Buy Red Hot Spectrum Brands At A Discount Through Harbinger

| About: HRG Group, (HRG)
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Spectrum Brands (NYSE:SPB) is a diversified consumer products company that sells everything from Rayovac batteries to Remington electric shavers, and even the once ubiquitous George Foreman grill, which still enjoys a strong following amongst college students and bachelors everywhere. It aims to sell reasonably priced second tier products that they claim are as good or better than the more expensive leading brands. This strategy, bolstered by several acquisitions including that of the Hardware and Home Improvement operations of Stanley Black & Decker in December of 2012, seems to be working well, as the stock is on an absolute tear ever since emerging from bankruptcy back in 2009, rising over 150% since then, 70% in the last year alone.

Given this rise, investors might be inclined to think they missed the majority of the move and that it's too late to get into the stock. Still, several prominent investors have recommended the stock in recent Barron's articles, including Larry Pitkowsky and Keith Trauner, the managers of the GoodHaven fund (MUTF:GOODX), as well as Eagle Capital Partners manager and recent Berkshire Hathaway (NYSE:BRK.A) board of directors addition Meryl Witmer.

Even more intriguing, there is actually a much cheaper way to buy Spectrum Brands. This is through its majority owner, the Harbinger Group (NYSE:HRG), which is also publicly traded. You might expect this company to have shared in Spectrum Brands' stellar performance since as the 58% owner of Spectrum it theoretically should have benefited as well, but it is up just 20 and 10 percent respectively in the same 3 and 1 year periods mentioned above for Spectrum Brands.

There are a variety of reasons that have acted as an anchor to keep Harbinger Group grounded while its subsidiary has been buoyed by the rising tide of improving performance. It had finally been rising in concert with Spectrum Brands last year, until they made the perplexing decision to do a share offering in the middle of December 2012 at a steep 25% discount to where the stock was trading. This otherwise puzzling offering likely stemmed from the fact that Harbinger Group itself was over 90% owned by the hedge funds of Harbinger Capital, which presumably wanted to raise money quickly and add further liquidity to the stock in case they ever need to do so again, so that next time it hopefully doesn't have to be at such a large discount.

The proceeds of this capital raise went directly to the Harbinger Capital hedge funds, which despite contrary assertions were probably struggling to meet investor redemptions amidst the trials and tribulations of the head of all the Harbinger operations, Philip Falcone. Falcone has been surrounded by a dark cloud of allegations as his hedge funds have contracted after he tried to parlay a fortuitous bet against the housing bubble into an even bigger payday with wireless company Lightsquared, but ran into regulatory issues that ultimately forced the company into bankruptcy.

It should be noted, however, that all these machinations were confined to his hedge funds and not connected in any way to the publicly traded Harbinger Group, other than the aforementioned fact that Falcone is the CEO of both and the hedge funds are also still the Harbinger Group's largest owner in addition to separately owning Lightsquared. All Falcone's other legal issues also originated with hedge fund activities and he has tried to put these behind him with a recent settlement that presumably will let him unwind his hedge funds and focus solely on running the publicly traded company.

So far, he has made several deals through the Harbinger Group, including Salus Capital Partners, a direct lender that makes asset backed loans, and a natural gas joint venture with Exco Resources (NYSE:XCO). Other company operations are in insurance and reinsurance, through its FGL and Front Street Re subsidiaries, respectively. The foundation of these was laid when Harbinger acquired the U.S. operations of British firm Old Mutual for $350M in 2011 at a deep discount to book value. Indeed, Harbinger has already seemingly orchestrated a nifty turnaround in these operations and now carries them on its books at nearly 3 times the purchase price, although this valuation has been questioned by another article here on Seeking Alpha.

Not to gloss over these somewhat complicated financial arrangements, but I'd like to instead focus on where the bulk of Harbinger Groups' value still lies, with its majority stake in Spectrum Brands. At SPB's recent price of around $60, Harbinger's 58% stake in Spectrum is worth about $1.8B. This should strike you as a bit bewildering considering Harbinger's entire market cap is only $1.1B. So their stake in Spectrum Brands is worth about 1.65 times the perceived market value of the entire company! This seems like an absurd discount even if the rest of their operations are worthless.

Considering that Harbinger has been continuously acquiring more SPB recently, we can extrapolate this to find out what would happen if Harbinger were to acquire all of Spectrum Brands. Assuming they could raise $1.6B to buy the rest of SPB at say a 20% premium, this would make their new 100% ownership stake worth $3.14B even at the most recent market valuation without the premium. If we substitute this actual value onto HRG's balance sheet instead of the portion of the assets they currently carry for Spectrum Brands as a partially owned subsidiary, as well as removing the corresponding liabilities since they are now contained within the recorded value, we can obtain the following adjusted balance sheet from the most recent quarterly report:

Total assets: March 31,
Consumer Products (Spectrum Brands) $5,520.7 $3,140.0
Insurance 21,295.5 21,295.5
Energy 680.1 680.1
Financial Services 295.7 295.7
Intersegment elimination (316.8) (316.8)
Total segments 27,475.2 25,094.5
Corporate assets 241.5 241.5
Consolidated total assets $27,716.7 $25,336.0
Total Liabilities $25,791.6 $25,791.6
Liabilities attributable to Spectrum Brands (4,578.6)
Debt required to acquire 100% of SPB 1,600.0
Adjusted Liabilities $25,791.6 $22,812.7
Redeemable preferred stock 326.8 326.8
Total Equity $1,598.3 $2,196.5
Unowned Interest in SPB $(426.7) $0.0
Total Harbinger Group stockholder equity $1,171.6 $2,196.5
Number of Outstanding Shares 136.27 136.27
Book Value Per Share $8.6 $16.1

We can see that consolidating all of Spectrum Brands onto the balance sheet results in an over $1B increase in book value. This is because the market values Spectrum at a much higher price to book ratio than the same assets get when they are on Harbinger's balance sheet at less than one times book. Since this is an increase in book value of almost 90%, this implies that Harbinger is currently trading at almost half price, a substantial margin of safety that should more than make up for any of its perceived issues.

Even if they don't feel the need to undertake such a transformative transaction, patient shareholders will likely realize substantial returns based on both continued improvement in all their operating segments and the market's gradual recognition of the value that should be assigned to them. While Falcone and by association Harbinger currently have a tarnished reputation, a little financial polish over time should allow both to begin to shine again as the market begins to recognize the turnaround that is already underway and the value that is contained within Harbinger.

Disclosure: I am long HRG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am also long BRK.A through closed end fund BTF