are likely to increase in value as the underdeveloped world acquires the means to increase their standard of living." This has included investments in commodity producers, including mining companies Fortescue, an iron ore miner in Australia, and Cobre Las Cruces, a Spanish copper mine. With sharp recent declines in commodity prices, Cumming and Steinberg warn that "patience will be required" to see these investments reach their full potential.
While generally sticking to their guns, the Leucadia co-heads readily admit that it will take an economic recovery for Leucadia to grow shareholder value. Cash flows from the company's manifold operating businesses do not currently cover corporate interest payments, making cash management and cost reductions a top priority. This dynamic also constrains Leucadia on the investment front at a time when true value investors like Cumming and Steinberg have got to be as excited as ever about the opportunities available to them.
While Leucadia is undoubtedly less well positioned to take advantage of the current downturn than company management would like, we have little doubt the company will survive -- and eventually thrive. Leucadia has always tried to make investments in assets that are worth substantially more than the purchase price, and they appear to have succeeded at doing so. Unfortunately, sometimes it takes years for Ben Graham's proverbial Mr. Market to come around to agreeing with those who are right. Indeed, "patience will be required."
Disclosure: No positions.