Wednesday, September 19, 2012

Leucadia FMG Note Resolution

This is just a quick follow-up to my LUK posts; today Fortescue and Leucadia came to an agreement on the 4% notes.  People who follow LUK know that FMG insisted that they had a right to issue more royalty notes and dilute LUK and they have been in court fighting this out.

Today LUK announced that they have come to an agreement.  FMG will redeem the notes for $715 million and LUK will book a pretax gain of $526 million.   With 245 million shares outstanding, that comes to $2.15/share gain for LUK.

Is this a good thing?  Well, of course, settling this thing is good. You never know where these things can go.  As for the price, I have no idea if it's a good price or not but knowing the folks at LUK, I don't think they would take a bad price to walk away.  Plus, with China in a state of slow-motion implosion and iron ore prices tumbling, it's probably not a bad thing for LUK to be out of this.

LUK Note Valuation
They already told us they will book a $526 million pretax gain, so we know that this note was on the balance sheet at $189 million.  The aggregate book value of the FMG notes (including prepaid mining interest, zero coupon note and interest accrued and receivable) was $295 million at June 2012.  The difference is accrued interest (for first half 2012) and whatever interest was paid and accrued since then until now.

On FMG's balance sheet according to their June 2012-end financial report, the notes were booked at $897 million; this included $770 million non-current and $127 million current (which is basically the interest accrued and payable).

So if we assume the $770 million non-current portion is a little lower (by say, $60 million for interest accrued in July, August and September), and all else unchanged, the notes would be worth $710 million (according to FMG's June 2012 model assumptions).

If this is correct, then LUK will have sold out the notes at a pretty decent valuation given that iron ore prices have declined substantially since then. 

I am not sure if this is correct as the $715 million may include accrued interest (but only for amounts accrued after June-end 2012 as interest accrued until then would have been paid out by now), in which case LUK would have sold the notes at a lower valuation.  But still, given the collapsing China and iron ore prices and the legal uncertainty, it still wouldn't be a bad deal.   I guess we will find out more in the next filing, and I'm sure LUK will summarize their FMG experience in the annual report.

FMG Overall
So how good are these guys?  Iron ore prices are falling, China may be imploding, and LUK is completely out of FMG including the notes (which would have exposed LUK to iron ore prices and other risks).

Just a quick look at this whole FMG experience shows how good these guys are.  According to the 2011 annual report:
  • In August 2006, they paid $400 million for 264 million shares and the $100 million 4% notes
  • In 2007, they paid $44.2 million for more shares
  • Their total investment in FMG, therefore, was $444.2 million

Further, in the report, they said that including the sale of FMG shares (sold most in 2011 and some in 1Q2012), dividends and the interest income on the notes, they took out $1.8 billion from their FMG investment, and they still had 31 million shares outstanding and the notes.  This is all as of the writing of the letter to shareholders.

Since then, in the 2Q2012, LUK sold the rest of the their FMG stock for $153 million (they will book a gain in the income statement but it won't affect book value much as this position is marked to market, unlike the notes which are not).

So adding that, that makes it $1.95 billion they took out of FMG.

Now with this note redemption, this comes to $2.67 billion.  Also, in the first six months of 2012, LUK received $117 million in interest income on the notes.   I don't think that's included in the $2.67 billion so far (as we only included what was in the 2011 letter to shareholders, the 2Q FMG stock sale and the note redemption).

So we now have $2.8 billion. 

If the $715 million redemption price doesn't include accrued interest from the end of June 2012 through now, then there would be $60 million more (first half was $117 million so I just took half of that for the three months from July 2012 -> September 2012).

So in total, that would be $2.86 billion.  Almost $3 billion from a $444 million investment.  Wow.  And that includes the not-so-great timing of buying not too long before the biggest financial crisis in history and exiting at a point where China is imploding (or seems to be). 

So let's put this in perspective for a second.  In June 2006, right before they made this investment, the shareholders equity of LUK was $3.8 billion.  They invested $444.2 million, so that's almost 12% of the net worth of LUK that they put into this deal.  That's concentration.

And they ended up taking out $2.86 billion.  Ten years ago, the year-end shareholders's equity was $1.5 billion (December 2002), and in 2001 it was $1.2 billion.

Who'da thunk LUK would make more than their entire net worth (or almost twice their net worth) in a single deal within ten years?

Did I already say wow?


  1. I worked in the levfin group at JPM and was on FMG's first HY issuance back in 2010.

    At the time my understanding of the loan note was clouded by our proximity to Andrew Forrest (FMG's largest shareholder and then-CEO). Hearing him tell the story, you'd think LUK practically forced him to take the money!

    It's been fun to watch the FMG story unfold since then - not just from the perspective of an overleveraged single-product natural resources company directly tied to China's slowing economy, but more recently from the perspective of a LUK shareholder.

    As you point out, FMG is proof of LUK's dealmaking acumen. I just hope that National Beef is not the last of the "great deals" as Ian and Joe look to retire.

    1. Hi, yes, it's been an interesting situation. I remember watching them buy and sell Wiltel which was a mistake, but they got out at break even (I think), plus they got to keep a huge tax loss.

      I don't think NB will be the last but I think there is still a few more years left in them even if Cummings leaves first (as he said he will).

      That's the problem with these situations; the next generation won't be the same.

    2. Looks like Mueller will repurchase LUK's 27% stake for $427mm. That's ~5% more than their cost basis of $407mm.

      KK, what do you make of this? Freeing up cash for a new deal? Seeing as Cumming and Steinberg are resigning from Mueller's board, it seems like they are divorcing themselves of this name completely in what became a relatively short holding period.

    3. Hi Ian, I don't know. This does seem to be something in the short term so it's a good question. I wouldn't think they would dump this so quickly for an acquisition if they still liked it unless it was an amazing deal, but I don't know.

  2. I'm happy to finally see the notes and litigation finally play out. I'm also trying to study the history of acquisitions done by Leucadia and I'm having a hard time finding letters besides those on their website.

    A question you might be able to answer, when Leucadia picked up companies such as Conwed, do they ususlly pay all cash or finance/LBO these companies?

    1. Hi, you should look at their 10-K's, which you can get at

      I don't know about all the acquisitions, but I think most of them are not LBO-type deals; they finance it through their own cash on the b/s which may be funded by corporate debt not specific to any deal or company.

  3. Interested in your view of what LUK is doing recently with their disposition of Mueller and Keen...seems like their building up cash to pay down debt, stack the war chest or possibly make a distribution/wind down?

    1. Hi, I don't know. I have no insight on that at all. Of course, the note resolution was just that, a resolution of a long dispute so that has nothing to do with liquidating or liquifying or anything like that.

      But Meuller was a little bit of a surprise. I have no idea what that's about. We shall have to see what unfolds. Maybe they want to put more emphasis on 100% owned businesses rather than minority positions but I have no idea, really.

      I do know (from the annual meeting) that both of them (C and S) are very bearish about the state of the world so maybe they are reevaluating their current holdings but who knows. Maybe they have a deal.

      Maybe some sort of distribution is possible but a wind down to me seems unlikely as I think they are trying to make LUK into a more sustainable ongoing entity (purchase of beef business to provide steady cash flow to LUK etc...).

  4. That's incredible! Leucadia National to Buy Rest of Jefferies!

    1. Yes, that's incredible. Of course, I will make a post about it, not that I have anything to add but since I talk about LUK so much here. It's not surprising in a sense how close Handler is to the LUK folks (history of deals together etc.) but it was sort of surprising that I didn't think it would happen.

      I have to step out today so I will listen to the conference call, look at the presentation and all that and sum up my thoughts in a post in the next couple of days.


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