Third Avenue Discusses their Leucadia Investment

In the latest annual report for Third Avenue Value, Amit Wadhwaney discusses his fund's investment in Leucadia. Here is the relevant excerpt:

Leucadia National Corp. (“Leucadia”) is a NYSE-listed holding company. Run by Ian Cumming and Joe Steinberg since its founding in the late seventies, Leucadia has compounded the NAV of its portfolio by about 18.5% per annum, on average, over the last 30 years.

Given such a long-term track record, it is hardly surprising that Leucadia’s stock has rarely been inexpensive. There have, however, been opportunities to purchase these shares at attractive valuations following sizable double-digit declines in stated book value, as occurred in 1999 and 2008. In 2008, mark-to-market losses on several of its investments resulted in a decline of over 55% in its stated book value. The company also took sizable accounting write-downs to its deferred tax asset. The resultant negative impacts on reported earnings and book value drew the ire of the market at large, and the company’s stock price plummeted to what we deemed to be unusually attractive levels.

While the mark-to-market declines and writedowns in these various assets conformed to accounting standards, the resultant declines in reported earnings and book value pushed many investors to the exits and provided us with precisely the type of opportunity that we look for – a short-term distraction which allowed us to partner, at bargain prices, with a management team which has proven its ability to grow NAV at truly exceptional rates over the past 30 years.

It was not particularly surprising that Leucadia recognized substantial accounting losses during the depths of the financial crisis, in early 2009. Its portfolio included equity and royalty interests in a large-scale, Australian iron ore mining operation and another base metals mining company, the market values of which had declined reflecting expectations of poor near-term profitability. In addition it held significant investments in a U.S.-based, full-service investment banking and securities firm, which, while its security price declined during the financial crisis,

had employed its strong balance sheet to expand its work force and build its market presence during a period when its competitors closed shop or retrenched. Our conclusion was that these reported losses did not represent a true permanent impairment to the underlying businesses and the long-term fundamentals of the businesses remained attractive.

Additionally, the sizable write-downs of deferred tax assets, which exceeded $1.5 billion in 2008 alone, were prompted by a mechanical interpretation of accounting law; but, had neither any negative effects on cash-flow, nor, we suspected, any longer-term economic repercussions. Presumably, when business conditions were to moderate, these substantial tax assets would once again be available to provide protection from taxes on future realized investment results; and given the aforementioned track record of the company, we believed that the odds of Leucadia delivering value realization in the future were in our favor.

Let us look more closely at these mark-to-market writedowns which helped spark a sell-off in Leucadia’s share price. Did they instill widespread fear in the market? Yes. Would such write-downs be undeniably unpleasant, if not downright scary, for those investors/speculators with shortterm time horizons and/or leveraged portfolios? Certainly. But from Third Avenue’s perspective – that of a long-term, fundamental investor which does not employ financial leverage – these accounting write-downs were merely distractions from the key factors in our analysis, and largely irrelevant to the consideration of economic book values which were considerably longer term in nature.

We find a bit of irony in that last point; specifically, that the environment which scared many investors out of Leucadia stock was precisely the type of environment in which Leucadia has historically been able to sow the seeds of long-term value creation. This point is one that should be clear to anybody who has analyzed Leucadia’s history, but also one which was, to many, drowned out by the noise of reported accounting statistics and general market anxiety. In this case, such noise ultimately lacked relevance to the fundamental, long-term health of the underlying business, and to the key factors which played into our decision to invest. Among these factors were the unusually cheap valuation at which we were able to invest, the longterm track record of value creation and the aforementioned exceptional tax attributes.

As usual, Marty Whitman and the rest of the Third Avenue team not only give you a lot of insight into their own picks but also into the mechanics of good investing. You can read the full report here.

Was Buffett's 1984 Prediction Proven Correct?

In a speech arguing that the efficient market theory is bogus, Warren Buffett identified 9 fund managers who he said would beat the market.

He claimed he didn’t pick these people because they already had an outstanding track record. He said he selected these people years ago based upon their framework for investment decision-making. Of course finance professors didn’t believe him, and many questioned his motivation. Warren Buffett was arguing that markets were inefficient, whereas professors were arguing they were.

That speech was back in 1984. Who was correct--Warren Buffett or the finance professors?Insider Monkey has the score at Business Insider.

Update: Fooling Some of the People

A bit over a year ago I pointed to my review of David Einhorn's book Fooling Some of the People All the Time, saying that you could read the opening paragraphs online. Since that time, Einhorn has linked to that review from the book's website and the editor of The Objective Standard has allowed the review to be read in full online. Enjoy!

Another Buffett Lunch

It's always amazing to me how much people pay for lunch with Buffett given that he is very transparent about the causes of past investment failures and successes.

Yet, perhaps due to tax write-offs, really liking the work Glide is doing in the community, or advertising for one's own fund (in a way that is sure to at least have some tangible result), people continue to pay millions for a lunch with the Oracle of Omaha.

This year's lunch was purchased for $2.11 million by Zhao Danyang. You can read some excerpts about what was said at the meeting here.

The one thing in the whole piece that I found interesting was what the manager of Pureheart Asset Management didn't share--Buffett's view on the USD--and in particular why he kept that a secret: it is too controversial.

Review of Einhorn's Book

In preparation for writing a review of Fooling Some of the People All the Time, I read all 16 reviews (from mostly major publications) listed at its site, and others besides.

With a few exceptions, most did not actually review the book--showing what it said and why what it says is important. I set out to write a review that did do these things. And I did. You can read the opening paragraphs of it here, at The Objective Standard.

Note, for the curious, this is partly why my posts here are going to be few and far between. I decided to focus on doing a few in-depth, quality articles or reviews rather than the many posts I've been putting up here these past few months.

Re: Morningstar Conference

Leading up to the Morninstar Investor Conference I had this to say about it:

As fund managers trying to cope with redemptions, there is likely to be a lot of people talking their book and a bit less candor than usual can probably be expected from each manager too. That said, the other managers are likely to be less polite about their differences--in both style and positions--and that could lead to some very interesting, educational conversations. If I had to bet, I'd say the conference is undervalued.

Haven't seen much more on the conference than the bit that follows (from the WSJ), but if this was all that was said, reading the annual reports for free would have been far better.

The participants of a panel of value-focused managers, including Marty Whitman of Third Avenue Funds, were defiant about their losses last year. Mr. Whitman's Third Avenue Value Fund was down 46% in 2008.

"It was a market fleeing from the asset class, and not correcting or rebalancing at all," said Bill Nygren, manager of Oakmark Fund. "[Value managers] don't add value in that market."

More than one manager called last year's crisis "irrational," caused by forced selling, particularly among hedge funds and quantitative managers, and overstated fears. The value managers said they haven't changed how they approach their stock-picking strategies, despite last year's losses.

One question frequently asked among financial advisers and investment professionals at the Morningstar conference is whether the crisis will push funds to make wholesale changes. Yet many managers see business as usual once the recovery gets under way, with estimates ranging from either later this year or in early 2010, but some did see a possibility of different times ahead.

Note: the posting forecast for the next couple months will be dominated by sporadic showers of wit that you can use to help you invest better (as opposed to the usual 5-day posting schedule).

Greenlight: History Behind the Name

I previously posted the somewhat complicated history behind Leucadia's name. For the curious, the history of how Greenlight Capital got it's name is pretty simple. It was given by Einhorn's wife.

As he explains it in Fooling Some of the People All The Time:

"In early 1996 ... Cheryl named the firm, giving me the green light. When you leave a good job to go off on your own and don't expect to make money for a while, you name the firm whatever your wife says you should."

Recap of the Ira Sohn Research Conference

Bloomberg does a good recap here of what David Sokol-- of MidAmerican Energy Holdings--and David Einhorn--of Greenlight Capital--had to say at the most recent Ira Sohn Research Conference.

Sokol said, talking about the economy, that "we are not seeing any green sprouts" and that the "shadow backlog" of home foreclosures will last until 2011.

Einhorn said that the Obama administration is just like the Bush administration--it is trying to take us back to 2006 and get everyone to lever up again.

The banks don't need to lever up. In fact, according to Einhorn, they still need to write down their assets. Quoting directly: "For the economy to recover, these underwater entities [i.e., banks] need to restructure their balance sheets."