Leucadia Sees Huge Increase in Book Value 18 comments
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Leucadia (LUK) is a conglomerate company based in NYC and Utah. The company invests in many different businesses, including wineries, casinos, real estate, medical companies, etc.
Per the 10Q for the period ending 3/31/2009, the company reported total equity of $2.6B. The point of this article is to show how this equity may skyrocket.
Included in Leucadia's many investments is the following:
- Approximately 48.5M shares in Jefferies Group, an investment bank
- Approximately 33M shares in Americredit, an auto loan finance company
- Approximately 278M shares Fortescue, a iron ore company
The Jefferies position had a FMV of $670M at 3/31 - today the position is worth approximately $1B. That is a $330M increase.
The Americredit position had a FMV of $193M at 3/31 - today the position is worth approximately $454M. That is an increase of over $250M.
The Fortescue position had a FMV of $490M at 3/31 - today the position is worth over $800M - $900M. That is an increase of over $300M.
For a company with total equity of $2.6B at 3/31, you will note that the three investments outlined will increase book value by over $800M. Of course, these valuations are always subject to change.
Perhaps these increases in values are already baked into the stock. However, based on the above, I believe you will see a positive quarterly report for Leucadia.
Disclosure: I own no shares of LUK, but I have sold puts on LUK at different prices.
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This article has 18 comments:
Luk sports negative growth and an eps that is almost incaluable-- i hope that people do not get caught investing based on your assumptions about book value--- incidently-- aig currently sports a book value of 365 dollars a share-- are you buying them?
I view it as a good field bet on several industries at this price. Both JEF and ACF have done nicely, despite the tough economy. And their mining interests are undervalued, IMO.
They also have been punished due to the writedown of the tax loss CFs at the end of last year. This may reverse by early next year, at least in part. These things are almost always misread by investors, who see a big negative earnings number and conclude that there is some horrible problem with the company, when in fact it's just a forced accounting adjustment per FASB.
That said, they just came off a pretty bad year (and they have lots of company) in terms of actual performance, disregarding accounting adjustments. One thing though - the LUK management team is very seasoned and straightforward, a rarity in corporate America. They always publish a really detailed annual letter that "tells it like it is" and doesn't sugar-coat blunders or disappointing investments.
Check the website, and read the past letters - they are very good, and will show you that this is not a lightweight team, or just a bunch of gamblers with OPM. They eat their own cooking in a very big way, just like Buffett.
I am holding this for another 10% or so, and then will write some covered calls once the stock reaches about 25, which it should get to easily in the next month or so. If it gets called away, I have about a 40% gain in short order - if not, I just write calls on it until it does get called away.
However, LUK is a smoke-and-mirror show. A large part of book value is represented by deferred tax assets (NOLs). To utilize NOLs you need to earn taxable income, not book unrealized gains.
LUK has earned very little in taxable income the past five to ten years, which means the NOLs will eventually expire worthless. Even if they don't, make yourself famous and tell us how you value the deferred tax assets, based on their revoverability potential - certainly not the current book value.
I believe they no longer carry the NOL's on the balance sheet, as their auditors required them to place a valuation allowance to offset the deferred tax asset.
Interestingly enough, there is some value in the NOL's. For instance, any of the investments I mentioned in the article are worth more than the cost basis. If they are sold, they can essentially be sold tax-free.
In addition, there are other ways to utilize NOL's, depending if they are subject to any 382 or SRLY limitations. But that is a topic for another story.
On Jul 23 09:37 AM Albert Meyer wrote:
> LUK always marks its equity holdings to market, which is why the
> author correctly anticipates an increase in book value.
>
> However, LUK is a smoke-and-mirror show. A large part of book value
> is represented by deferred tax assets (NOLs). To utilize NOLs you
> need to earn taxable income, not book unrealized gains.
>
> LUK has earned very little in taxable income the past five to ten
> years, which means the NOLs will eventually expire worthless. Even
> if they don't, make yourself famous and tell us how you value the
> deferred tax assets, based on their revoverability potential - certainly
> not the current book value.
Sorry you find the aritcle worthless. To me, the best way to value companies such as this is to look at the underlying assets. To say there is no value in this company would be ridiculous.
I am trying to point out that there is a going to be a bump in equity, and that should change the way the company is valued. If you read the bottom of the article, I am not long LUK at these prices.
However, if a company has $4B in assets and trades for $2B, then it is worth examining. I don't really buy into the AIG comparison - the assets I have discussed trade on public exchanges and are valued on a FMV basis daily.
On Jul 22 09:17 PM jaydensen wrote:
> Your article is meaningless-- sorry--- the prices are probable sale
> market values that as you say are subject to change--
> Luk sports negative growth and an eps that is almost incaluable--
> i hope that people do not get caught investing based on your assumptions
> about book value--- incidently-- aig currently sports a book value
> of 365 dollars a share-- are you buying them?
That reflects a strong company relative the market.
In the 20 years before the meltdown LUK was averaging ...what... 15 percent a year growth in price?
LUK prompted me to buy into JEF, and that purchase made last year is profitable, again compared to an overall market that is way down.
I find the Braem article useful, while, at the same time, acknowledging where the detractors are coming from and their rationale too.
LUK upper management is more committed to sharing wealth with shareholders than many other execs.
From the 3/31 F/S, page 20 - "the Company has concluded that a valuation allowance is required against substantially all of the net deferred tax asset" (referring to the NOL's). It seems like you are twisting the story about a bump in equity into some past hatred against LUK and potentially auditing firms. I can't really help there.
As a CPA, I will agree that in the past this type of accounting was subject to financial maneuvering. However, this particular area (valuation allowances) has tightned up quite a bit.
On Jul 23 05:41 PM Albert Meyer wrote:
> Why don't you check the balance sheet and footnote... the last time
> I looked they reversed a billion dollar valuation allowance to pump
> up earnings and book value... auditors just do what management wants...
> they are toothless bulldogs... you can't write about LUK's book value
> unless you have looked at the balance sheet... you can't set off
> capital gains against the NOLs they hold... derived from a previously-owned
> Telecom company...
There has been no tightening in the rules. The credit crisis obviously made the auditors nervous and they got the company to set up the allowance again. Just give them a couple of years and they will play the merry-go-round all over again.
As a CPA, you should be able to recognize that LUK's financials have been a rat's nest the past ten years. Financial information is supposed to be reliable and relevant, useful to decision making. It is supposed to have predictive and feedback value, etc. LUK's financials depict none of these desirable characteristics. If you want a good example of annual financial statements that are inconsistent and incomparable from year to year look no further than LUK. In 2005 they reported $0.93, then $5.34 (yippee), then $0.60 (oops), then $2.09 (oh great), ($11.19) – oh my.
The only problem I have with your analysis is that you claim LUK has 4 billion in assets and sells for 2 billion. Last I checked, the market cap is about 5.74 billion. I also think that if you factor in the NOLs, and that their closely held companies and illiquid assets are grossly understated on their balance sheet (see Goober Drilling, Cobre Las Cruces, and their various real estate holdings, for example), they have far more than 4 billion in assets, and that's not even factoring in the potential current undervaluation of their liquid assets (they'd benefit hugely, for instance, if Fortescue regains its commodity boom highs, but this is obviously uncertain). On a long-term risk-reward basis, the shares are still undervalued, though I couldn't give you an exact figure of where the risk-reward breaks even, given the potential for inflation / deflation. All I know is that I'm very comfortable owning shares at this price, and am a buyer on any serious dips. Looking at temporary changes in book value is not as productive as trying to value the assets yourself, and then not giving a damn what the accountants or the market pegs them at for the moment.
I was using the 4B / 2B as a hypothetical to illustrate why the bump in equity may have significance. In other words, if you can add up the pieces in the company, you can approximate FMV. Using a Graham approach, you can then buy at an appropriate discount to FMV. For those that like arbitrage, you can hedge some of the underlying components.
Thanks for the feedback. I agree that there are other understated components. It is an interesting company to analyze, albeit somewhat of a challenge. Maybe we can all agree to that.
On Jul 28 12:32 AM BlackStars wrote:
> Please pay no attention to Albert Mayer; he's clearly a moron. <br/>
>
> The only problem I have with your analysis is that you claim LUK
> has 4 billion in assets and sells for 2 billion. Last I checked,
> the market cap is about 5.74 billion. I also think that if you factor
> in the NOLs, and that their closely held companies and illiquid assets
> are grossly understated on their balance sheet (see Goober Drilling,
> Cobre Las Cruces, and their various real estate holdings, for example),
> they have far more than 4 billion in assets, and that's not even
> factoring in the potential current undervaluation of their liquid
> assets (they'd benefit hugely, for instance, if Fortescue regains
> its commodity boom highs, but this is obviously uncertain). On a
> long-term risk-reward basis, the shares are still undervalued, though
> I couldn't give you an exact figure of where the risk-reward breaks
> even, given the potential for inflation / deflation. All I know is
> that I'm very comfortable owning shares at this price, and am a buyer
> on any serious dips. Looking at temporary changes in book value is
> not as productive as trying to value the assets yourself, and then
> not giving a damn what the accountants or the market pegs them at
> for the moment.
On the balance sheet, you will find assets of $5.2 billion. $777 million represent current assets, which have no additional intrinsic value other than their book values. Then there are $746 million in intangibles (only $14 million), deferred tax assets and other assets. You are not going to find much value there other than book value. Then you have $1.84 billion in investments in affiliates. These investments contributed losses of $83 million in Q2 2009 and $74 million in Q2 2008. You also have debt of $2.0 billion. Net book value is $2.66 billion. Let’s see by how much you can inflate this number to justify the current market capitalization. I’m not holding my breath. As Dan says, it’s “somewhat challenging.”
On Jul 28 12:32 AM BlackStars wrote:
> Please pay no attention to Albert Mayer; he's clearly a moron. <br/>
>
> The only problem I have with your analysis is that you claim LUK
> has 4 billion in assets and sells for 2 billion. Last I checked,
> the market cap is about 5.74 billion. I also think that if you factor
> in the NOLs, and that their closely held companies and illiquid assets
> are grossly understated on their balance sheet (see Goober Drilling,
> Cobre Las Cruces, and their various real estate holdings, for example),
> they have far more than 4 billion in assets, and that's not even
> factoring in the potential current undervaluation of their liquid
> assets (they'd benefit hugely, for instance, if Fortescue regains
> its commodity boom highs, but this is obviously uncertain). On a
> long-term risk-reward basis, the shares are still undervalued, though
> I couldn't give you an exact figure of where the risk-reward breaks
> even, given the potential for inflation / deflation. All I know is
> that I'm very comfortable owning shares at this price, and am a buyer
> on any serious dips. Looking at temporary changes in book value is
> not as productive as trying to value the assets yourself, and then
> not giving a damn what the accountants or the market pegs them at
> for the moment.
Ordinary mortals and morons like me finding it puzzling that astute investors like Bruce Berkowitz at Fairholme Capital owns 7.5% of LUK. Maybe some of the admirers of LUK could persuade Bruce to provide us with additional insights as to the merits of owning LUK, a company where insiders are regular sellers of stock.
I think the mistake you are making is to look to earnings instead of asset value. In an ordinary environment, earnings for a conglomerate, especially one that invests in troubled or marginal businesses, and counts on them going from horrible to merely bad, is a poor enough proxy for value, but in this economic environment, where earnings have been temporarily (let's hope) decimated, but long-term value still exists, earnings are truly irrelevant. I don't care how much their copper mine, for instance, which is just coming onstream makes this year, as long as I can project an income stream over the next few years.
In terms of valuing the company, like Dan said, it's terribly difficult. You start with their current assets, subtract debt, and you're left with about - 1 billion. You then add in their fortescue stake, say 1.2 billion for the equity and another 500 million (conservatively estimated) for the note, and you have 0.7 billion. Then you add in the JEF and ACF stakes, which are currently worth about 1.5 billion and 0.5 billion respectively, and you come to 2.7 billion. This does not count their stake in Jefferies High-Yield LLC, which judging by JEF's most recent quarterly results, is an increasingly large contributor to profits. You then add in say 1 billion for the present value of the NOLs, and get 3.7 billion. You then have the Inmet stake AND Cobre Las Cruces. They own 11.6% of inmet, which has a market cap of 2 billion C$, so say 200 million USD, and 30% of CLC, which should be worth at least 300 million given their copper reserves and cost-structure (see annual report). Adding these in, we have 4.2 billion. We then have all the rest, including Goober Drilling, the Hard Rock, the wineries, Teluride, the Panama City airport, the possible coal gasification project, the possible LNG terminal, Sangart, HFED, Idaho Timber, Conwed Plastics, STi Prepaid, and ResortQuest, and some various other real estate investments. The market is factoring in this long list of relatively illiquid investments at around 1.5 billion, which is probably about right, give or take a few hundred million, if nothing good happens to any of them (say, Sangart's drug working). My only point is that the risks are greatly skewed to the upside, especially if the market improves and their liquid investments are revalued (up). The downside is that if the economy continues to collapse, we could see ~$10 a share for a few years, especially if iron ore (China) and financials fall off the face of the earth. This may very well happen. However, even if it does, you need to factor in the probably inflationary government response, and I do not know an asset that I would rather own in that environment (perhaps gold is the exception, but both cash and bonds of all kinds would be a disaster). In terms of compensation of C&S, the question is whether you really think they're trying to screw the public shareholders out of a few extra million, given that 1) they are the largest shareholders, and 2) they already have about $500 million each (in shares alone); I doubt it, and their track record over the last 30 years of growing the company and being extremely shareholder-friendly undercuts those concerns. I cannot imagine a management you would want instead of those two, given that track record.
In short, the reason to own LUK is not that it's a risk-free ticket to instant riches. Rather, in comparison to many other companies and asset-classes in this market, the risk-reward is favorable. You get a company very unlikely to go bankrupt, that is ethically and competently managed, and that is not ridiculously overvalued. Thus, I would argue that LUK is an exceptionally poor choice to short, and an excellent long hedge against shorting other, lesser quality companies.
Overall, the point of the article is to show a big pop in the value of some of the assets compared to the prior quarter. I didn't address the current FMV of the company - which you both did (although with opposing viewpoints). I think this kind of debate is very constructive - unfortunately, you don't really see this on other sites (i.e. Yahoo message boards). Thanks to both of you.
A few things have always bothered me about management. Their covert claim to being like Buffett and yet they draw huge compensation packages, both cash and stock-based. Unlike Buffett they are happy to divest at times and like all insiders, at most opportune times - a giveaway for short sellers.
They invest in hedged funds, which for shareholders means a fee-upon-fees situation. After all the fees, is it worth it? I'm not convinced.
OK, I'll take time out later this month to "second-guess" you on your asset play, if you don't mind, but thanks for enlightning us.
Unfortunately, I can't find many management teams that closely resemble Buffett in the area of compensation.
The funny thing is, Buffett made billions by keeping cash in the company and allocating the capital effectively. In my opinion, he actually made more money than by not being a pig.
As an individual investor, Buffett could never pull off the Goldman Sachs (recently) or the Gillette preferrd deals. But with the capital in Berkshire, he is able to do some amazing transations. Anyway, just my 2 cents.
I haven't examined their F/S since July, but it doesn't look good from a cashflow standpoint.
From before this acquisition:
$535MM Cash + Short Term Investments
-$188MM for Capmark equity contribution
-$95MM Term loan maturity in October 2009
-$145MM Interest Expense 1
-$143MM CAPEX2
-$406MM SG&A1
-$442MM