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.

Leucadia Investment in Trouble?

The financial partner in The Market Common project in Myrtle Beach has defaulted on its loan agreements with a national bank and might consider filing for bankruptcy protection, according to a notice issued Tuesday.

Leucadia National Corp., a financing partner with developer McCaffery Interests Inc., is contesting the defaults but said it is "exploring all options and remedies available to it including, but not limited to, a bankruptcy filing."

Thus begins an article on the Market Common fiasco--which you can read in full at Myrtle Beach Online. The trouble, however, doesn't stop there.

...[M]ore than one-third of The Market Common's tenants have asked the project's developers to lower their monthly rent payments, according to Tuesday's notice.

Jewelry store Carlyle & Co. plans to close in August and at least two other stores - Victoria's Secret and Bath and Body Works - have said they may close.

The stakes are actually pretty big on this one--i.e., foreclosure on the property by the bank is a possibility, however slim:

The financial default involves $7.6 million worth of payments Leucadia owes as part of an interest rate swap agreement tied to a construction loan.

Failure to pay that amount triggers another default on the primary $92.7 million construction loan and would let JP Morgan Chase foreclose on the property.

Leucadia, in the notice, said it has not paid the $7.6 million "and has no intention of paying such amount to Chase."

In addition to a possible bankruptcy filing, Leucadia said it is trying to negotiate new loan terms with the bank.

As the primary construction loan to Leucadia is scheduled to mature on October 10th, there's an end date to this financial posturing by both sides. But the problems at The Market Common seem likely to continue for a good while after.

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.

Berkowitz Sticks with Leucadia

In an article titled "Being Like Buffett May Mean Parting Ways With Him," Morningstar presents why Bruce Berkowitz decided to sell Fairholme's position in Berkshire Hathaway--and what he has decided to keep, or buy.

It's not often you give one of your idols his walking papers. But that's what happened in late 2008 when Bruce Berkowitz of Fairholme (FAIRX) eliminated his stake--once as high as 20% of assets--in Berkshire Hathaway (BRK.B) ...

..Berkowitz doesn't think Buffett is washed up. Far from it. But he's taking the Oracle of Omaha at his word. Buffett himself says Berkshire's size makes it unlikely the firm will return better than a percentage point or so more than the S&P 500 going forward. Berkowitz thinks Fairholme can do better.

That's not hubris. Berkowitz says he's not smarter than Buffett--just smaller. And that gives him a wider range of opportunities in a target-rich environment than Berkshire has due to its girth. The same goes for most Buffett-inspired funds...

I especially enjoyed this bit, on why Berkowitz decided to keep Leucadia shares, and then add some of the company's within LUK's portfolio to his own:

A secret of Buffett's success has been to buy firms outright and then leave proven managers in place and alone. Likewise, a big part of Fairholme's success has come from identifying and investing in top capital allocators while remaining a silent partner.

The fund has long held Leucadia National (LUK), a holding company run by Ian Cumming and Joe Steinberg. Leucadia has compounded capital at a high rate over the years. It has interests ranging from copper mines to wineries to an early-stage biotech firm, among others. Berkowitz and his team know Leucadia's underlying holdings well and think they're cheap. But Leucadia has ownership restrictions that prevent anyone from owning more than 5% of its shares, and Fairholme is at that level. So, Berkowitz has invested directly in a couple of what he thinks are the more attractive firms from the Leucadia stable.

The fund now has a small stake in Fortescue Metals, an Australian iron ore firm whose shares have tumbled alongside ore prices. But Fortescue is a low-cost producer and has a geographic advantage over many rivals due to its proximity to China, a top ore consumer. And AmeriCredit is another Leucadia holding that overlaps with Fairholme...

For more names that Berkowitz is investing in via Fairholme, including some detail on Americredit--a position shared with Leucadia--click here.

When will the Recession End?

From the most recent Leucadia shareholder report:

"Out of prudence we have a pessimistic view as to when this recession will end. To think otherwise would be to gamble about the beginnings of good times whereas by imagining a bleak future we will most likely survive for the good times to arrive."

That last line is worth reading more than once. It reminds me of the part of an old A.E. Housman poem that Charlie Munger often quotes:

The thoughts of others
Were light and fleeting,
Of lovers' meeting
Or luck or fame.
Mine were of trouble,
And mine were steady,
So I was ready
When trouble came.

Is it a surprise that great investors think alike in this regard? Or is there something about being extra cautious about the future that leads to good results over the long term? You decide.

Pershing Mentioned in Leucadia Letter

While Pershing Square, the investment firm managed by Bill Ackman, was not mentioned directly in Leucadia's latest shareholder letter--it was mentioned indirectly. I quote:

Over the past several years we have invested our excess cash with various outside managers with a view towards receiving a good return and hoping to uncover investment opportunities. We were disappointed with the results. The returns were not good and we did not uncover investment opportunities. With few exceptions, our fund investments were not immune to the market upheaval experienced in 2008, but the overall return since inception was minus .5%. It could have been worse. For the most part, we do not intend to continue this activity.

Leucadia shareholders will no doubt be happy (or at least happier than otherwise) to hear that last sentence. The move to make a leveraged bet on the valuation of Target was much criticized--in large part because of all the money that would have gone to Pershing (in fees) if the bet was successful.

The Leucadia Way

In the 2006 Chairman's letter, Leucadia's management team laid out their "rules of the road"--the particular manner in which they run their company.

1. Don't overpay, no matter what the madding crowd is up to.

2. Buy companies that make products and services that people need and want and provide them as cheaply as possible with consistently high quality. Lower cost and higher quality is a never-ending task.

3. Earnings sheltered by NOLs are more valuable than earnings that are taxed!

4. Compensate employees for performance and expect hard work and honesty in return.

5. Don't overpay!

Those familiar with Buffett's two rules of investing--where rule number one is to not lose money and rule number two is to never forget rule number one--will see a similarity in points 1 and 5 above.

While that's not where the similarities end, this post is meant as a "foundation post" that I'd like to refer back to in a general way later on--so I'll let you make connections if you want in the comments section.

One thing worth pointing out here, is what Leucadia does when its management team views everything as overvalued. From the 2004 Chairman's letter:

"Our investment philosophy is bimodal, either we invest in high return opportunities or have the money in the bank or under our mattresses."

Thus, while they like to buy "assets that are out of favor and, therefore, cheap" ... then "work very hard at improving their performance until they are the most efficient and productive in their market segment," when there are too many people competing for even those investments, they'll step aside--or, according to their philosophy, should.

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.

Distressed Investing with 3 of the Guru 5

A lengthy but excellent article comparing Americredit to Clayton homes appeared in SeekingAlpha recently.

Written by Sumit Shah, a writer we've never heard of but hope to read more from, the article even used the term "outside passive minority investor"--which is how Marty Whitman refers to "regular" stock investors in two of his great but little-read books. (Call us impressed!) Here's the beginning of the article:

The goal of the value investor is to identify investments where there is a potential for earning outstanding returns over time with little to no risk of permanently losing one’s capital. Such investments are relatively rare when considering the entire universe of publicly traded equities, and outside passive minority investors usually have to scour the stock market to find companies that trade at deep discounts to intrinsic value and that have attractive risk profiles.

Usually, the securities that meet these criteria trade at such deep discounts because they are misunderstood or underappreciated by the marketplace, but sometimes securities that appear to be misunderstood are trading at depressed levels for legitimate reasons – because the underlying companies are at risk of going into default or, even worse, into bankruptcy.

Distressed equity securities are usually too difficult for most ordinary investors to handle, and the majority of outside passive minority investors would be well-advised to stay clear of such companies unless they are extremely confident that they will not lose their principal in the case of bankruptcy, run-off, or, in times like these, receivership or nationalization.

Deep-pocketed outside investors or control investors, on the other hand, enjoy quite a different position than ordinary investors, as they can try to influence a distressed company’s restructuring process, implement turn around plans, invest new capital into the company, or in some cases acquire the troubled company at an extremely low price.

Warren Buffett has often stated that he tries to purchase great businesses trading at fair prices, but Buffett, unlike many investors, also often has the opportunity to acquire distressed companies that could be great businesses under different circumstances, and that are trading at great prices.

Last year, for example, Berkshire’s MidAmerican Energy subsidiary made a bid for Constellation Energy (CEG) that was so low it would have effectively been stealing the company had another bidder not appeared. Buffett was able to make such a lowball bid because Constellation had severe liquidity issues, and Berkshire (BRK.A) was offering Constellation an immediate cash infusion that would have enabled the company to avoid filing for bankruptcy protection.

Deep-pocketed value investors such as Bruce Berkowitz’s Fairholme Fund and Leucadia National (LUK), the conglomerate run by Ian Cummings and Joseph Steinberg, are at their best when they are able to find distressed investment opportunities like the ones Buffett enjoys. Fairholme and Leucadia have found just such an opportunity in their investment in AmeriCredit (ACF), an auto finance company that operates primarily in the subprime space.

To understand what they see in AmeriCredit, it is important to recognize that Berkowitz, Cummings, and Steinberg – some of the shrewdest investors out there – are huge Buffett admirers and have probably learned a great deal from closely following his deal making.

Indeed, their investment in AmeriCredit has many similarities to Buffett’s acquisition of a manufactured housing company called Clayton Homes in 2003, which Buffett discussed at length in this year’s annual letter to the shareholders of Berkshire Hathaway. It would be instructive to discuss Buffett’s acquisition of Clayton Homes to understand the opportunity Fairholme and Leucadia see in AmeriCredit and also to learn some useful lessons about subprime lending and securitization along the way...

If you're not intrigued by that lead-in, you're in the wrong place. You can read the rest at SeekingAlpha or at Sumit Shah's website. (Note: I added a handful of paragraphs to make the above more readable in the different format.)

Leucadia Discloses Loss in Pershing Square

From the latest 10k:

"In June 2007, the Company invested $200,000,000 to acquire a 10% limited partnership interest in Pershing Square, a newly-formed private investment partnership whose investment decisions are at the sole discretion of Pershing Square's general partner. The stated objective of Pershing Square is to create significant capital appreciation by investing in Target Corporation (NYSE:TGT). The Company recorded losses under the equity method of accounting from this investment of $77,700,000 and $85,500,000 in 2008 and 2007, respectively, principally resulting from declines in the market value of Target Corporation's common stock. At December 31, 2008, the book value of the Company's investment in Pershing Square was $36,700,000."

(Hat tip: Wall St Nation)

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.

Leucadia Finds a Friend in Pabrai

Dave Bui, at Seeking Alpha, notes that Pabrai added eight new positions to his portfolio recently, one of which was Leucadia.

Pabrai's new positions can be summed up as a bunch of commodities with a hint of financials. New mining stakes include Horsehead Holding Corp (ZINC), Teck Cominco (TCK) and indirectly, Leucadia National (LUK). He also moved into the agriculture space with Potash (POT) and Cresud SA (CRESY). He also added a good-sized position in Goldman Sachs (GS), which received a well-publicized capital boost from Pabrai's acknowledged idol, Warren Buffett. Pabrai completely divested his WCG position and massively reduced stakes in Buffett's Berkshire, Cryptologic (CRYP), CompuCredit (CCRT) and Fairfax Financial (FFH).

The same link has information on the new picks by Berkowitz and Rodriguez, noted value investors. Well worth clicking over.

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.

Cresud--A Leucadia Pick

A recent article at the Fool.com website, focused on Cresud--noting that Ian Cumming and Joseph Steinberg of Leucadia National are invested heavily in it.

Another is Cresud (Nasdaq: CRESY), a Buenos Aires-based asset holding company that owns and operates farms in Latin America and that holds equity stakes in IRSA (NYSE: IRS), a mall and hotel owner in Argentina, and BrasilAgro, an agricultural asset play in Brazil. We've watched over the past few months as the stock has dropped from $18 to $14, then $14 to $10, and finally from $10 on down to $5.

It's since rebounded to around $8, but that price still seems too cheap for a company with Cresud's quality management team and asset base -- regardless of what commodity prices do in 2009. Further, Ian Cumming and Joe Steinberg of Leucadia National (NYSE: LUK) -- two value investors with a stellar track record -- own shares, having bought in for a far higher price.

It's to the point where I (Tim) turned to Nate recently and asked, "Does the market think Argentina is going to nationalize all of its land and shut down its export market?"

Read Nate's reply, and the rest of the article--which goes into some detail on Latin American politics--at the following link.