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Now this is a strange Special Situation. Hedge Fund Manager Phil Falcone is finally making his move with HRG

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August 18, 2010 – Comments (11) | RELATED TICKERS: HRG , SPB

 

Back in May I came across a public company called Harbinger Group (HRG) that was trading for less than the value of the cash on its balance sheet.  Here's what I had to say about the stock at the time:

"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.

Is anyone out there familiar with this situation? If not, then does anyone have any stories about investing in similar blank check companies and how it turned out? I'd love to hear your thoughts."

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.

Spectrum Brands (SPB) has a current market cap of $841.99 million. 65% of that (this isn't the exact number of shares that Harbinger controls, but its close enough for my back-of-the-envelope style) is a current market value of $547 million for its stake.

So the current discount that Mr. Market is providing on HRG essentially enables anyone who purchases its shares in the near future to get a 6.5% discount on SPB's stock. 

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" :). 

Here's a link to an 8-K on the deal and an article about the proposed transaction from today's WSJ.

Form 8-K for HARBINGER GROUP INC.

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.

Deej

11 Comments – Post Your Own

#1) On August 18, 2010 at 10:31 AM, Regal78 (< 20) wrote:

I see the market cap of SPB @ 1.37b.  What am I missing?

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#2) On August 18, 2010 at 10:46 AM, CBeeks1984 (< 20) wrote:

Good catch, Regal.  There seems to be a discrepancy between the market cap that CAPS has listed for SPB and the market cap that Yahoo! Finance has listed for it.  

http://finance.yahoo.com/q?s=SPB 

I am in the habit of using the latter.  I wonder which one is right.  We'll have to do some digging.

It looks like Yahoo! was wrong.  It figures.  I should make a habit of using CAPS for data.  According to Spectrum Brands' website the company's market cap is $1.4 billion. 

This larger market cap dilutes the discount that one would receive on SPB by purchasing HRG even further,

Deej 

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#3) On August 18, 2010 at 10:52 AM, CBeeks1984 (< 20) wrote:

Here's an amazingly detailed presentation that Spectrum recently made to investors.  I haven't had a chance to go through it yet:

http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9MzkwMzc0fENoaWxkSUQ9MzkzNzQ2fFR5cGU9MQ==&t=1

Deej 

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#4) On August 18, 2010 at 11:15 AM, MKArch (99.71) wrote:

Their 8K announcing results of operations shows 34M shares outstanding and they are trading at ~$27/ share so I come up with a market cap of ~$918M. Yahoo is showing ~30M shares outstanding under key statistics so that appears to be the discrepancy on their end. I think they just closed a big acquisition and I believe shares are the average of the quarter so maybe TMF is up to date on what they will be after all dilution from acquistion is accounted for?

 Deej or CBeeks1984? I'm not sure if I'm following the discount on SPB. From what I can tell HRG is going to pay for the acquisition entirely in stock at the 30 day volume weighted average price of HRG stock and SPB stock. Just eyeballing the charts it looks like HRG stock will come in ~$6.30/ share while depending on what market cap you use and exactly how much of SPB HRG buys it looks like they will be issuing in the neighborhood of 90M-100M new shares for a majority stake in SPB. From what I can tell though they will still have the cash to play with.  This is not my area of expertise so I could be missing something but I'm not sure I understand the discount on SPB? It seems to me from an HRG shareholder standpoint SPB needs to be more undervalued than HRG for this to make sense.

 

Mike

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#5) On August 18, 2010 at 11:18 AM, TMFDeej (99.27) wrote:

New calculations:

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.

Deej 

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#6) On August 18, 2010 at 11:31 AM, TMFDeej (99.27) wrote:

Hey Mike.  My thinking is that the discount comes into play from the fact that HRG is currently trading for much less than it's worth. The additional shares created for the Spectrum acquisition will dilute HRG's current discount to its assets significantly, but it will still have some affect.  Do you concur with this line of thinking?

Deej 

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#7) On August 18, 2010 at 11:57 AM, MKArch (99.71) wrote:

I'm a novice financial analyst Deej but I think I'm on the same page. Based on the discount to cash HRG stock is undervalued before this acquisition. So they are going to use an under priced stock to make a purchase but it could make sense if what they get back is even more underpriced. Just a quick check of the stats on Yahoo last night price to book on SPB was ~1.46 which doesn't seem particularly cheap these days but prices to sales was something like 0.34. 

My first thoughts were moving SPB down to HRG would give the hedge fund managers more power to control SPB and maybe there is a plan to make SPB more valuable. I listened to the SPB cc last night to get a sense of what's going on and there are a lot of moving parts. Just emerged from BK recently, did a significant acquisition that's muddying the waters a bit right now. There was talk of some pretty significant fcf generation in 2011 and beyond that will be used to pay down the debt. Mr. Market mostly seems to have yawned at this point but I'm waiting to see what you and Jim come up.

 Mike

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#8) On August 19, 2010 at 8:39 AM, MKArch (99.71) wrote:

http://finance.yahoo.com/news/Harbinger-Capital-Partners-prnews-249384960.html?x=0&.v=1

 

Here's a little more color.

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#9) On September 28, 2010 at 3:32 PM, IlluminatInvest (66.77) wrote:

If "Harbinger Capital will give about 27.8 million shares of Spectrum to Harbinger Group and the transaction is expected to give Harbinger Group a 54.4 percent stake in Spectrum", then there really are 51M shares of SPB outstanding and Yahoo does seem to now have its market cap of almost 1.4B correct.

This means there really is an arbitrage situation with HRG, since it will own about 750M worth of SPB in addition to the 150M in cash they have, so dividing by the ~140M shares of HRG that will be outstanding, you can get almost $6.50 worth of value for each share (which you can buy for less than $4.50 now).

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#10) On September 28, 2010 at 3:58 PM, IlluminatInvest (66.77) wrote:

Sorry, meant to say you can buy it for about $5.50 now, but still seems like a compelling way to get a "free" dollar worth of value.

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#11) On October 11, 2010 at 1:13 PM, IlluminatInvest (66.77) wrote:

And now complicating things is them buying Old Mutual U.S. Life Holdings, Inc. since Harbinger Capital transfered their right to buy it to HRG.  Is Falcone using HRG as a dumping ground for his mistakes, or his best ideas?

Any thoughts, Deej?  Thanks.

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