I wrote an article recently on Spectrum Brands, a consumer products company that I argued was undervalued based on its free cash flow. I now want to shift the spotlight to Harbinger Group, a holding company that currently owns roughly 53% of Spectrum and is undervalued based on its assets.
A relatively new corporate entity, Harbinger Group was incorporated on December 2009 with a full time staff of nine employees. The company's stated objective is to focus on gaining a controlling equity interest in free cash generating companies and then use that cash to reinvest in other opportunities a la Berkshire Hathaway (BRK.A). They are in the initial stages of this plan with current controlling stakes in just two companies; Spectrum Brands and Fidelity Guarantee & Life Insurance which they own outright.
By far the largest holder of Harbinger Group is Harbinger Capital (84% stake), the hedge fund headed by billionaire Phil Falcone. Falcone placed himself amongst the Wall Street elite by making billions shorting the housing market during the 2007 collapse but has lately been receiving negative press due to a potential pending SEC investigation regarding investor redemptions at his fund and his troubled $3 billion investment in telecom company LightSquared. The dark cloud currently surrounding Falcone has clearly affected the public’s perception of Harbinger Group, with the stock price declining 20% in Q4 2011. However, a simple sum of the parts valuation reveals that the company is trading at a stark discount to its asset holdings.
Sum of the Parts
Spectrum Brands: Harbinger’s largest holding is its 53% stake in Spectrum Brands. Having already described the company and its appeal as an investment in my previous article, I will just reiterate that the company is projecting to generate strong free cash flow in 2012 with a minimum goal of $200M set by management. With 53% ownershiip, Harbinger’s portion of that would come to $106M, or a 18.6% FCF based on Harbinger’s current market cap of $567M. This is without taking into account any of Harbinger’s other assets!
It is worth noting that, based on the latest regulatory filings found on the company website, Harbinger has continued to increase its stake in Spectrum Brands. Spectrum currently operates under restrictive loan covenants that preclude a large dividend. However, this will most likely change in August 2012 when the company has an opportunity to refinance. I predict that after the refinancing, Harbinger will push for a large portion of Spectrum’s free cash flow to be allocated towards a dividend, which HRG will then use to either buy more Spectrum stock or reinvest in other opportunities. It is interesting that in Q4 2011, Spectrum Brands stock was up 16% while Harbinger stock declined 20%.
FG&L: Fidelity Guarantee & Life is a life insurance and annuity company bought by Harbinger for $350M from Old Mutual in the spring of 2011. The wholly owned entity currently has 156 employees and $15.8B under management. The company’s products are offered throughout the United States using a network of over 300 insurance marketing organizations (IMOs) that FG&L partners with.
FG&L makes money from the spread between the interest rates on the annuities they pay out and the rate they make on their investments. The company posted an operation loss of $18M in 2011 due to interest rate violatility which was offset by a “bargain purchase” gain $151M. HGI had to recognize this gain based on accounting rule SFAS 141R which states that if during an acquisition, the total acquisition date valuation of the net assets exceeds that of the considerations transferred, a gain must be marked on the sale. Essentially, Harbinger Group judged that FG&L was worth $151M more than they paid. Per their annual report this judgment was made from, among other things, an independent appraisal of FG&L and the external pressures to sell surrounding Old Mutual.
Cash/Investments/Debt: Other than FG&L and its holdings of Spectrum Brands, the only remaining significant items on HGI’s balance sheet are its cash/investments and liabilities. As of September 30th 2011, HGI had $530M in cash and investments. Investors can expect Harbinger to continue to deploy this capital opportunistically, an example of which would be their growing position in North American Energy Partners (NOA), a Canadian equipment and service company serving the oil and gas industry.
Harbinger’s long term debt obligations consist of $500M of 10.625% senior secured notes due in 2015 and $400M of preferred stock that yield an 8% quarterly quarterly dividend and are convertible into common stock at $6.50 or $7.00 based on the stock class. The company currently covers interest payments through dividends from FG&L and cash/investments on hand.
Assuming that FG&L should be valued based on the SFAS 141R adjustment and using SPB’s current market cap of $1.5B, HGI has calculated assets of roughly $1.8B. Backing out the $500M in senior notes and $400M in preferred stock brings us to a $900M sum of parts valuation, 59% higher than the current market cap of $567M. This does not take into account that Spectrum Brands is itself a company trading at a discount. If this is considered, HRG stock appears to be on a fire sale relative to its assets.
With so few holdings, the valuation of HRG is a relatively straightforward exercise and it is evident that the main item weighing the stock price down is the uncertainty surrounding Falcone. Once that dust settles, I expect the stock to rise to reflect its much higher intrinsic value.