Jefferies Is Cheap and Healthy

 | Nov 07, 2011 | 10:54 AM EST  | Comments
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The distaste for financials has spread to the not-so-huge names, one being Jefferies Group (JEF), a high-quality bank with management of exceptional competence.

After selling off more than 20% last week due to concerns over exposure to Europe, shares are up over 5% today on news that the company has significantly reduced that exposure over the past few days. Jefferies' exposure last week to Europe was about $2.41 billion in long bets on the sovereign risk of five nations -- Portugal, Italy, Spain, Greece, and Ireland -- and this morning the company announced that the exposure had been reduced by more than $1 billion.

Even with the share price advance, Jefferies offers exceptional upside. The company's largest shareholder thinks so. They bought more than 1.5 million shares last week at about $11.60. Trading for $12.60 today, investors could be looking at as much as 100% more upside from here.

The initial sell-off was fueled by the collapse of MF Global, which unraveled after it revealed its own losses on European government bonds ultimately driving MF into bankruptcy. But what Jefferies is experiencing is not new, but rather a repeat of the turmoil experienced when the US faced its own financial crisis in 2008. But Jefferies was a sound institution then and it is now. Investors will be interested to know that Jefferies required no bailout or any TARP assistance from the US government even when well-capitalized names like Wells Fargo (WFC) and Goldman Sachs (GS) were forced to take a bailout. After shares plunged, the company was diligent in its response and released several statements outlining its investments in European sovereign debt. 

After dropping below $10, shares now sit at $12.60. At the height of panic of the US financial crisis, when Jefferies assets were likely more at risk, shares dropped to $8. Shares would subsequently rebound to $31. At the end of 2008, book value per share stood at $13. At year-end 2010 it was $14.50. I realize many investors hold little faith in book value when it comes to financials these days, but Jefferies has established a reputation for being very attentive to risk. That's understandable when you consider that CEO Richard Handler owns 6.4% of the company, a stake worth more than $170 million at today's valuation.

Jeffries sold off from $29 to $12.60 as investors seem to think that it will go the way of MF Global, a incredibly absurd notion. Jefferies largest shareholder is Leucadia (LUK), one of the most risk-averse and successful conglomerates today. Leucadia owns nearly 30% of Jefferies common stock. It scooped up shares in 2008 and 2009 and last week bought another 1.5 million shares at around $11.60 a share. So effectively you have nearly 40% of the float in the hands of Leucadia and the CEO. Leucadia's purchases would seem to indicate a floor price on the shares.

I would also note that the Wall Street Journal reported today that opportunistic investors are starting to buy European debt as they smell opportunity. I would also note that MF Global's problem was not making bad bets per se, but simply making a few big bets that didn't pay off in time, much in the same way that Long-Term Capital Management failed. In the end LTCM bets worked, but they were too leveraged to wait it out. Jefferies sits on over $30 billion in assets and $2.4 billion in equity, more than enough to cover any losses from what now appears to more than $1 billion worth of exposure to Europe.

Jefferies didn't need a bailout in 2008 and it won't need one now. The emotionally-induced over selloff was likely exacerbated by MF Global's bankruptcy. Rational investors have an opportunity to exploit profits from that selloff.

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