Why this $3.6 Billion Deal Signals Opportunity in Beaten-Down Sector

Tom Essaye

Over the past week, the market has focused mostly on the new political reality in Washington and the upcoming negotiations designed to avoid going over the “fiscal cliff.” So investors are right to focus on it, too.

But at the same time it’s important you realize that successful investing is still about identifying profitable companies at compelling valuations … regardless of the macro concerns of the moment.

Keeping that in mind can help you recognize opportunities, while other investors are solely focused on trying to decipher the latest rumblings from Washington. Fiscal cliff or not, business will continue in the country. And shares of strong companies bought at deep discounts will offer solid returns.

In spotting those types of companies, sometimes it helps to follow a leader …

Earlier this week, Leucadia National (LUK) bought the global investment bank and brokerage firm Jefferies Group (JEF) for over $3 billion or about a 24 percent premium to Jefferies’ closing price last Friday before the deal.

Leucadia buys attractive assets at a discount and runs them better than the last guy.
Leucadia buys attractive assets at a discount and runs them better than the last guy.

Leucadia looks for businesses it thinks has brighter days ahead. It has a wide range of interests, including: Beef processing, casino gaming, and medical product development. No wonder it has often been called the “Baby Berkshire Hathaway,” a smaller version of the company Warren Buffett runs.

It’s interesting then, that Leucadia opted to acquire Jefferies when the macro environment looks so ominous, especially for the financial services sector.

Taking Advantage of Negative Sentiment,
A Shrewd Contrarian Move

Specifically, the fiscal cliff threatens to increase capital gains and dividend taxes, certainly not good for the investment climate. And the Obama administration is hardly considered friendly to Wall Street. What’s more, trading volumes and merger activity — two main sources of revenue for companies like Jefferies — are below levels seen over the past several years. Plus, with recent debacles like the “Flash Crash” and the Facebook IPO bungling, the public is as disenchanted as ever with the market.

But I believe Leucadia, like a good contrarian investor, sees Jefferies as a compelling value given the depressed sentiment in the industry. Jefferies is one of the smaller groups of investment banks. It’s also considered a rising star, aggressively hiring talent away from larger banks and building on a reputation of quality service and stand up business.

Looking out over the coming quarters and years, as the investment business returns to normal, Jefferies will be well positioned to capitalize. What’s more, the current Jefferies management weathered the financial crisis and a dis-information crisis last year very well. Simply put, they are battle tested.

More importantly, this could be one of the first signs of a trough in the slumping investment industry. A smart company like Leucadia wouldn’t fork over more than $3 billion without thinking the sector is close to a bottom.

You could pick up some shares of Leucadia as a way to potentially profit from growth in the brokerage and capital markets sector.

Or for a more diversified approach, you might consider the SPDR S&P Capital Markets ETF (KCE). It offers exposure to firms like Jefferies that should profit as the brokerage and investment banking business returns to glory. But this exchange traded fund is thinly traded, so pick your entry point carefully if you decide to invest.

Best,

Tom Essaye

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