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Jefferies Group (JEF) recently announced that “its board approved a program granting the managers permission to buy back as many as 20 million of the investment bank’s common shares. The authorization includes 6.7 million shares remaining under a previous buyback program. Jefferies repurchased about 3.1 million shares during its fiscal third quarter ended August 31. Jefferies had about 200 million shares of outstanding stock as of August 31.”

As potential investors, we ought to ask ourselves whether the Jefferies Group has the financial wherewithal to successfully complete this buyback (after all, authorizing share repurchases and actually committing the repurchases in full are two separate matters), as well as approximate how much value this move will offer potential shareholders.

As of August 31, Jefferies Group had $4.6 billion in long-term debt (and no short term debt), which amounted to 59% of capital. After earning $.42 in the March quarter and $0.39 in the June quarter, most analysts project that the Jefferies Group will produce $1.55 in annualized earnings this year, of which $0.30 will most likely be paid out as dividends.

In April, Jefferies bought Prudential’s Bache Global Commodities Group for $430 million in an attempt to expand its commodities trading division, and this diluted shareholder interests, as Jefferies has increased its share count from 172 million shares to 198 million shares to accommodate the purchase.

Jefferies is currently trading around $12.66 per share. If the company repurchases 20 million shares at that price, it will cost about $253 million dollars. Jefferies is on pace to generate $306 million in earnings this year, of which $59.4 million will be paid out to investors in the form of dividends. Most likely, the company will have to take on debt to fuel the buyback or else spread out the repurchases over a period of 2-4 years.

If Jefferies buys back 20,000,000 shares (assuming no further dilution lies on the horizon), that will reduce the share count from 198 million to 178 million, or an 11.2% reduction. Since Jefferies is projected to earn $1.55 this year, the stock buyback plan would raise the projected earnings per share to $1.72, and allow the annual dividend to grow to $0.33 per share at the same payout ratio (without taking into account future growth prospects).

The company took on $800 million in debt as part of the Bache purchase, on which it’ll be paying 5.125% interest until maturity. By today’s standards, Jefferies is one of the more aggressive banks when it comes to investing in its future, as it has established offices in Mumbai, Hong Kong, and London in attempts to calibrate international expansion with its growing commodities division.

If you’re a conservative investor, the memory of the financial crisis is probably still lingering. Jefferies saw earnings collapse from $0.97 per share in 2007 to negative $3.23 per share in 2008 before recovering to $1.38 in 2009. And Jefferies investors shouldn’t expect consistency with the dividend—over the past ten years, the dividend has grown by 14% annually, but it’s been a bumpy ride, as investors have had to endure a cut from $0.50 annually to $0.25 annually in 2008. But fortunately, the current payout ratio for the company is only 20%, and the analyst consensus for earnings growth over the next five years is 13%, fueled mostly by the full accretion of Bache to earnings in 2012.

I like seeing that BlackRock owns 6% of the company and Leucadia (NYSE:LUK) 28% of the company, as well as the fact that the CEO Richard Handler owns 6% of the common stock outstanding. It tends to bode well for investors when CEOs eat their own cooking, so to speak, as it hopefully suggests increased discipline and stewardship over your investment, as it represents a large portion of their money as well.

Right now, Jefferies is trading at a discount-to-book value, as the estimated book value for the company is $16.65 per share, and the shares are only trading hands at $12.66. That suggests that Jefferies is only trading at 68.5% of book value, which seemingly indicates a bargain for potential investors. Currently, Jefferies is trading at about 9x earnings. Over the past decade, Jefferies has generally traded between 14-20x earnings. That seems to represent a decent margin of safety for investors, because if shares increase to 14x estimated earnings of $1.55, that would suggest a rise in share price to $21.70 per share. If the share buyback increases earnings to $1.72, then a 14x multiple would suggest a share price of $24.08. And that’s before taking into account the expected 13% annual growth over the coming five year stretch. Between the buyback, expected growth, and the potential for an expansion of the P/E multiple, there’s some significant potential for investors to earn a hefty return over the coming half of the decade.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Why The Jefferies Group Stock Buyback Is An Opportunity For Investors