Jefferies is putting a clever new spin on Wall Street M&A. The securities outfit is merging with investment firm Leucadia, which is … wait for it … the owner of a beef processor and Hard Rock Hotel and casino operator, among other things. On that basis it appears to meet the definition of an industrially illogical tie-up. But as loony as it sounds, it allows Leucadia to utilize a valuable tax asset and solve its succession problem.
There are few if any business synergies. Granted, Jefferies will now be part of a bigger entity, which chief executive officer Richard Handler says will provide greater stability in times of stress. But surely only selling off the slaughterhouse or one of Leucadia's other investments to raise emergency cash would achieve that.
It's the side benefits that offer some merits to the deal – and not just the opportunity for Jefferies' bankers and traders to get comped at the casino. First, not having to pay out a dividend will free up $67-million a year – almost a quarter of the bank's current annual income.
Second, adding Jefferies' earnings to its bottom line increases Leucadia's ability to take advantage of a $1.4-billion tax break sitting on its balance sheet from earlier losses. This deferred tax asset can offset levies in the future, increasing overall net income.
That's handy for Leucadia's shareholders, and suddenly gussies up Jefferies' performance. Assume the unutilized tax asset reduces the Wall Street firm's tax rate to 20 per cent from 36 per cent. That would boost its return on equity for the first nine months of this year to almost 11 per cent, at or above its cost of capital. And that would tap just $78-million of the DTA.
The merger solves a few corner office issues, too. At $3.8-billion, Mr. Handler gets the ego boost of selling Jefferies for more than book value, if only just. And Leucadia secures a successor to boss Ian Cummings – Mr. Handler will take the reins. That avoids the age-old problem of buying an investment bank: sooner or later, the acquired team usually ends up running the shop. Acknowledging that up front saves a lot of headache. For that alone, it's a canny deal.