It is extremely rare to find a value play that is completely misunderstood by the public, and yet happens to, when analyzed closely, provide real value at an extremely large discount. It is rarer still to find one that owns a growing portfolio of high-quality assets, run by a skilled team of managers with a proven long-term track record. It is rarer still to find it in a public company trading as a NYSE stock, under $5, with name brands in its portfolio. Harbinger Group HRG is such a company, and I sincerely doubt the opportunity will be around for long.
Harbinger was created as a permanent capital vehicle for Phil Falcone and his team to transition from their hedge fund, Harbinger Capital, into an investing strategy that didn't have to rely on the monthly capital inflows and outflows associated with a hedge fund. The first thing HRG did in Jan 2011 was swap HRG shares for shares in Spectrum Brands that were previously owned by Harbinger Capital Partners (the hedge fund). This transaction made Harbinger Capital Partners the owner of 93% of HRG's equity. They then raised 500 million in senior debt to fund the acquisition of U.S. Life Holdings from Old Mutual (UK) for 350 million in March of 2011 at a fire sale price of 22% of IFRS Net Book Value of 1.6 billion. They simultaneously brought in Lee Launer, the former Chief Investment Officer of Met Life, to be Chairman and CEO, and have since changed the name to Fidelity & Guaranty Life.
In May of 2011, they closed on a 400 million dollar Preferred led by Fortress Investment Group. This would give them the flexibility to pursue other acquisitions.
Since there are only two major assets plus cash and debt, this is very simple sum of the parts story, which is highlighted on HRG's website at (www.harbingergroupinc.com), valuing the company at $9.28 based on values from the end of Q1. Both FGL and Spectrum Brands values have appreciated significantly in the last year.
Here is the simple math at current prices in millions:
29.5 million shares of SPB at 33 973.5
FGL Book Value Q1 802
Receivable from Old Mutual 50
Senior Debt (500)
Divided by 139M shares = 10.04 / share
So why is this stock trading at 4.70 in the market currently? There are a few reasons, none of which have any relevance to HRG's value. One is the uncertainty and confusion regarding Phil Falcone and Lightsquared. Every time there is a headline on Lightsquared it comes up under HRG, and many people believe Lightsquared is owned by HRG (which it is not). There is also the misconception that Harbinger Capital Partners could be forced to sell their shares in HRG to meet redemptions. Lastly and perhaps most importantly, this stock is extremely illiquid, and there has been an institution River Road Asset Management selling stock into this illiquidity for over 6 months, reducing their position from 1.2 million shares to what is currently approximately 500,000 shares. This has put significant pressure on the stock, pressure that is likely to abate when this selling is done.
With regard to potential redemption's, first and foremost, I believe that Phil Falcone's own personal investment in HCP could cover the HRG piece, meaning that he could distribute everything else if necessary to liquidate the fund and retain the bulk if not all of the HRG shares. As he has publicly pronounced that HRG is his primary focus and his vehicle for the future, it is highly likely he will do everything in his power to retain this stake. Second, if they did need the liquidity, as the controlling shareholder in HRG, they would more likely put SPB up for sale. If SPB were sold at just 10X Free Cash Flow it would fetch over 40 dollars a share, in turn generating $8.50 in cash/share for HRG holders. Faced with this undeniable pile of cash, HRG would then likely trade up to Net Asset Value. This wouldn't be such a horrible thing.
Since less then 10% of the shares are in the public float, and the shares trade an average of only 46k shares a day, institutions stay away. Most money managers won't even take the time to look. Some of you may have heard of IEP (Icahn Equity Partners). IEP was previously ACP (American Real Estate Partners) and was an eerily parallel situation to this. Icahn controlled over 90% of the shares. The remaining shares were highly illiquid. Icahn at the time had just bankrupted TWA for the second time and Marvel Entertainment. Everyone said he was finished, had lost his touch, and that if you invested with him, he would likely disappoint you. That stock sat at $8 for a few years. And then, once the story got out, in one year, it ran from $8 to $170.
Back to HRG. The bull case for its primary holding, Spectrum Brands, is all in the cash flow generation. The company recently presented at the CFA Society of Minnesota where they outlined how they get to $300 million in two years from the $200 million in Free Cash Flow this year. $10 million savings from the PIK note refinancing and $30-40 million in savings from the ending of the synergy programs from the Russell Hobbs acquisition get them to $250 million in 2013. $45 million from the refinancing of the senior notes which have a no call provision until June 2014 gets you close to $300 million in 2014. If you add in modest top-line growth, maybe they get to $350 million in FCF in two years, or nearly 7 dollars a share, up from the 4 dollars they generate this year.
If you put an 11.5 multiple to those numbers, you can see SPB trading to 80 dollars in two years. That would make HRG's investment in SPB worth $16.75.
A couple of other things of note are that SPB has had consistent insider buying, and the recent refinancing of the 12% notes and $300 million revolver enable them to start paying out a dividend.
HRG has also quietly begun putting FGL's $18 billion in float to work. They recently formed an asset-backed lender named Salus Capital Partners (saluscapital.com), run by seasoned veterans. After only a few months, they were cash flow positive. They quietly transferred control of $15 billion in FGL's float from Goldman Sachs to Harbinger Capital; the result of which has been numerous upgrades from ratings agencies, citing an increase in the quality and mix of investments in the portfolio. As recently as last week, Fidelity & Guaranty Life was recently upgraded and given a positive outlook by S&P. There is a lot of information in this upgrade, but what is clear is that this business is growing and the investment portfolio has improved significantly since the acquisition. This is also evidenced by the quarterly mark-ups to their book value. HRG took 40 million dollars in dividends from FGL last year, and they could take much more if they choose to.
So how do they close the gap between the current stock price and the NAV? Sometimes it's as simple as a couple of smart investors learning about it. In such an illiquid stock, it doesn't take much. On a macro scale, the company just started doing investor relations to get the word out, including things as basic as creating a website, and, they said, starting earnings conference calls next quarter (it is worthy to note that when IEP exploded, it was almost immediately after they did their first conference call). Since HRG never did an IPO and came public through a reverse merger, they have never been exposed to the institutional market. I also think the noise coming from Falcone and Lightsquared will die down, and people will start to recognize the value HRG offers. Even if the gap doesn't close, there is reason to be hopeful with their ownership in SPB and FGL. They could do a buyback of HRG stock. They could distribute shares of SPB to HRG holders. They could sell SPB. They could and likely will do additional deals with their large cash hoard. However they do it, it will likely get done. And the good news is that if you buy HRG now, you get over 50% off for starters. That is over 50% off of the current value, and over 70%-80% off what is likely today's fair value of these holdings. The upside to current valuesis huge, but to tomorrow's values are likely even bigger.