In a world of 24/7 news, investors react to any piece of news they read, no matter how trivial it seems. When markets are in a state of constant turmoil as they are now, buffeted by the EU debt crisis, as well as a slow-moving US economy, stocks often sell off based on rumors, not fact. There is one company that has been affected by this rumor driven market, making it a great investment at these levels.
Jefferies (JEF) is a global investment bank with nearly 50 years of operating history. The company functions much like a Morgan Stanley (MS) of Goldman Sachs (GS) but on a smaller, much more conservative scale. The company usually manages to stay out of the spotlight, but recent events have brought it into focus. The stunning fall of MF Global (OTC:MFGLQ) frightened Wall Street, and sent investors looking for the next victim. The trouble with such a mind-set is that they are often sell-fulfilling prophecies. Investors, frightened by possible weakness in a company turn those rumors into facts. After the bankruptcy of MF Global, Jefferies has come under the spotlight for its EU sovereign debt holdings. Yet, Jefferies could not be more different than MF Global.
The company is far less leveraged than MF Global, with a leverage ratio of around 13, compared to MF Global's 40. The company is far more conservative than MF Global, or even its larger rivals. Wall Street does not seem to realize this fact, setting the stage for a run in the shares when it is revealed that Jefferies will NOT suffer the same fate as MF Global. Egan-Jones, a small credit rating firm, downgraded Jefferies on Thursday, citing its exposure to EU sovereign debt. The rationale for the downgrade was that Jefferies has $2.7 billion of exposure to EU sovereign debt, representing 77% of its shareholder equity. The shares promptly tumbled by 20%. However, the report ignores one critical aspect. The report cited Jefferies' gross exposure, not its net exposure. In an extraordinary move, designed to combat the rumors surrounding the company, Jefferies opened up its books, disclosing all current positions in PIIGS debt.
As the press release shows, Jefferies has no exposure to Greek debt, and has an overall short position in PIIGS sovereign debt. And the firm has stated repeatedly that its exposure is hedged not by CDS, which have come under scrutiny as hedging instruments, but via offsetting short positions in sovereign debt, as well as futures. The company, in effect, stands to make a small profit should PIIGS debt decline further. Jefferies is not in the same league as MF Global, and investors who treat it as such are misguided. The company has found several defenders, however, and we would like to highlight them.
Meredith Whitney, a prominent banking analyst made famous by her prescient calls on the financial crisis, defended the firm on Friday, saying that, "Rich Handler is one of the best CEOs no one's ever heard of...[he has] managed the company so conservatively and has raised capital and done the largest debt deal ever just to play it safe and have cap buffers." Jefferies is managed very conservatively, and the expansion of the business is funded with cash flow, not debt. Michael Holland, chairman of Holland & Co. also defended the firm, saying that "Jefferies is opportunistic by history ... the history of the firm indicates that the burden of proof would be on the people who are making the negative observations and assertions." Jefferies is a firm pleased to stay out of the headlines, unlike its larger brethren. The company is not cavalier about risk, and we think that current share price reflects rampant speculation about a crisis that will not come to pass.
Sometimes, the market hands investors special situations, where a stock price in no way reflects the company's underlying fundamentals. We initiated a long position in Jefferies on Friday because of our belief in this mismatch. Jefferies is now trading under its tangible book value of $13.97 (as of August 31, 2011) and we think that the stock will not be undervalued for long.
Jefferies shares have fallen due to false rumors and speculation, which are inconsistent with both the facts, as well as the culture of Jefferies. Despite several price target cuts, Jefferies stock is still a great investment. KBW cut the stock to $17, noting that its cut from $22 adequately reflects the situation. Even at $17, the stock would hand investors a substantial return from present levels of over 40%. We think that now is a great time to take advantage of this uncertainty and invest in Jefferies. The company has been transparent in disclosing its debt positions, and is not hiding behind spokesman. Jefferies is being proactive in addressing the rumors surrounding the company, and this level of candor is refreshing. Jefferies has been in business for over 50 years, and we see no signs that Jefferies will not be successful in the years to come. Leucadia National (LUK), Jefferies' largest shareholder has boosted its stake amid this dramatic fall in the stock, now owning 57.5 million shares of the company, or almost 30%. We see this as a sign of confidence in the future. Jefferies employees also own a significant stake in the company, and we think that this sets it apart from other investment banks. Jefferies has been targeted by false rumors and speculation, making now the time to invest in the company. Once the financial markets see that Jefferies is not the next MF Global, the stock will recover. And investors who had the conviction to invest at the appropriate moment will be rewarded.