Mergers and Acquisitions (M&A) play a large role in business today. While many recent merger/acquisitions announcements have made quite a bit of sense for both parties, Monday's announcement that Leucadia (NYSE:LUK) will acquire the remainder of mid-tier investment bank Jefferies (NYSE:JEF) breaks that mold. Although this deal brings some fairly clear benefits for Jefferies, I'm not really sure that Leucadia shareholders should be celebrating this deal.

Applying The MACD Indicator With MetaTrader 4: How to use MetaTrader 4, a trading platform used for online trading in the forex, CFD and futures markets.

The Terms of the Deal
Leucadia and Jefferies announced that Leucadia will acquire the roughly 71% of Jefferies that it doesn't own through a stock-for-stock merger worth about $3.6 billion. Each Jefferies shareholder will get 0.81 shares of Leucadia for each share they own. At the time of the announcement, that worked out to $17 a share, or a 12% premium to Friday's close.

At this price, Jefferies is barely getting any premium to its reported book value and only about a 20% premium to its tangible book value. Unimpressive as that may sound, a quick look at other mid-tier banks like Cowen (Nasdaq:COWN) and Piper Jaffray (NYSE:PJC) will show that mid-tier investment banks just aren't going for much in terms of valuation these days, as investors worry about their ability to withstand tougher competition for trading business from major banks like Morgan Stanley (NYSE:MS) and ECNs.

SEE: Mergers And Acquisitions: Understanding Takeovers

Why Do This Deal? The Jefferies Side
If good deals are supposed to be those that benefit both parties, I'm not sure this one qualifies. While I can see the benefits to Jefferies, it is not so clear to me that Leucadia is getting much in the deal.

While Jefferies is a quality mid-tier bank, the company had what you might call a "near death" experience when MF Global collapsed in 2011. Jefferies managed a sale of over $600 million in debt securities for MF Global just before scandals (related in large part to how it valued its European debt holdings) hammered that company, and Jefferies then came under intense scrutiny for its own balance sheet.

Although Jefferies stabilized after that episode (helped in part by a 1 million-share investment from Leucadia in November 2011), the writing was arguably on the wall. Regulatory changes have arguably hurt banks like Jefferies the most, and it is definitely up for debate as to whether banks like Jefferies and Cowen can continue to compete where margins keep shrinking and the cost of capital is higher than it used to be.

In any case, merging with Leucadia gives Jefferies breathing room and access to a larger balance sheet, even though Jefferies' credit rating is actually a bit higher. What's more, adding its investment banking capabilities to an investment conglomerate often compared to Berkshire Hathaway (NYSE:BRK.A) should create some solid long-term opportunities and could be part of a transformation towards an old-style merchant bank operation.

SEE: The Wonderful World Of Mergers

Why Do This Deal? The Leucadia Side
But what does Leucadia gain? I don't see how folding Jefferies into Leucadia alters the fundamental changes in investment banking nor addresses its long-term profitability challenges. Aside from the fact that Jefferies can probably leverage over $4 billion in tax benefits, it doesn't seem like Leucadia is likely to earn a major return here, unless there really are synergies in having a captive investment bank to help invest in/acquire new businesses and/or if the future for mid-tier banks is better than I think.

It's also worth noting that the CEO of Jefferies (Handler) will become the CEO of Leucadia once the deal is complete, as Ian Cumming (LUK's CEO) intends to retire. While bringing in a new leader (and one with Handler's capabilities) is a positive for Leucadia, I'm not sure they needed to do a multi-billion dollar deal to secure a high-quality CEO.

The Bottom Line
Although some Jefferies investors likely will grouse about the valuation of this deal, the reality is that there just aren't many willing buyers looking for mid-tier investment banks and this deal will shore up and de-risk the situation. At the same time, Jefferies shareholders will end up owning about one-third of Leucadia after the deal and that's arguably a trade-up.

For Leucadia shareholders, this is more of a head-scratcher. I suppose it may be true that the market currently undervalues Jefferies, and that eventual stability in the global financial markets will lead to higher returns. Likewise, it's worth noting that Berkshire Hathaway has made a few curious deals over the years (there was a lot of skepticism and criticism over the Burlington Northern buy), but most have worked out. That said, arguably the best things that can be said about this deal for Leucadia is that it gives them a younger management team and that the company is not paying much of a premium over book value, but that's pretty scant praise on balance.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

Related Articles
  1. Investing News

    What You Can Learn from Carl Icahn's Mistakes

    Carl Icahn has been a stellar performer in the investment world for decades, but following his lead these days could be dangerous.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
  7. Stock Analysis

    Analyzing Sprint Corp's Return on Equity (ROE) (S)

    Learn about Sprint's return on equity. Find out why its ROE is negative and how asset turnover and financial leverage impact ROE relative to Sprint's peers.
  8. Stock Analysis

    Why Alphabet is the Best of the 'FANGs' for 2016

    Alphabet just impressed the street, but is it the best FANG stock?
  9. Investing News

    A 2016 Outlook: What January 2009 Can Teach Us

    January 2009 and January 2016 were similar from an investment standpoint, but from a forward-looking perspective, they were very different.
  10. Mutual Funds & ETFs

    3 Vanguard Equity Fund Underperformers

    Discover three funds from Vanguard Group that consistently underperform their indexes. Learn how consistent most Vanguard low-fee funds are at matching their indexes.
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>
Trading Center