Why We Added Leucadia National To Our Portfolio

The model's most recent purchase was Leucadia National Corporation (LUK). LUK is somewhat similar to Berkshire (BRK.A) Hathaway, although much less well known. Like Berkshire, LUK has a succession issue because the chairman is 71 years old.

The planned merger of Jefferies & Co. (JEFF), is a big step towards resolving that issue. Jefferies is a stock brokerage firm catering to institutional investors. "In connection with the merger, Jefferies current Chief Executive Officer and current Executive Committee Chairman will become the new Chief Executive Officer and new President, respectively, of the Company,"  according to LUK.

The merger is, however, subject to the typical regulatory approval process. Plans have been made to spin off LUK's Crimson wine division to shareholders because disposal of it was a precondition to the merger.

LUK and Berkshire have a joint venture in the commercial real estate mortgage business called Berkcadia. While that is not exactly a similarity, it does encourage me to compare the two. Both are highly diverse enterprises. The industry diversity makes analysis by Wall Street Stock Analysts a difficult proposition.

LUK invests in enterprises that seem risky at first glance.  For example, "Sangart is a development stage company that does not have any revenues from product sales," according to LUK. It is working on bringing a drug used in trauma treatment to market. Sangart completed the stage 2a clinical trial and is embarking on the 2b, that will be followed by the stage 3 clinical trial if the 2b is successful.

All of these activities are a big cash drain with an uncertain payback. Despite potentially favorable income tax ramifications, it is doubtful that Berkshire would be a backer of such a venture.  Interestingly enough, LUK invested another $50 million in Sangart in May 2012.

National Beef is another large operation for LUK that was acquired in December 2011. There are barriers to entry into the meat packing industry, but there is not much of a brand identification. In the case of National Beef, their Kansas City Steak subsidiary has a brand name asset.

To illustrate the vagaries of a commodity type business, National Beef lost its contract to supply case ready beef to Wal-Mart (WMT). That one will not be easy to replace. Luckily, case ready meats are but 7% of National Beef's business.

Another commodity type business is Idaho Timber, whose results are strongly tied to the housing market. Another company, Conwed Plastics, manufacturers plastic netting like the netting used in landscaping. "The primary raw material in Conwed Plastics' products is a polypropylene resin, which is a byproduct of the oil refining process, whose price has historically fluctuated with the price of oil,” according to LUK.

In my opinion, an interesting business whose fortunes could be better this year than a year or so ago is Garcadia Holdings, LLC.  Garcadia buys distressed automobile dealerships and turns them around. Fortunately, of their 19 dealerships, only one is a Fiat dealer. LUK’s distributions from Garcadia have moved upward for the past three years.

LUK is involved in the hotel and gaming business with its Premier division that owns and operates the Hard Rock Hotel and Casino in the Gulf Coast area of Mississippi. The casino business was negatively impacted by the recession, but appears to be getting better.

LUK owns 31.4% of the outstanding common stock of HomeFed (HOFD), a publicly traded company on the NASDAQ OTC Bulletin Board.  HomeFed is engaged in the investment in and development of residential real estate projects in California.  As of December 31, 2012 LUK's net investment in the domestic real estate segment was $262 million, according to LUK.

Some of these properties are as follows:  a large scale mixed-use development project in Panama City, Florida, $56 million, a substantially developed large scale mixed-use development project in Myrtle Beach, South Carolina, $31 million, 73 acres used by Garcadia, the automobile dealership joint venture, $56 million.

To round out the picture there are 76 acres of land on the island of Islesboro, Maine that are approved for 13 residential waterfront lots,  and 45 fully developed residential lots on approximately 120 acres of land located in Rockport, Maine on Penobscot Bay, $45 million in the aggregate. Finally LUK owns a 15 acre unentitled air rights parcel above the train tracks behind Union Station in Washington, D. C., $12 million.

A substantial portion of LUK's businesses are tied to the economy, and to the real estate and homebuilding industry, in particular. Housing related stocks have been doing quite well, in my opinion, over the last several months.

In my opinion, LUK has some catching up to do. A very important issue related to investment in LUK is its similarity to Berkshire Hathaway, in my view. It pays no cash dividends. It is a capital allocator in the same way that Berkshire is.

LUK does not, however, enjoy the ability to borrow money at the low rates available to Berkshire. LUK recently redeemed some outstanding bonds that carried a coupon of around 7%.  Nor does LUK have the ability to deploy capital from its insurance subsidiaries.

The investments discussed are held in client accounts as of March 28, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable.

James Roberts

James Roberts

I worked for a micro-cap value hedge fund as a research analyst for 8 years and then opted for semi-retirement