Leucadia (LUK) co-managers Ian Cummings and Joseph Steinberg are legends amongst the value investing community, having managed to increase the book value of the company 18.5% annually since 1979 through their proven ability to spot undervalued assets. Their ability is so reminiscent of another well known value investor that Leucadia is known as the "mini-Berkshire." However, with such a long track record of success unfortunately comes advanced age; Cummings and Steinberg are 71 and 68 respectively, with Cummings already stating that he will be stepping down from his chairman position after July 2015.
With both Cummings and Steinberg nearing retirement, shareholders have become increasingly concerned about succession planning and while both men have acknowledged the issue, few details have been brought to light regarding what will happen to the company once they both step away. A flurry of recent sales by Leucadia adds further questions regarding the future of the company.
Leucadia's investment in Fortescue Metals (FSUMY.PK) has arguably been the best in the company's history, having reaped $2.7B in dividends, capital appreciation and royalty payments on an initial investment of $440M. Fortescue is an iron ore mining company in Western Australia and like all commodity companies in the region, it saw its stock rise dramatically in recent years due to China's insatiable appetite for the raw commodities needed to fuel its skyrocketing growth. Cummings and Steinberg adroitly observed early on that due to its vast mineral reserves, Australia was destined to become the supply center of the Asian developing world.
Since its initial investment in 2006, Leucadia had been slowly liquidating its equity position as Fortescue's stock continued to rise. However, they continued to hold a $100M, 13 year unsecured royalty note that granted them 4% of revenue from certain mine sites and became incredibly valuable as Fortescue's production skyrocketed. This note became a point of contention between Leucadia and Fortescue in 2010, with the latter taking the position that they had the ability to issue additional royalty notes and thereby dilute Leucadia's interest. Leucadia sued Fortescue in the Supreme Court of Australia and the case had been ongoing for two years.
After protracted litigation, the two parties finally agreed on a settlement of $715M in September 2012. It is hard to determine if this was a good deal for Leucadia or not without knowing what type of future production there will be at the mine sites in question and becomes even harder with the current uncertainty regarding future China demand. However, given the fact that the note was valued on Fortescue's books at $897M I believe one could make the claim that Steinberg and Cummings were more interested in getting their hands on the cash now even if it meant taking a haircut on the note.
In 2011, Leucadia acquired 27.3% of Mueller Industries (MLI), a manufacturer of copper, brass, plastic and aluminum products for $400M. Many of Mueller's products are used in housing and as such, the company's growth is levered to a recovery in the housing market. Steinberg and Cumming were both on the board of directors until very recently.
On September 24th, Leucadia agreed to let Mueller repurchase its shares for $427M, leaving them with a gain of roughly 7% on the investment. This low return shows that either Cummings and Steinberg had grown disillusioned with the company in an uncharacteristically quick amount of time or they wanted to convert their shares into cash for some other reason.
Leucadia entered into business with a Oil & Gas drilling operation known as Goober Drilling in 2006, supplying them with funding to purchase new drilling rigs. Due to liquidity problems encountered by the managers of Goober, Leucadia eventually bought them out and renamed the company Keen Energy.
While originally drilling mainly for natural gas in the United States, the company's rigs have shifted mainly to oil due to the well publicized drop in natural gas prices driven by the widespread adoption of hydrofracking. As of the end of 2011, the net book value of Keen Energy on Leucadia's books was $210M.
On October 17th, Leucadia entered into an agreement to sell Keen Energy for a cash payment for $100M and a 4 year, $40M note, along with keeping possession of Keen's working capital. Leucadia recorded a $20M pretax loss on this sale.
With these three deals, Leucadia has raised roughly $1.2B in cash, which equates to 21% of their current market cap, in a little over a month. Given the advancing ages of both Steinberg and Cummings, my first instinct would be to think that this is the beginning of the slow liquidation of the company which would ultimately result in a substantial return of capital to shareholders through a special dividend.
However, this thesis does not make sense when one considers that Leucadia just completed one of its largest acquisitions to date at the end of 2011, the $870M purchase of a 79% interest in the beef packing company National Beef Packing. They also announced in March 2011 the appointment of company veteran Justin Wheeler (age 39) to the position of COO. With this in mind I believe the most likely scenario is that Steinberg and Cummings are positioning Leucadia for one more major acquisition before they step away. What this acquisition will be is anyone's guess but based on the amount of cash the company has raised, it will most likely be big.
An added benefit of the current rationalization taking place is that by liquidating some of the smaller positions of the company and redirecting the cash towards larger acquisitions, Leucadia becomes an easier company to operate from a management perspective and to value from a shareholder perspective, two worthwhile goals to pursue for an outgoing management team.
I believe Leucadia remains a strong value at current levels where it is hovering just below book value. Cummings and Steinberg have proven to be two of the greatest capital allocators in the world and with their own elephant gun reloaded, I believe they will find some compelling value in today's market. With a high amount of their net worth tied into Leucadia stock, shareholders can rest assured that the two managers will make certain that the company's future remains bright before they depart into retirement.
Disclosure: I am long LUK.