Jefferies agrees to sell itself to Leucadia in $2.8 billion deal

November 12, 2012 09:00 AM

Jefferies Group Inc. agreed to be acquired by its biggest shareholder, Leucadia National Corp., in a $2.8 billion deal the companies said would make the investment bank better able to weather market turmoil.

Investors will get 0.81 Leucadia share for each Jefferies share they own, minus 81 cents a share for the spinoff of a wine business, the companies said today in a presentation. That gives Jefferies investors $17.01 for each of their shares, valuing the entire firm at $3.78 billion, according to the presentation.

Leucadia, which already holds about 28.6 percent of New York-based Jefferies, boosted its stake in November 2011 as Jefferies’s stock slid during Europe’s sovereign-debt crisis. The combined company, to be led by Jefferies Chief Executive Officer Richard Handler, will help the investment bank guard against “market dislocations,” the firms said.

“For Jefferies, the deal may allow them to grow and invest without market pressures in the short term,” said Christopher Wheeler, an analyst at Mediobanca SpA in London.

Excluding the spinoff of the wine company, the deal values the entire company at $3.59 billion, based on the 203.1 million shares outstanding as of the firm’s Aug. 31 10-Q filing.

Including the divestiture, the value is about 19 percent higher than Jefferies’s closing price on the New York Stock Exchange on Nov. 9. Jefferies climbed 3.8 percent this year through Nov. 9, after dropping 48 percent in 2011. The stock advanced 12 percent to $15.98 at 12 p.m., while Leucadia fell 4.6 percent to $20.80.

Jefferies Management

Jefferies management will run the combined company, according to a statement today from the companies.

Handler, 51, will remain CEO of Jefferies after the transaction with New York-based Leucadia is completed in the first quarter, the companies said. Brian Friedman, chairman of Jefferies’s executive committee, will become president of Leucadia, an investment firm with stakes in beef processors, mining companies and auto retail. Leucadia shares have declined 4.1 percent this year through Nov. 9.

The transaction values Handler’s stake, the third largest in the company, at about $260 million excluding the wine-company spinoff, according to data compiled by Bloomberg. It was worth $210 million on Nov. 9, the data show.

“We were surprised by the announcement of the deal as we did not view JEF as a likely seller given its substantial growth over the past five years,” Joel Jeffrey, an analyst with KBW Inc., said today in a note, referring to the company by its stock ticker. “That said, given the firm’s constraints on balance-sheet leverage, we struggled to model significant earnings growth that would result in return on equities in the high teens.”

Employment Contract

Leucadia said in April that Chairman and Chief Executive Officer Ian Cumming, then 71, didn’t plan to request a renewal of his employment contract, ending in June 2015. Cumming has run the company since the 1970s with President Joseph Steinberg, who was 68 at the time of the company’s proxy filing in April.

“Over the next few years there will undoubtedly be more developments on the succession front,” Cumming and Steinberg said in a letter to investors posted on the company’s website in April. “We will keep you informed.”

Before the announcement, Leucadia shares were trading at 1.02 times tangible book value, a measure of what investors are willing to pay for a firm’s equity after removing intangible items such as goodwill and brand names that would have little value if the company went out of business, according to data compiled by Bloomberg. Jefferies was trading at 97 percent of tangible book value before the deal, the data show.

Retention Deals

Jefferies won’t offer retention deals to its employees and it doesn’t expect layoffs, Handler said on a conference call following the announcement.

The company said it will continue to issue long-term debt.

Jefferies has boosted headcount by 68 percent since 2008 to more than 3,800 as bigger rivals contracted in the wake of the financial crisis. Handler has said his firm is focusing on transparency and managing risk after the collapse of MF Global Holdings Ltd. last year fueled investor concern that Jefferies might be hurt by Europe’s market turmoil.

MF Global filed for bankruptcy on Oct. 31, 2011, after revealing a $6.3 billion bet on the bonds of some of Europe’s most indebted nations, which prompted a credit rating downgrade. Following MF Global’s collapse, Jefferies issued at least six statements detailing its investments in European sovereign debt to stem losses in its shares, which fell 14 percent in November 2011.

‘Finest Hour’

Cumming and Steinberg called Jefferies executives’ response to the crisis “their finest hour,” according to the April investor letter.

The takeover comes a month after Moody’s Investors Service downgraded Jefferies’s senior debt to Baa3 from Baa2, citing “risks presented by institutional capital markets activities and the challenges of operating the investment-banking model.”

Fitch Ratings said it expects to downgrade Jefferies one level to BBB-, one grade above junk, once the deal is completed.

“After the proposed merger, Jefferies would become much more exposed to the market risk inherent in the other subsidiaries’ investments at Leucadia,” Fitch said today in a statement. “Conversely, becoming a privately-owned company may help insulate Jefferies from external market pressures similar to those experienced in November 2011.”

Leucadia had $6.19 billion in equity as of Sept. 30 supporting $8.74 billion in assets, according to a filing from the investment firm. It’s buying a company with $3.71 billion of equity supporting $34.4 billion of assets, according to Jefferies’s latest quarterly filing.

‘Sugar Daddy’

“The MF Global scare last year also exposed how fragile Jefferies’s banking model was, and it needed to find a big sugar daddy to protect it and allow it enough capital to grow,” Mark Williams, a lecturer at Boston University’s School of Management, said today in an e-mail. “The merger is good for Jefferies’s shareholders as it reduces risk associated with a firm that is too small to stay independent and produce adequate profit.”

Moody’s said it’s putting Leucadia on review for an upgrade following the deal as the firm has been able to monetize investments in a “timely” manner, according to a statement today from the rating company.

“Jefferies’s ongoing performance and its ability to maintain its investment-grade rating will remain an ongoing consideration in Leucadia’s rating in part because Jefferies will be the company’s largest investment,” Moody’s said in the statement.

Warren Buffett

Leucadia has joined in ventures with Warren Buffett’s Berkshire Hathaway Inc., including a 2001 deal to extend a $6 billion loan to Finova Group Inc., a Scottsdale, Arizona-based lender.

Buffett praised the work of Steinberg and Cumming in 2010, a year after they joined with the billionaire to run Berkadia Commercial Mortgage, previously known as Capmark.

“Joe and Ian did far more than their share of the work” with Finova, Buffett wrote to shareholders of Omaha, Nebraska- based Berkshire in 2010. “I was delighted when they called me to partner again in the Capmark purchase.”

Jefferies will become part of a firm that has a more successful track record in acquiring businesses than Berkshire Hathaway, said Bruce Berkowitz, whose Fairholme Fund is among the biggest shareholders in Jefferies and Leucadia. The combination of the two is “an unbelievable organization,” Berkowitz said in a phone interview.

Merchant Banking

“With Leucadia, Jefferies becomes what I would call the classic investment bank and broker-dealer with a more beefed-up merchant-banking operation,” said Berkowitz, who manages more than $7 billion as head of the Fairholme Fund. “As a shareholder of Jefferies, I’m for. As a shareholder of Leucadia, I’m for.”

Rothschild was Leucadia’s financial adviser on the Jefferies transaction, and Weil Gotshal & Manges LLP was legal adviser. Jefferies was its own financial adviser with JPMorgan Chase & Co., and Morgan Lewis & Bockius acted as legal adviser. UBS AG was a financial adviser and provided a fairness opinion to Leucadia’s board.

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