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

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