Leucadia National: Another Berkshire?

by Gavin Graham, contributing editor Gordon Pape's Internet Wealth Builder

Our latest recommendation Leucadia National (LUK) is a diversified conglomerate with a long-term approach; indeed, the company could be viewed as another Berkshire Hathaway.

It has been run by the duo of Ian Cumming and Joseph Steinberg since 1978. Over that time, book value has compounded at 18.5% per year, compared to 8% for the S&P 500 with dividends reinvested. Leucadia's market price and shareholders' equity have compounded at 19.8% and 19.1% respectively over that period.

This excellent track record has not come without volatility. Although Leucadia's stock was up eight out of past 10 years, it fell 58% in 2008, compared to a 37% decline in the S&P 500, and was down 22% last year while the index was up 2%.

However, volatility is not the same as risk. Warren Buffett has famously said he would much rather make a lumpy 15% than a smooth 12%, especially as the lumpiness of the return will deter investors who have a low tolerance for volatility.

Messrs. Cumming and Steinberg fall into the same camp and an examination of their largest and single most successful investment reveals a great deal about the reasons for their success.

Believers in the long-term growth of Chinese demand, in August 2006 Leucadia invested $400 million, or almost 15% of its shareholders' equity, in Australian start-up iron ore miner Fortescue Metals Group.

This investment has proven to be an enormous success, and Leucadia has taken the opportunity to crystallize profits. It sold 117.4 million shares last year for $732.2 million, as well as receiving $193 million in royalties net of withholding taxes.

It sold another 100 million shares for $506 million in the first quarter of 2012, leaving it with 30.586 million shares worth $186 million and another seven years on the royalty note.

Leucadia has taken the same bold approach to several of its other investments. It swapped its interest in a Spanish copper project, Cobre Las Cruces, for a shareholding in Canadian miner Inmet, becoming largest individual shareholder.

Leucadia also owns a 29% stake in Jefferies, which cost $980 million. Jefferies is a leading U.S. middle market full-service investment bank and broker, with 30 offices in 11 countries. Messrs. Cumming and Steinberg sit on its board of directors.

Leucadia increased its position in Jefferies in 2008-09, when investment banks were probably the least popular sector in the entire market. Its willingness to take large positions when it is convinced of the underlying soundness of the business has been a hallmark of its management.

For instance, in October 2007, just as the recession was beginning, it began buying stock in auto-finance company Americredit which provides car loans to customers with bad credit.

Leucadia sold its Americredit stake to General Motors for cash in October 2010, receiving $830.6 million for shares that had cost $428.5 million to buy. That generated an internal rate of return of 29%, compounded.

The company's Berkadia 50/50 joint venture with Berkshire Hathaway is another example of counter-cyclical thinking. It is one of the largest and lowest cost non-bank owned commercial mortgage servicers and originators in the U.S.

The joint venture was established in December 2009 with $434 million in capital, of which half is Leucadia's. Through the end of 2011, Leucadia has received $84.6 million in dividends. Both cash flow and dividends increased in 2011 from 2010.

Leucadia owns a number of other interesting smaller operations, such as the Hard Rock Hotel and Casino in Biloxi; the Crimson Wine Group; oil and gas driller Keen Energy; valve and tube maker Mueller Industries; manufacturers Idaho Timber and Conwed Plastics; and auto dealership joint venture Garcadia.

But its most recent and largest investment is in beef! The simplest way to explain Leucadia's latest acquisition is to quote from the Chairman's letter discussing the purchase of 79% of National Beef Packing for $868 million on Dec. 30.

"While the U.S. is a mature market, global protein consumption is growing at an astounding rate. People across the globe have an ever-growing desire to consume high quality U.S. beef and we will do all that we can to make that possible."

Worried about the outlook for credit markets, Leucadia paid cash for National Beef. It also reduced its total leverage by over 40% by calling $511 million of long-term debt in 2012 and buying back more of its debt in the market over the last three years.

While both Messrs. Cumming and Steinberg are in their 70s, the board of Leucadia recently appointed Justin Wheeler as Chief Operating Officer. Mr. Wheeler has been with the company since 2000 and was largely responsible for the Americredit and National Beef deals.

Leucadia underperformed the S&P 500 in three of the last four years, despite realizing $2 billion in capital gains in the last two years and reducing its leverage. I believe it offers good value at current levels.

I am recommending it for investors willing to undergo some volatility to gain exposure to a widely diversified and well-managed group of businesses run by two of the top investors of the last quarter-century.

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