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A stock that could be more than 50% undervalued

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November 30, 2010 – Comments (8) | RELATED TICKERS: HRG , SPB

Back in May I was looking around and came across a small, basically overlooked company that had more cash on its balance sheet than Mr. Market was giving it credit for.  That company was Harbinger Group (HRG).  There has been a ton of interesting developments with this story since then.  Much to my chagrin, the stock has dropped 29% since I added it in CAPS (fortunately not in real life).  Having said that, many intelligent people are touting it as a good investment with a ton of upside right now.

First, here's the original story as I wrote it up earlier this year 

Here's an interesting "blank check" company that I came across today that is trading at a 17% discount to the total cash, cash equivalents, and investments that it has on the books (none of the money is in equities).

The company is called Harbinger Group Inc. (HRG). As of May 5th of this year it had $148.7 million in cash and a market cap of only $123.4 million. Harbenger is basically a shell company that has money and is looking for a place to invest it. OK technically something called Zap.Com Corporation is the shell company, but HRG owns 98% of that so it's basically the same thing. 

HRG is so unfollowed and unloved that CAPS doesn't even list the right name for it. CAPS still lists this company's name as Zapata Corp., but it officially renamed itself Harbinger Group a while ago.

Harbinger has been sitting on this wad of cash for quite some time, December 2006 to be exact. At that time it sold its 57% ownership interest in common stock of Omega Protein Corporation, which CAPS mistakenly states that it still owns.

Confusing huh? The short story is that one can buy HRG at a 17% discount to the cash on its books. The all important question is...what will Harbinger do with this cash, how long will it wait to do it, and how quickly is is burning through its cash.

One has to have a tremendous amount of faith in the management of a company to assume that they will spend their money wisely in this sort of situation. So who is managing Harbinger? One might automatically assume that this sort of company is being run by some pump and dump scheister or penny stock scammer. That is absolutely not the case. Controlling interest in Harbinger (51.6% to be exact) was purchased in July 2009, by a group of funds run by Harbinger Capital Partners. That's the private investment firm aka hedge fund run by the famous investor Philip Falcone.

So we know that someone smart is supposedly pulling the strings here. The next question is how quickly is HRG burning through its cash? The company spent nearly nothing in 2008, but it spent $13.3 million on "professional fees associated with advisors retained to assist us in evaluating business acquisition opportunities" (this money probably went straight to the hedge fund or its friends) in 2009 and $2.7 million during Q1 2010 ($10.8 million annual rate). HRG's current market cap is $25.3 million less than the cash that is has on the books, so it can tread water for approximately two years before the discount that we are being given on its assets today completely disappears. 

Will HRG actually purchase something of value over the next two years? I certainly have no idea, but given the pedigree of the company's controlling shareholder and the nice discount I have decided to take a leap of faith and add Harbinger to my CAPS portfolio today at $6.40/share. Having said this, I definitely am way too conservative to purchase this company in real life.

Flash forward to August and Harbinger actually decided to do something with the stock.  Here's my August update:

There has been some substantial developments in this story recently that I wanted to update everyone on. HRG has fuinally decided to do something with all of its cashWhether or not that thing is good is another question. HRG is about to get a whole lot bigger. It looks like Falcone is attempting to sell his hedge funds' stake, 65% in total, in Spectrum Brands (SPB) to HRG.

For those of you who are not familiar with Spectrum, it is a consumer products company that owns such household names as 

Rayovac batteries

Remington shavers

Black & Decker Home products

Tetra Fish Food

Spectracide garden products like weed and bug killer

and of course, the recently acquired George Foreman Lean Mean Grilling Machine

Among other brands.

Obviously HRG as it stands right now is way too small to absorb 65% of Spectrum. I suspect that HRG will attempt to issue new shares to fund the deal rather than use debt. Perhaps it will issue shares to the Harbinger funds. 

Spectrum hasn't exactly been on my radar. I'm not wild about anything that is exposed to the consumer in this environment. Having said that, companies that are emerging from bankruptcy can often be solid investments. I need to take a closer look at Spectrum to get a feel for the company and the value of its stock.

I have been trying to figure out what the point of this transaction is. What's Falcone's angle? I had my AH HA! moment on my drive into work this morning.

So Harbinger's hedge funds currently owns 65% of Spectrum's common stock, giving them controlling interest in the company. If they transfer that 65% to HRG, they can reduce their exposure in HRG to 51% and still maintain control of 65% of Spectrum at slightly over half the cost. This frees up cash for Harbinger's hedge funds to invest in other opportunities.

As an added bonus, I'm sure that there's investors out there who are going to be like, "What in the heck is going on here?" and liquidate their shares of HRG. If there's enough selling pressure on HRG and its stock price drops low enough Falcone can scoop up the remaining outstanding shares at a discount...essentially buying back its stake in Spectrum for less.

In essence, swapping the Spectrum shares with HRG enables Falcone to maintain control of 65% of Spectrum's stock for the price of 33.15% (assuming that it only holds on to 51% of HRG). As an added bonus, if HRG comes under selling pressure and its price per share drops enough Harbinger's hedge funds can essentially scoop up more shares of Spectrum at a discount to what it holds them for right now. Pretty tricky, huh? 

HRG is currently trading at around a $36 million discount to its tangible book value.

65% of $1.4 billion is $910 million worth of stock that Falcone is trying to unload on HRG.

HRG is trading at a $30.63 million discount to its tangible book value.

So owners of HRG are able to purchase Spectrum at around a 3.37% discount at the current prices.

That's not a very large discount, so the only reason for one to purchase HRG today is if one thinks that Spectrum Brands is cheap. 

I have not done any research on Spectrum yet, so I don't know if that is the case.

If the share price of HRG drops more rapidly than SPB or if it drops after the average share costs of the two for the swap has been computed the 3.3% discount would grow and make HRG more compelling.

I personally don't see any advantage to owning HRG's stock at this price level, but I am putting it on my radar and will likely scoop up shares IF the stock drops significantly and I decide that I like what Spectrum is doing. 

The purchase of a majority stake in a company emerging from bankruptcy by an empty corporation that is run by a hedge fund certainly qualifies as a "special situation" :). 

Being able to poll other intelligent investors about stocks and situations is one of the great things about CAPS. I'd love to hear other's opinions on this deal. Do you agree with my interpretation of what is happening? Do you believe that HRG represents an attractive buying opportunity? What do you think about Spectrum Brands? Let's get some discussion going about this interesting situation.

A couple of days ago I started coming across articles touting (HRG) as a good buy.  The author of this Seeking Alpha piece believes that Harbinger has 50% upside from this level:

Post deal - How do the numbers look?

HRG will sell 119,909,830 new shares for 27,756,905 shares of SPB.

Current market value of 27,756,905 shares of SPB (27.64) = 767,200,854.20

Current market value of 119,909,830 share of HRG (4.34) = 520,408662.20

246 mil of additional value hidden based on current market prices, which market will recognize eventually.

Quite sure, Harbinger Capital Partners LLC will exploit it, if the market does not.

Cash + STI – TL + SPB holding = 130.59 mio + 767.20 mio = 897.79 mil

Outstanding shares including the new shares issued = 139.198 mil

Per Share value = 6.45

Current Share price = 4.34

Upside if the transaction goes through = 48.6%

Harbinger Group Should Be at Least 50% Higher 

There is additional upside to this deal if one believes that the stock of Spectrum Brands (SPB) is currently undervalued.

Here's another article on the situation.  This one is from Barel Karson.


Harbinger Group (HRG) is a holding company that hasn't held much of anything other than cash for the last several years. As such, it mostly traded at a market cap commensurate with its cash holdings. But that changed in the last couple months as the stock price dove, creating a potential opportunity for value investors.

HRG has agreed to issue new shares in return for a majority stake in another public company called Spectrum Brands (SPB). The opportunity arises because HRG's price does not appear to properly reflect its ownership in Spectrum Brands.

After the deal (which is scheduled to close this quarter), HRG will have less than 140 million shares outstanding. At its current price, that would give it a market cap of about $630 million. But it will own 27.8 million shares of Spectrum, which is worth $734 million at its current price of $26.40 per share. In addition to its future holdings of Spectrum, HRG currently has $140 million of cash and short-term investments, versus just $10 million worth of liabilities. This suggests that the market is valuing the $730+ million of Spectrum at just $490 million.

Harbinger Group: Cash At A Discount

Of note, this isn't a riskless investment because Harginger recently issued $350 million worth of debt at a fairly high rate in this environment of 10% that it plans to use to make additional investments.

If anything, this is an interesting situation to watch.

Deej

8 Comments – Post Your Own

#1) On November 30, 2010 at 12:10 PM, CharlieBeLong (29.67) wrote:

Nice write up, as usual.  Extremely risky. 

 

I am going to have to do something that I don't normally do:  disagree with TMFDeej.  I just can't see investing in a management team that doesn't know how to DO anything.

 

 

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#2) On November 30, 2010 at 12:14 PM, lemoneater (81.74) wrote:

Perhaps the George Foreman lean grilling machine will be enough to propell the company into profits. It does seem to be making a comeback as a Holiday gift idea.

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#3) On November 30, 2010 at 2:00 PM, tekennedy (67.07) wrote:

I see this simply as a way of combining a company which is cash flow negative with a company with cash.  I wouldn't go near this personally but maybe long Spectrum short Harbinger would be a safe bet as 1 hedge fund has a controlling stake in each.

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#4) On November 30, 2010 at 5:46 PM, fewl10 (< 20) wrote:

dumbest pitch ever.  I have no clue what this company does to produce value, but BUY this stock.

TMFwhatever should go to hell.

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#5) On November 30, 2010 at 10:22 PM, Option1307 (29.65) wrote:

Another interesting idea and good write up, thanks for sharing! +1.

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#6) On December 01, 2010 at 5:49 AM, devoish (98.56) wrote:

So Harbinger's hedge funds currently owns 65% of Spectrum's common stock, giving them controlling interest in the company. If they transfer that 65% to HRG, they can reduce their exposure in HRG to 51% and still maintain control of 65% of Spectrum at slightly over half the cost. This frees up cash for Harbinger's hedge funds to invest in other opportunities.

Do I misunderstand this?

Falcone as investment advisor to his Harbinger Capital Partners is selling Spectrum, and Falcone as investment advisor to Zap is buying Spectrum.

If this a good investment for ZAP shouldn't it also be a good investment for Harbinger?

Is Falcone cashing out of Spectrum to benefit his hedge fund at the expense (using the money) of the common shareholders in Zap?

Should you be calling the SEC with this pitch?

Regards,

Steven

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#8) On August 24, 2011 at 12:10 PM, cnbcgb (28.39) wrote:

Spectracide garden products are good.  I use their weed and feed because it is by far the cost leader and has much more active ingredient.  In fact it was the only weed and feed that effectively improved my lawn.  I tried the well known brands first.  The other brands you listed are quite strong as well.  Rayovac is a price leader and sells well.  It is probably #3 in market share behind duracell and energizer.  Black and Decker and Remington are strong brands. I find this investment very interesting.  I don't know if I will invest, but you gave a good write-up.  I have enjoyed your posts before, and I like a lot of your caps picks.

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