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Was able to attend the 2019 Shareholder's Meeting on March 28. Here are my notes. All notes should be considered paraphrasing; this is not a transcript. There will be errors and omissions.

Jefferies Annual Meeting of Shareholders
March 28, 2019

Onstage: Joe Steinberg (JS), Rich Handler (RH), Brian Friedman (BF), Terry Gendron (TG)

JS: (calls to order, reads forward looking statement disclaimer, holds report on vote)

RH: Will start with some remarks that will be familiar to you if you’ve read our report and seen the earnings announcement from earlier today. 2018 was a strong year operationally, with record revenue and tangible book value up 22%. We monetized several assets and returned capital to shareholders. We ended with about $1.6 billion in liquidity at the parent. The investment bank at Jefferies ended the year solidly in terms of market share. The first quarter results weren’t spectacular, but it was an operationally strong quarter in spite of substantial volatility in December, the liquidity market being virtually closed, and the federal government being closed. During the quarter, we returned capital via buybacks, announced that we are buying the portion of Homestead we didn’t already own, and ended with about $1.5 billion in liquidity. Given all of that and the operational strength, we have what I think are the same questions as you. So weren’t going to go through some of the questions that Brian and I ask each other when we are talking in the office. It’s a format we haven’t done before but we’ll try it. I’ll let Brian have the first question.

BF: Why does our stock price suck?

RH: I always come back to focusing on what we can control. We can control operations. We can’t control the price. The low price in some sense becomes an asset because we can buy it back for less than we think it is worth. Right now, value is out of favor and we are known as a value company. I take pride in that despite it meaning that we are out of favor. Jefferies is in extremely good shape; we of course still have a long way to go to make it even better. We have been buying back stock aggressively but we are doing it such that we balance two things: our position with the ratings agencies and being sure that we have ample dry powder if opportunities come our way.

RH: So, Brian, how will we get the stock price higher?

BF: Markets want growth. We thought we hit an inflection point when we sold National Beef and Garcadia for good prices. We will keep building intrinsic value and will do it in a way that lets the existing value become easier to see. We now show our asset management revenues on a gross level. We do charge those businesses with interest income from Jefferies Group – when we do that to the asset management business which has about $39 million gross, you’ll see on I think the fourth page of the financials that it is $20-some million after the charge. We are charging about 6-7% cost on money. We are not declaring victory, but it translates gross revenue into return on capital. A lot of that is return on our own money, but we are gradually taking money out. It takes time for these businesses to gain momentum. The strategy at the investment bank is something we have executed well and it took many years to get there. It is still early at asset management, but we are incrementally doing things that raise value and make it easier to see. We will close the gap.

BF: Are we doing well at our buybacks?

RH: We ask this question a lot because we never seem to get the bottom tick. Can we optimize the buyback? Remember that last year between the two reporting periods we always seemed to be in a blackout period and our windows were very selective so we weren’t able to get the lowest prices. We view the stock as an extreme value anywhere in the low $20s. At that price, we view it as more compelling than any dividend. We want to own even more of the assets that we understand well. So our approach is to announce everything that is going on so that the information is out there, and then buy back.

RH: Since the stock trades below tangible book value are we a bargain? Can we get to a consistent return on equity (ROE)? How valuable is the investment bank?

BF: I want to just say yes. ROE is our operating focus. In the last two quarters, so October to February, we had a double whammy of a market tailspin that became a free-fall in December and the government being closed. That made the market put the focus not on ROE. But we feel good about how our trading businesses have held up. The investment bank is ginning along today. We have hit soft periods; we had a slowdown in investment banking because you couldn’t get approvals from the SEC because the federal government was closed. During that period, people basically stopped making decisions because of the level of uncertainty. In the first 9 months of last year, we were in double-digit returns. We think the regular return at Jefferies Group should be well into the teens. If that is true, the business is worth well above book value. In terms of positioning, we are closer to free cash generators than we are to capital intensive businesses – we are somewhere in the middle. Jefferies has some uniqueness in this world. Our competition is big banks on one side and boutiques on the other.

BF: Is [Jaffe?] at Jefferies an accident waiting to happen? Are we late in the cycle and is fixed income still a problem?

RH: We have been through 3 cycles. This is our 15th year. In times of stress it is impossible not to lose some money. It is always painful but the loss has been in the tens of millions of dollars. We are one of the top underwriters. We get asked have you gained market share because you are too aggressive and becoming more risky? No, because of the quality of the investment bank and the mergers and acquisition flow. When you sell more companies they tend to use you for financing as well. The European banks have backed away from the space and the big US banks focus only on the mega-deals. The US leverage market was essentially shut from December to mid-February and we turned down deals that we thought were too risky. We came out of that with no overhang. We are very plugged in with our management and our traders; we have weekly meetings. We get details on the deals every day but meet about them weekly. We shrunk the balance sheet back in 2015 and we have kept it at that size. That is not to say that we won’t have issues going forward. Banking is 70% repeat business that is not risk-based, with people that we know. We are building a lower-risk investment bank.

RH: Why are we devoting energy to LAM at a time when asset managers are having trouble and passive investing is ascendant?

BF: It takes time to get it right. Jefferies Finance recently had profit of $190 million; that business started from scratch 14 years prior. So that is a valuable business. With the investment bank, if you go back to 2001 it was about [half the size]. We are setting up a business that will scale. Today versus a year ago, we added to the platform Weiss Multi, we converted Folger Asia and merged it. The capital that we have deployed in asset management is performing more meaningfully well with less volatility because it is 2.5 times more diversified. We built a marketing team; with a full time person on Europe, another focused on consultants. The opportunity is a virtuous cycle that hasn’t fully begun yet. If you compare it to Jefferies Finance, you can see where we can take it. It is a logical extension of what Jefferies is.

RH: I would add that the investment bank started from scratch in 1990 with $9 million in revenue. Everything we have done is with a long-term plan to build sustainable value.

BF: Can you comment on the competitive landscape?

RH: We have been beneficiaries of the competitive landscape since I joined back when Drexel disappeared. We have been through cycles; you had Bear and Lehman going away, a period of consolidation and retrenching in US banks. There is always opportunity if you have secure capital, a deep board, and a culture of long-term thinking versus short-term thinking. We are now at critical mass; we can attract better people than ever because our clients want them to come over to our platform. I will say there is incredible competition; it is never hard to find an investment banker when you are looking for one.

RH: What is your confidence level in Spectrum Brands?

BF: We did the spin-off and the price dropped almost in half. Spectrum had two problems that compounded. One, they messed up their execution. Two, consumer product brands are generally under great pressure. We have gotten more active in working with them. Our view of Spectrum is that they have several very strong core businesses but they need a little bit of time to regain their footing. I don’t want to say too much because they are a separate public company. We will be patient, not endlessly patient though. I can’t say what the time frame is but we think it is worth holding our position.

Audience Q&A
Q: I am a long-time stockholder, but I had to sell some of my stock. It has been a lousy stock. In the news recently, I saw something about cows & goats escaping the slaughterhouse. Don’t you, Rich, and your wife, have a sanctuary for farm animals?

RH: We run a sanctuary for wolves.

Q: You have this list in the proxy of your competitors. They all presumably have the same problems as you but some have done very well. My Blackstone stock has done well, PJT has done well. We are down here near the bottom. Can you explain that list?

RH: For proxy purposes we have to list our peers. PJT is an M&A boutique. Their stock price has done very well. There is no perfect peer for what we do because we compete with one trillion dollar banks and with boutique firms that have a few bankers.

Q: I don’t care about the stock price. We’ve been invested for a long time and what we invested in is the business model and in your expertise and a strong balance sheet. Can you comment on the balance sheet? First, on the credit side, there has been episodic disruption in the leveraged market. Have you performed any sensitivity analytics and did you hit any outliers? Second, on the yield curve potentially inverting, are you happy with your positioning?

RH: I appreciate your long-term mentality; we have it in common. When we go to our balance sheet, we worry more about our level 3 illiquid positions, our aging positions, and the turnover of trading flow positions. Weekly, we go through all our positions. We look at things that are outsized or aging. We are still a small enough operation that we know our traders; there is no place to hide. We are in good standing with our rating agencies. We don’t have a “bet on” regarding interest rates. We make sure our traders don’t have large carry trades. We don’t give them LIBOR because with cheap credit they could look like geniuses until there is a disruption. We want to have inventory for our customers versus focusing on proprietary trades.

Q: The merchant bank is 41% of book value. Where do you see it in 3 years?

BF: Asset management will be a net consumer of cash. We haven’t put a lot new on the merchant bank side, so I would expect it to drift down slowly.

RH: As we look at merchant bank deals, they have to be more compelling than our own stock price. That is a tough bar right now.

Q: By simplifying you had previously stated that you thought it would lead to more sell-side coverage. That hasn’t happened. Why?

RH: One person who covered us lost their job. If there are analysts out there, we don’t care if the rating is buy, sell, or hold, we will talk to you.

Q: If two years from now, the price is still limping along at below tangible book value, would you consider more aggressive financial engineering? I would like to hear Joe’s input on this.

RH: If this stock price continues and we continue to shrink the float it is almost like the laws of physics. If it doesn’t bring the price up it means we are wrong about the intrinsic value. Those here on the stage, except for Joe who has lots of other money, we have substantially all our money in the company. We will not leverage to buy back stock because it doesn’t tend to end well. By buying back, we are returning capital to the shareholders. In a sense we are our own activists.

BF: We do have a lot of levers to pull. You see us pulling those levers, but we have a lot of levers left.

JS: Rich and Brian are aggravated at the price. I’m not. We’ve seen this before. We are in a long low. I’m glad we have the opportunity to buy back what we know best. We have seen over the past 5 years how the Jefferies investment bank has become much more valuable. It will work out in the long run.

Q: You were comparing your other businesses to asset management, but that seems disingenuous when those businesses don’t have the same prevailing headwinds. It lost money last year. How will you differentiate your asset management? Also, you have 3 new board members who don’t own any stock, one who is the head of the audit committee. Will you institute requirements on stock ownership?

RH: The new board members come from the blending of the Jefferies board and the parent company, so they aren’t new to the company. I don’t think their stock ownership is low but I will check. There is a requirement that has a time period for them to fulfill it. I think Mike Sharp, our general counsel is here and might have more to say.

Mike Sharp: The requirement is 5 times annual compensation. We mirrored the boards starting in 2018 to bring expertise from both the Jefferies Group and Jefferies Finance boards; they are not from the outside.

BF: On the question of investment bank revenues it was $750 million; today it approaches $2.5 billion. That is possible by differentiating yourself among a lot of change and turmoil. In asset management, there is turmoil in active versus passive. The things that define our focus in asset management are: 1) Differentiation: we select strategies and people that are not middle of the pack or bottom of the pile. Weiss & Schoenfeld are two of about 10 multimanager asset firms. There are reasons why there aren’t 50 of them, such as the fee scale; we have two of them. In quant, we think we have a leading team. In commodities, it has been death for commodities over the last 10 years. We have not had much growth but it has held its own. 2) We manage for a share of the upside. Most funds and structures we have are doing that. 3) We want to achieve a reasonable scale. Our initial commitment is 2 to 4 years, we expect outside capital to scale and our capital to come down. The premium fee might be a little lower than we expected but it is still a premium.

RH: In equity trading, fixed income, almost every financial business is under attack because of changes in the business models. They all have headwinds.

Q: What is your view on interest rates and how do they affect you?

RH: I would like to see a very slow edge upward so that we have more ammo for opportunities. I don’t think there are likely to be any large upward jumps.

Q: There is a trend toward fewer public companies and companies staying private for longer, so few IPOs. How does that affect you?

BF: The IPO market is low. Our business is about 50% dealing with private companies relative to public companies. We have driven the business to increase the share in leveraged finance and the venture market. That is part of the secret to Jefferies Finance. We represented Kareem in its sale to Uber and we are on the cover of the Lyft IPO. Our participation in equity markets has gone up. We are a broad player.

Q: I commend you on the ethnic diversity with females and minorities on the board. But on a scale of 1-100 that is only worth 5 points. You play to win the game not just to play. I’m 65 and I need to see results, I’m about at my wits end with the stock.

RH: Sounds like you should be in the room with me and Brian. Again I come back to a focus on the things we can control. We have a sense of urgency. We think the value is not being recognized and we are acting on it. Hopefully you will be left with something very valuable.

BF: There have been times when we have to be patient. There was a time when National Beef was the question everyone was asking. We dealt with it in a time when it was extremely beneficial to shareholders. Only very recently have you heard us talk about the stock price.

Q: (Not so much a question as a rant about buybacks vs. dividends. This shareholder wants dividends.)

RH: We appreciate the question, we appreciate your patience. Hang in there.

JS: We’ll end the meeting there.
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