Leucadia: Inside The Black Box

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 |  About: Leucadia National Corporation (LUK)
by: The Lucky Pilot

Leucadia (NYSE:LUK) is described as a "mini-Berkshire Hathaway." Noted for its long history of the same management, the fact that the firm was saved from near collapse, and its impressive track record in growing book value at a compounded rate of 18% per annum for more than 30 years, the description seems appropriate. Still, deciding whether to invest in this firm is a particularly unique case study. So, let's take a look at how one might analyze this firm to determine whether to invest and at what price to do so.

1. Into the Rainbow Vein. Leucadia is a firm of many colors. Here's a summarized list of the firms it owns: Nation Beef Packing, Berkadia Commercial Mortgage, The Hard Rock Casino and Hotel (located in Biloxi, Mississippi), Keen Energy Services (oil drilling), Crimson Wine Group, Idaho Timber, Conwed Plastics, Sangart (biopharmaceutical products), Garcadia (auto retailers), Leucadia Energy (gasification projects), and Oregon Liquefied Natural Gas. Leucadia also manages various real estate properties. Additionally, it owns a considerable amount of stock in Muller (27% interest), Inmet Mining (16% interest), Jefferies (29% interest), Fortescue Metals Group (10% interest, plus debt notes paid through royalties) and HomeFed Corp (31.4% interest).

2. A Moment of Clarity. Trying to find one is not easy in this firm. Due to the various industries Leucadia operates in, performing a financial statement and ratio analysis is difficult, and possibly impractical. Comparing numbers with a firm that has operations in wine vineyards, plastics, and lumber is like using batting averages together with free-throw percentages to arrive at a conclusion about whether Tiger Woods is good at lacrosse. This brings up the all important question, how does one value the firm?

3. Dayvan Cowboy. One way of putting a price on this firm is to think of it as a mutual fund. In this case, it would be a closed end mutual fund (that happens to be able to invest in private firms), since it can sell for a premium or discount to net asset value. If one can sum up the value of all the firms Leucadia owns, then one could take advantage of when the discount is large enough.

An asset valuation would be best for all the firms rather than by earnings due to the lack of clarity within the financial statements, as well as the lower volatility of assets relative to earnings. When looking into the 10-K, one needs to mind what valuation method is used for the different investments Leucadia has made.

For instance, the holdings made in Jefferies on the balance sheet is valued using the equity method. Adjusted to fair value valuation, the amount is reduced by about $300 million. Adjusted to July 22, 2012, the number is reduced even further, by another $400 million to about $770 million.

If one is unwilling to determine the present net asset value, then one could intelligently speculate by using the book value of the most recent quarter as the net asset value and purchase shares at a large discount.

Regardless of either method used, the premise of Leucadia being analogous to a closed end mutual fund assumes that returns will be based entirely on management's ability to grow book value at a rate exceeding the market. The investor gets to play the part of the vicarious observer, riding the volatility.

4. Farewell Fire. Unfortunately, management seems to be changing within the foreseeable future. An 8-K filed in April 2012 states that Leucadia's Chairman, Ian Cumming, "does not plan on requesting a renewal of his employment contract, which ends in June 2015."

Meanwhile, Justin Wheeler, age 40, who is Leucadia's current COO, has been credited for the investments in AmeriCredit Corp and National Beef, which have both created a large return on investment. While there have been no explicit signs yet, but it appears that Wheeler may be a potential successor.

At the current price level, Leucadia is still too close to its net asset value, making it an undesirable investment as of today. Personally, I would buy once the discount is greater than 25%. However, given the historical price fluctuations of Leucadia's stock, it is very possible that it could be an attractive candidate within the foreseeable future.

Sources: here and here.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in LUK over the next 72 hours.