As several people here have said, when buying stock in Leucadia Corp., you are essentially exercising an act of faith. Not that this is essentially alien behavior for owners of Berkshire Hathaway. However, in this case the faith you are exercising is in Ian Cumming and Joseph Steinberg instead of Warren Buffett. Though these names are not nearly as well known, as Buffett’s, they have established a similar record.Since 1978 when they founded Leucadia, Cumming and Steinberg have grown the company’s book value at annual rate of 21.5% annually. While their investment results closely match that of Buffett, their basic investment style is very different. Despite this style difference, they have run a couple of joint ventures with Berkshire that have been successful. Leucadia generally exhibits the kind of investment behavior that Buffett shuns, they fund startups and attempt to rescue of troubled situations, and their favorite holding period is a good deal short of forever. As general rule, Leucadia’s GAAP earnings are lumpier and even more meaningless than is the case with Berkshire.Perhaps a good way to understand the company, then, is to take a detailed look at one of its investments, and an interesting example of Leucadia’s style is Fortescue Metals. In August 2006, Leucadia invested in Fortescue Metals Group, an Australian start-up iron ore mine. Leucadia invested $400 million in exchange for 264 million common shares and a $100 million 13-year unsecured note of FMG maturing in August 2019. A year later, they invested an additional $44.2 million for almost 14 million additional shares. Interest on the note is calculated at 4% of the revenue from certain mine areas, net of government royalties and a 10% Australian withholding tax. As a result of this equity infusion, Fortescue went around the world and raised $2.1 billion from other large investors. With this money in hand, Fortescue dug a mine, built a gigantic ore processing facility and a train loader, bought 15 new G.E. rail engines, 976 Chinese ore cars, laid 280 kilometers of railway with a rotary train unloader which dumps ore on a two meter wide (6.56 feet) conveyor belt, a huge sorting yard, and a huge dinosaur-like ship loader on a newly built dock in a newly dredged part of the port in Port Hedland-- all of this being accomplished in 21 months.Fortescue shipped its first ore in May 2008 and in 2010 shipped a total of 40.9 million tonsfor $3.9 billion in revenue. Fortescue has nearly completed its expansion to 55 metric tonsPer annum (“mtpa”) and has announced plans to expand further to 155 mtpa. We all know that Buffett would never become involved in a start-up operation, and this mine was not only a start-up, but one in an industry with a lot of competition and several large and very successful international companies (BHP Billiton and Rio Tinto). Clearly, CEO Andrew Forest has done an incredible job to get this operation going.So while it is clear that Steinberg and Cumming operate in a different world from Buffett, it is also true that there is more than one way to make a buck, and making a buck is definitely what they are doing with Fortescue.What can Leucadia expect to get back from their $442 million?In the first quarter of 2010, Leucadia sold 30 million shares of Fortescue for $121.5 million or $4.03 a share against an average cost of $1.23. Interest on their $100 million note (4% of revenue) amounted to $40.4 million in 2008, $66.1 million in 2009, and $149.3 million in 2010. In June of this year, Fortescue announced Leucadia sold another 92 million shares of Fortescue for $618 million. So, to date, Leucadia’s $442 million has returned $121.5 + $40.4 + $66.1 + $149.3 + $618 or $995.3 million. Not a bad start, but as they say in the old song the “best is yet to come”.Leucadia is still left with 4.9% of Fortescue, worth $980 million or so, and, better yet, eight years of payments on their note. In 2010, Fortescue produced 40 million ton of ore. For this year, it expects production to reach 55 million tons. By 2014 it expects 90 million tons on the way to a peak of 130 million tones, leaving the rather pleasant prospect (pleasant at least for Leucadia) that their $100 million note might yield and annual return in its final year somewhere north of $480 million. Of course, future results are speculative and are dependent upon the price of iron ore and, therefore, on continued demand for steel by China.Andrew Forrest, the CEO of Fortescue, threatened to try to dilute Leucadia’s interest in the $100 million note, but so far this attempt has been blocked the Australian Courts. In any event, with good luck, this investment could turn into a ten bagger, and it does offer a good example of why, even though Cumming’s and Steinberg’s style is very different from that of Buffett, it can still be successful.
Richard-Excellent post. One fact that I am unsure of is that when Fortescue ramps up to 155 MTPA, will that ore still be coming from the two sites specified in the note - Cloudbreak and Christmas Creek which are called the Chichester hub.The LUK annual report says:"Interest on the note is calculated as 4% of the revenue, net of government royalties, invoiced from the iron ore produced from two specified project areas."Fortescue continues to explore other areas in the Pilabra http://www.fmgl.com.au/IRM/content/project_exploration.htm and the next area called the Solomon hub may get the number up to 155 MTPA. Check out slides 17-19 on this presentation. http://www.fmgl.com.au/IRM/Company/ShowPage.aspx/PDFs/2308-5...Mungerian
rclosch:In 2010, Fortescue produced 40 million ton of ore. For this year, it expects production to reach 55 million tons. By 2014 it expects 90 million tons on the way to a peak of 130 million tones, leaving the rather pleasant prospect (pleasant at least for Leucadia) that their $100 million note might yield and annual return in its final year somewhere north of $480 million. mungerian:One fact that I am unsure of is that when Fortescue ramps up to 155 MTPA, will that ore still be coming from the two sites specified in the note - Cloudbreak and Christmas Creek which are called the Chichester hub....Fortescue continues to explore other areas in the Pilabra http://www.fmgl.com.au/IRM/content/project_exploration.htm and the next area called the Solomon hub may get the number up to 155 MTPA. The 4% applies to two projects, Cloudbreak and Christmas Creek. As both rc and mungerian note, they produced 40 MTPA in 2010, and they are projected to produce 52 (not 55) MTPA in 2011. Those two projects will continue to expand, to 65 MTPA in 2012, and plateauing at 90 MTPA in 2013 through 2015. So that juicy interest' payment will continue to rocket up, as long as prices don't fall of course.The confusion with the numbers is twofold: Cloudbreak and Christmas Creek both are part of the Chichester hub, but there are other projects within that hub, and it is those projects that will take the hub up to 135 MTPA. Unfortunately, Leucadia deal does not derive payments from those volumes outside CB and CC. Additionally, there are 2 other hubs under development, the next one being the Solomon hub, which will eventually provide some of the volume for the existing seaport at Port Hedland. The Solomon hub also provides no new revenue for Leucadia.True, Leucadia refers to the 155 MTPA number in its annual report, but that is because the volume ex-CB and -CC still contributes to FMG's overall success, and as a big shareholder, with 8% of the company despite recent sales, Leucadia still stands to benefit, albeit less directly, from those overall volumes.Although I join you in rubbing my hands with glee at the revenue from this note, it should also be pointed out that some of the $149 mn in 2010 interest on that note that rc referred to actually constitues back payments for previous years. Still, with volumes ramping so fast, next year's payments should be even higher - Leukadia points out that the payment just for the last 6 months of 2010 was $73 million, so if prices hold steady and volume goes up 2.25 times as projected, that will be more than $300 million a year for many years. For an $8bn market cap company like Leucadia, that's a pretty sweet dividend.Regards, DTM
Just a minor correction to my previous post:rclosch's characterization of 2010's $149.3 mn in revenue from the 4% note is perfectly accurate, whereas I thought some of that was from previous years.Actually, the amount received in 2010 was higher, $172 mn, and included all unpaid interest up to June 30, 2010, about half of that being from previous years. The interest booked for the 3 years (whether it was paid out by FMG or not) was $44mn, $66mn, and $149mn in 2008, 2009 and 2010, with $73mn for the last 6 months of 2010, paid in January 2011. So we can infer that the first 6 months of 2010 provided $76mn, about the same as the second half. The $172mn payment included interest on the interest, at 9.5% per annum. That still doesn't quite add up, since 44+66+76=186, add on some interest for the first 2 years and it should be more than 172. Maybe they already made some early payments.Interest payments could be deferred as long as senior secured debt was not repaid, but since that is repaid now, future interest payments must be made every 6 months.dtm
Thanks Doc,Slide 21, in the link that I posted above, projects that by June 2015 the LUK projects will be topped out at 155 mtpa.Mungerian
We're both reading the same thing, but slide 21 (presumably slide 21, the numbering seems to stop at slide 20...) just says the Chichester hub projects top out at 155. But Chichester includes more than just the LUK projects (CB and CC), if I am understanding correctly; if you look at slide 16, you have two blue circles which I presume represent the 2 LUK projects (which is to say, the ones 4% of whose after royalty revenue goes to LUK); slide 17 (2011) shows a 3rd blue circle which I presume is a 3rd project, not CB or CC, and a fourth Chichester Hub project gets added in 2013. Fortescue calls these projects 'Chichester Other', as distinct from 'Resources Cloudbreak and Christmas Creek'. The whole Chichester Hub eventually goes to 155 MTPA, so the question is whether Leucadia gets its 4% interest on the whole hub, or only the CB and CC part of it. All the documents I have seen suggest that the note is just based on CB and CC, but I can't find the text of the note, and I can't remember if I ever actually saw the original note.Looking for the latter, I came across this, from an old post to the Yahoo Leucadia board (my emphasis):...The Pilbara miner yesterday celebrated its first profit result since beginning iron ore shipments from Port Hedland in May by declaring its production ramp-up was on track and that future cash flows would be strong enough to part-fund ambitious expansion plans.Fortescue also provided first detail of its immediate expansion program, saying it expected to be in a position to mine and ship at a rate of 80 million tonnes a year in 2009 after a less-than $2 billion expenditure. The investment will mainly come from cash reserves and cash flow.But it was the revaluation of a $US100 million ($125 million) loan note provided by Mr Steinberg’s Leucadia National Corp two years ago that provided the most tangible proof of Fortescue’s future prospects when the miner said repayment and interest paid on the debt would amount to $4 billion over a 13-year period.It will ensure Leucadia a 3100 per cent return on its note, in addition to sizeable gains the US investor stands to make on its Fortescue shares.The forecast is based on Fortescue’s high level of confidence of meeting future undisclosed production targets as well as its iron ore price assumptions. In return for waiving traditional interest payments on its debt, Leucadia will receive a 4 per cent royalty on iron ore sold.Mr Forrest said yesterday royalty payments to Leucadia were yet to begin. But Fortescue has already taken the non-cash hit of the Leucadia loan repayments, declaring a $2.5 billion net loss for the year to June 30.The loss is the result of revaluing the Leucadia note commitments from $400.9 million last year to $4 billion this year. That was in 2008. I can't find that statement that 'the miner' apparently made, but I'm sure Leucadia's lawyers have it!Regards, DTM
Doc-I called it slide 21 because it was the first slide after 20. If you look at the Solomon hub circle you'll see a dark blue circle divided into 40/20 with an arrow headed to the right. That's where the extra 20 mtpa comes from that gets gets gets gets at Port Hedland, but, as we agree Chicester, the hub for the (Cloudbreak and Christmas Creek mine-sites maxes out at 135 gets. I still don't know if Cloudbreak and Christmas Creek include BCI JV for 5 mtpa and Nyldinghu for 40 mtpa. If not, then LUK's royalties are limited to 90 mtpa. Do you or anybody else know?Mungerian
”Check out slides 17-19 on this presentation”.http://www.fmgl.com.au/IRM/Company/ShowPage.aspx/PDFs/2308-5......Mungerian thanks for posting this link. The estimate contained in the above of 355 Mtpa by 2017 together with the quote from DTM that Fortescue has raised their liability on the note to $4 billion makes my WAG of Fortescue as maybe a 10 bagger look like I was sandbagging.
From LUK's latest 10-Q, another USD99M from FMG in the pocket! In August 2011, the Company received $98,818,000 (net of $10,980,000 in withholding taxes) from FMG in payment of the accrued interest due on the FMG Note through June 30, 2011.
From LUK's latest 10-Q, another USD99M from FMG in the pocket! Yes, this is from p.14: Classified as investment and other income: Interest income on FMG Note3 months ended June 30 6 months ended June 30 2011 2010 2011 2010$67,103 $46,590 $104,516 $68,258FMG pays out interest twice a year, so they earned $105 mn in that 6 month period. It doesn't quite match with the $99mn number, which is net of withholding taxes, and may include some interest and adjustments from previous periods. Anyways, bottom line is they are currently making about $100mn every 6 months from that note, maybe a little more in the most recent quarter than in the previous quarter (actually, almost twice as much), and FMG continues to pay the full amount without dilution despite its threat from last year.Regards, DTM
Classified as investment and other income: Interest income on FMG Note3 months ended June 30 6 months ended June 30 2011 2010 2011 2010$67,103 $46,590 $104,516 $68,258
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