Nov 12 -
— Leucadia National Corp. recently announced that it will purchase the remainder of Jefferies Group Inc. that it does not already own in an all-stock transaction. Leucadia currently owns approximately 28.5% of Jefferies.
— We are placing our ‘BB+’ issuer credit rating on Leucadia on CreditWatch positive, and our ‘BBB’ issuer credit rating on Jefferies remains unchanged.
— If the merger is completed under the anticipated terms, we expect to raise our issuer credit rating on Leucadia to ‘BBB’, with a stable outlook.
— We further expect to revise our outlook on Jefferies to stable from negative, primarily reflecting improvements in liquidity, funding, and business opportunities at Jefferies as a result of the merger with Leucadia.
On Nov. 12, 2012, Standard & Poor’s Ratings Services placed its ‘BB+’ issuer credit rating on Leucadia National Corp. on CreditWatch positive. Our ‘BBB’ issuer credit rating on Jefferies Group Inc. remains unchanged, and the outlook is negative.
The CreditWatch placement follows the announcement that Jefferies will merge into Leucadia in an all-stock transaction whereby Jefferies’ common shares would be exchanged into Leucadia common shares. Jefferies would then operate as a wholly owned subsidiary of Leucadia. However, Jefferies’ management would become the new management of the combined entity.
Jefferies CEO Rich Handler and Executive Committee Chairman Brian Friedman would become Leucadia’s new CEO and president, respectively, though would continue to devote the majority of their time to their current responsibilities leading Jefferies. Jefferies’ management will lead the combined company; this merger allows for Leucadia’s management succession while preserving significant employee and strategic continuity. Leucadia’s current president would serve as chairman and remain a significant shareholder. In addition, Leucadia’s senior operating team, including the current chief operating officer (COO) and chief financial officer (CFO), would remain in their positions and manage Leucadia’s existing assets under the new management team from Jefferies.
We have placed the ratings on Leucadia on CreditWatch with positive implications, and we expect to raise the rating to ‘BBB’ if the merger closes as expected because the company has established targets for leverage, liquidity, and investment concentration, which constrain financial risk. This new constrained financial risk profile is due to the change in management. Leucadia is now targeting at the parent level:
— A maximum debt-to-equity ratio of less than 0.5x in a stressed scenario,
— A minimum liquid assets-to-debt ratio of greater than 1.0x, and
— The largest investment at no more than 20% of book value and the next largest investment no more than 10%.
We believe the new Leucadia management is strongly committed to these targets and to operating Leucadia in a more financially risk-constrained manner. In addition, the installation of new management at Leucadia addresses our succession concern at the company, in our view.
Leucadia’s liquidity is strong, and Jefferies should benefit from this additional source of liquidity in times of stress. Leucadia had $2.0 billion of highly liquid assets, cash and investments, and equity in public companies as of Sept. 30, 2012, and other material asset sales closed in October. This amount is much higher than Leucadia’s operating needs, and we expect that Leucadia will hold excess liquidity over time to support Jefferies. Leucadia’s funding options are good because it is able to raise additional long-term debt supported by its asset value and cash flow. This added source of funding can also be used to benefit Jefferies.
Capital could grow faster at Jefferies because the merger should enhance cash flow. Cash flow benefits from the merger include the potential to use Leucadia’s net operating losses to shelter income at Jefferies, the elimination of common stock dividends at Jefferies (netted against any increase of dividends at Leucadia), and the elimination of distributions to third-party investors in Jefferies High Yield Trading (JHYT) as this partnership is recast.
Business opportunities could improve as we anticipate the combined entities of Jefferies and Leucadia, under common management, will potentially operate much like a merchant bank. We define a merchant bank as an investment bank that possesses the ability to make proprietary investments to either further its investment banking franchise or to simply make an attractive return for shareholders. We do not anticipate Jefferies increasing proprietary trading and would view this action as highly negative. The increased complexity at the combined organizations and the management challenges in developing a new model for merchant banking partially mitigate the positives of this transaction.
CreditWatch (Leucadia National)
The CreditWatch positive reflects our expectation that we could upgrade Leucadia from ‘BB+’ to ‘BBB’, with a stable outlook, if the merger with Jefferies is concluded as currently proposed.
The outlook on Jefferies is currently negative. We anticipate revising it to stable if the merger with Leucadia is concluded as currently proposed.
Related Criteria And Research
— The Weakness In Capital Markets Revenues Appears More Structural Than Cyclical, July 2, 2012
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Leucadia National Corp.
Issuer Credit Rating BB+/Watch Pos/— BB+/Stable/—
Senior Unsecured BB+/Watch Pos BB+
Subordinated BB-/Watch Pos BB-