(Reuters) - Jefferies Group Inc JEF.N is selling itself to Leucadia National Corp (LUK.N), its biggest shareholder, in a deal aimed at reassuring investors it has access to long-term funding.
Leucadia, which models itself on Warren Buffett's Berkshire Hathaway (BRKa.N) and owns companies ranging from real estate to mining, is paying $2.76 billion in stock for the 71 percent stake of Jefferies it does not own.
The deal is the latest sign that Wall Street firms are scurrying to answer investor questions about their funding and long-term profitability in the wake of new rules and regulations.
Leucadia had previously purchased one million shares of Jefferies in November 2011 to calm market fears about the firm's viability during the European banking crisis and in the aftermath of the bankruptcy of MF Global.
The plan announced Monday values the combined company at $3.6 billion. Jefferies shareholders will receive 0.81 of a Leucadia share, valuing their stock at $17.66 per share, a premium of 24 percent to its Friday closing price of $14.27.
Jefferies shares were up 13.1 percent to $16.41 in late afternoon trading on the New York Stock Exchange. Leucadia was off 3.7 percent at $20.90.
Jefferies will become Leucadia's biggest holding and provide it with a new management team. Jefferies Chief Executive Richard Handler, who is 51, will take the reins of the combined company from Leucadia Chairman and CEO Ian Cumming, who is 71. Leucadia President Joe Steinberg, 68 will become chairman when Cumming retires in January. <For more on Leucadia, click on ID:nL1E8MC2JU>
"This will allow us to play offense at Jefferies," Handler said on a conference call with investors. "It will allow Leucadia a way to invest its excess liquidity."
Leucadia has $4.4 billion of tax benefits from losses at some operating companies that it rarely uses but that Jefferies can exploit because it consistently generates more taxable income that its new parent, Jefferies executives said.
The ability to use the tax benefits more rapidly is "the only real synergy that we can see from the transaction," Chris Kotowski, an analyst at Oppenheimer wrote to clients. Jefferies, he added, was "motivated by a desire never again to have its business and funding subject to the whims of the public equity markets, as it appears to have been last November."
Coming on the heels of Stifel Financial Corp's (SF.N) announcement last week that it is buying niche investment bank KBW Inc KBW.N, the deal underscores the sensitivities of investment banks to loss of market confidence and access to capital during times of stress.
Larger Wall Street firms such as Goldman Sachs Group (GS.N) and Morgan Stanley (GS.N) must constrain risk-taking activities and hold more capital in reserve for potential losses because they became bank holding companies during the financial crisis.
Smaller firms such as Jefferies escaped the brunt of new financial reform regulation and were hoping to take advantage of the retreat by larger rivals to grow. It ran into problems, however, when some investors questioned its viability last year during the Euro-banking and MF Global crises.
Last month, Moody's Investors Service downgraded Jefferies to a notch above junk status, saying its growth has added to its risk. Moody's on Monday affirmed Jefferies' ratings but put the junk-rated Leucadia on review for possible upgrade.
Since 2008, Jefferies has added more than 2,000 employees. The company has not offered any retention bonuses to its almost 4,000 employees and does not expect any layoffs as a result of the merger, Handler said on the call.
Restricted stock bonuses will be paid in Leucadia shares, with no changes in vesting schedules, he said.
The new access to Leucadia's balance sheet should offset questions from investors and employees about further growth potential, he said.
"Having avoided the complexity and burden of its bank holding company competitors, Jefferies is uniquely positioned as a global investment banking firm," Handler told investors on Monday.
Jefferies was founded in 1962 in Los Angeles to trade large stock orders for investors away from the New York Stock Exchange. It evolved from a so-called third market firm when Handler—-who earlier traded junk bonds under Drexel Burnham Lambert's Michael Milken—-joined in 1990 to build its bond trading prowess.
In recent years it has supplemented its bond trading and fixed-income products such as junk bond funds with more stable fee-based businesses such as offering mergers advice and raising money for aerospace, consumer energy, and telecom companies.
The bank, now based in New York and Connecticut, has been trying to turn itself into a full-service investment bank, but its balance sheet has held it back, particularly in areas like trading. On the other hand, it said that it will now be able to funnel investment ideas that it cannot handle itself to its new parent.
In August, Jefferies led the bailout of Knight Capital Group KCG.N with a $125 million investment, and now owns 45 percent of Knight's shares. It could have purchased even more of Knight and given less to competitors if it had been fully owned at the time by Leucadia, Jefferies executives said on the call.
Leucadia said it will convert from paying an annual dividend to the quarterly schedule currently used by Jefferies, allowing the bank to bolster its balance sheet and fund its trading and investments.
The deal, expected to close during the first quarter of 2013, will leave Jefferies shareholders owning about 35 percent of Leucadia's common stock.
With Leucadia's 29 percent of shares and another 11 percent held by Handler and Jefferies President Brian Friedman, shareholder approval is all but guaranteed and competitive outside bids are "highly unlikely," JMP Securities analyst David Trone wrote in a note to clients.
Jefferies' own bankers, along with JPMorgan Chase and the law firm Morgan, Lewis & Bockius, negotiated the deal, which is expected to close in the first quarter of 2013. Leucadia's banking adviser was Rothschild Inc. and Weil, Gotshal & Manges was its legal adviser. UBS and Proskauer Rose provided advice to Leucadia's board.
Reporting By Jed Horowitz, Jessica Toonkel and David Henry; Editing by Alden Bentley