Recently, a money manager wrote a four page memo wondering if the Harbinger Group (HRG) is the next Berkshire Hathaway. It's a nicely written letter.
Of course, as he says, every time someone says "the next Warren Buffett...", you should put your hand on your wallet and make sure it stays in your pocket.
Having said that, any time there is an opportunity to invest with a successful investor at an attractive price or a discount, I am interested.
HRG is basically an investment vehicle with around $927 million in equity capital and a total market value of around $724 million. This 22% discount to book value is enough to get value investors interested. HRG was founded by George H.W. Bush in 1954 as the Zapata Corp, an oil company. Then it became Malcom Glazer's investment vehicle in 1994 and in June 2009 was sold to Harbinger Capital at $7.50/share. At that point, HRG only held cash previously having sold whatever business they owned.
HRG is currently 93.3% owned by the Harbinger Capital and related parties. Harbinger Capital is the main hedge fund management entity run by Philip Falcone, a successful billionaire hedge fund manager (although he has had some performance problems in the last couple of years).
So the general idea is that you get to invest in a vehical run by the hedge fund superstar Philip Falcone at less than book value.
First, just a couple of comments about Mittleman's letter. He talks about some of the great successes where an investor or investors took over a company and used it as a vehicle to grow over time. Of course, exhibit one in any such list is Berkshire Hathaway. Some others are Cumming/Steinberg and Leucadia National, the Rales brothers and Danaher Corp and Carl Icahn and Icahn Enterprises.
I may be wrong, but one point is that in most of the above cases, the investment vehicles were the primary investment vehicle of the investors. Berkshire Hathaway was just an investee of Buffett's hedge fund and turned into his primary investment vehicle only after the hedge fund closed, and Icahn Enterprises (intially American Real Estate Partners) eventually became Icahn's primary vehicle.
However, with HRG, it is a $770 million market capital company owned by Harbinger, but Harbinger Capital still runs a hedge fund with $7 billion or so in assets under management. Therefore, the primary focus of Philip Falcone is going to be his hedge fund. That is where he will focus on creating value.
I suppose one can argue that this will shift over time as the hedge fund now seems to be a single bet on Lightsquare, a wifi project of Falcone's that has upset hedge fund investors. So maybe Lightsquare will be one business and the investment business will be run in HRG. I don't know.
So we don't really know if this HRG is going to be a primary focus of Falcone's or not over time. If the hedge fund doesn't work out, it may become it, but that would mean going from managing $7 billion to what is now less than $1 billion in equity of HRG.
The second point is that in the letter, Mittleman says that Spectrum Brands in which HRG holds a large stake is grossly undervalued. He used Clorox as one comparable which I think is a bit of a stretch. Clorox has a brand value that is very valuable, I think. Spectrum Brands brands are not nearly as valuable, I don't think. For example, Spectrum Brands owns Rayovac batteries. I don't think Rayovac is really as competitive and valuable as Duracell, for example. Clorox is dominant, Spectrum doesn't really seem to be to me. Having said that, I have to admit that I haven't really dug into Spectrum Brands. A casual look a while ago made me feel their brands are OK, but not dominant or special.
Anyway, Mittleman feels that HRG is worth around $7.19/share now, or if Spectrum Brands is valued higher in the market, HRG can be worth up to $12.82/share or $10.95 on a fully diluted basis versus a current stock price of $5.20.
To keep this post simple, I won't look at all the separate businesses that HRG owns. Most of the value in HRG is in Spectrum Brands (SPB), a listed stock they own 54.5% in.
SPB is a fully consolidated holding of HRG, so to do a sum-of-the-parts (value the listed SPB separately), we have to separate out the SPB portion from the balance sheet and see what is left over. I will assume that the new businesses HRG has acquired is worth book value (Fidelity & Guaranty Life and North American Energy Partners).
So here are some figures:
stock price shares outstanding market cap
HRG $5.20 139.3 million $724 million
SPB $24.27 52.3 million $1.27 billion
So HRG owns 54.5% of SPB, so their ownership stake is worth: $692 million. $724 million market capitalization minus their stake in SPB is $31.9 million. So basically, the 'stub' is trading at $31.9 million.
What is the stub actually worth? As I said, since they do have cash on their balance sheet and whatever they purchased this year is probably worth close to book value, looking at shareholders' equity of HRG excluding the consolidated shareholders' equity of SPB would give a reasonable value for the stub. What is HRG's shareholders' equity excluding SPB?
HRG's shareholders' equity at the end of the second quarter was $926.6 million (this excludes the minority interest portion of SPB). SPB's shareholders' equity at the end of the same period was $1.05 billion. Therefore, HRG's portion of SPB's equity on it's balance sheet would have been $572 mllion.
HRG's equity excluding it's share of SPB equity is $354 million. This is what, at book value, HRG is worth excluding it's holdings in SPB.
So the market is valuing HRG's equity excluding SPB at 8.9% of book, or a whopping 90% discount to book value! That is mighty cheap.
But wait. It's not like we can buy HRG and then make 10x our money if this corrects (unless you do a stub trade where you buy HRG and short SPB stock; this has other issues to that need to be addressed but we'll skip that here).
It just means that HRG now is undervalued by $319 million. The total value of HRG's non-SPB position at book value is $354 million, and adding back the current value of the SPB holding of $692 million is $1.05 billion. Divide that by 139.3 million shares and you get $7.53/share as the fair value of all of HRG versus the current stock price of $5.20.
HRG is therefore trading at 69% of fair value, or a 31% discount.
That is not bad at all.
However, we have to keep in mind that almost 70% of the value of HRG as it stands now is dependent on SPB. You have to like SPB to like HRG as the SPB performance will have a big impact on the value of HRG.
I don't own HRG currently, but it is certainly an interesting thing to watch.
Again, the risks are basically the future of SPB, future deals, and how much time Falcone actually spends on this vehicle. It is not an insignicant position for Harbinger Capital, but his priority must still be with his $7 billion hedge fund.