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.

Notes on the Notes from the Leucadia Meeting

For those who haven't read the complete notes from Leucadia's shareholder meeting, Inoculated Investor has posted seven pages worth. Here are my quick notes on the notes:

*The succession plan is basically to focus more on buying great (read: durable) companies, to develop capable managers, and to not die.

*Jeffries shouldn't compensate young know-nothings so highly--and if they use stock as compensation they should buy some back too (in order to cut down on diluting present shareholders).

*Americredit was bought too soon and is heading into a tough time as business shrinks, but it is a viable business, will survive, and at some point will prosper.

*Their top investments, including Fortescue, should outperform as the markets come back.

*Cresud has a great set of assets but the fundamentals in Argentina now are terrible and they're not optimistic.

*Commercial real estate? No thanks, say Steinberg and Cummins. And don't ask again, until they are full of durable companies.

*The company is positioned for inflation as they have borrowed in dollars and invested in hard assets.

*Sangart's Hemospan seems to be working fine but more tests are needed. Nobody has died yet, so that's cool. If it works, it will be a lot cooler.

*Third money managers? Never again, say both collectively. It was a huge mistake--especially the Pershing investment where they lost pretty much everything.

*The two couldn't care less about Moody's rating--and don't think you should either. (Hard to argue on this point.) "They have missed almost everything and been late at each turn."

*They don't have a crystal ball and don't know how long the downturn will last.

*Jeffries (JEF) is in retrospect even a better deal now than what they thought when they first made the deal. The deal was done with LUK stock--when it was trading around $54. (There's a message in that for all the JEF-deal-haters.)

*They buy when something is on sale and start to think about selling when the discount disappears.

*Long-term view on natual gas prices is six to seven dollars per Mcf.

*LUK has cash. Is looking to invest. Have been buying back their debt in the meantime.

Leucadia: History Behind the Name

For the curious, here's the history behind where Joseph Steinberg and Ian Cumming got the name for Leucadia National:

We have been asked numerous times from whence the name Leucadia appeared. Thirty years ago in the summer, one of us, then age 37 was elected Chairman of Talcott National Corporation, the other, then age 34 became President shortly thereafter. Talcott’s existence goes back to 1854. We have documents showing that, during the Civil War, Talcott financed socks for the Union Army.

Talcott became listed on the New York Stock Exchange in 1937 and evolved into a finance company with four businesses: consumer finance, commercial finance, factoring and real estate. Interest rates were very high and imprudent real estate investments left the Company with a negative net worth and lots of debt. That is when we jumped where others had feared to tread!

On May 27, 1980, we sold Talcott’s factoring business, James Talcott Factors, Inc., to Lloyds and Scottish Limited, a joint company of Lloyds Bank and the Royal Bank of Scotland. James Talcott was a name long associated with factoring and the buyers wanted the name. After a spirited negotiation, we were paid more money but were left nameless.

We had suspected this might be the outcome and had been trying to register names acceptable to New York State. There have been lots of names filed in New York since the Indians sold Manhattan Island. Driving north on Route 5 from San Diego, California, we passed a big green sign “Leucadia Next Exit”, so decided to try Leucadia. It was immediately approved.

The word Leucadia is of Greek origin. Lefkadia (Leucadia) is one of the Ionian Islands and has a long and colorful history.

Taken from the Chairman's letter for 2007, so you'll never have to ask "Where did they get the name Leucadia from?" ever again.

Leucadia on AmeriCredit

Having already read (in this post) some of the reasons why Cumming and Steinberg might be invested in AmeriCredit, you might find it worthwhile to actually read what they said on the company themselves (at the start of their investment).

As of this writing, we have acquired 26% of AmeriCredit Corp. (“ACF”) for $373.9 million. We have known of this excellent company for many years, having been in the sub-prime auto business ourselves. ACF has made and financed over $53 billion of these loans and none of its lenders has lost a penny. In this environment, financing for ACF is going to be very difficult and management is taking appropriate steps to downsize the company. We are guardedly optimistic that the financial market will climb out of its bunker next year. People need auto financing to get to work.

The above was taken from the 2007 Chairman's letter. What's the deal with the last line--about people needing auto financing to get to work? That's something I'll cover later, as it refers directly to the "rules of the road"--their particular method of investing--that Leucadia's management team follows.

Leucadia picked at Motley Fool

From the Motley Fool:

For example, 98% of the 876 members who've rated Leucadia National have a bullish opinion of the stock.

Two weeks ago, one of those Fools, decrooj, cited the holding company's dynamic investment duo, Ian Cumming and Joseph Steinberg, as the main reason to get in:

This company has its hands in every sector and is bound to pick up with the economy. ... They have some good natural gas plays. ... Timber company will pick up after housing bottoms. They also have wineries that will be major players in the next 1 to 2 years. ... the owners invest fearlessly, but they know what they are doing. "Buying good companies at low prices." This stock stands to grow at least 20% year over year for a good while.

Gayner Increases Leucadia Stake

After noting that Tom Gayner, of Merkel Corp, is selling more than he is buying (at least as of the latest report), Guru Focus points out that the well-respected money-manager has increased his stake in Leucadia.

Quoting: "Tom Gayner added to his holdings in Leucadia National Corp. by 54.39%. His purchase prices were between $14.56 and $31.83, with an estimated average price of $22.3."

The investment vehicle of Ian Cumming and Joseph Steinberg, was also added to Jean-Marie Eveillard's portfolio. He joins a long list of fellow value investors--including Marty Whitman and Bruce Berkowitz--who are confident in LUK's strategy, management team, and its market price relative to its intrinsic value.