Description

Harbinger Group (HRG) is a holding company that consists of 27.8 shares of publicly traded Spectrum Brands (SPB) and several other public and private investments. We believe that SPB is an excellent investment on a standalone basis, and that HRG trades at a 17% discount to its fair value.

Previous write-ups from pokey351 and beep899 have focused on the investment rationale for SPB. Spectrum focuses on non-discretionary consumer products. It operates 4 divisions:

• Batteries & Appliances – 50% of revenues / 41% of EBIT – Offers batteries, personal care products and small appliances thru brand names such as Rayovac, Remington, Farberware and George Foreman. Batteries are the largest component of the business (24% of total revenues.) Their battery strategy is easy to understand and representative of the corporate strategy – offer a product that is just as good as the #1 player (Duracell) at a lower price point (Rayovac typically sells for a 20% discount to Duracell.)

• Home & Garden – 9% revenues / 13% EBIT – Insecticides and pest repellants thru brand names such as Spectracide, Cutter, Repel, Hot Shot and Black Flag

• Global Pet Supplies – 15% revenues / 15% EBIT – Tetra (fish food) Dingo, Furminator.

• Hardware & Home Improvement – 25% revenues / 32% EBIT – Recently purchased from SWK, this business includes residential locksets (Kwikset, Baldwin), builder’s hardware and faucets (Pfister.)

Taken as a whole, SPB’s portfolio is not sexy. While improvement in residential housing is a modest tailwind for the HH&I business, overall we expect topline at SPB to growth 2 to 3% per year. While the revenue growth is small, when coupled with cost savings initiatives, margin improvement, low capex requirements, and large NOLs, the FCF outlook for SPB is very exciting.  

We estimate that SPB will generate $7+ in FCF in 2014 and $8.50 in 2015. The company recently refinanced $950MM of 9.5% notes with debt at just over a 3% interest rate.  Given the $1.3B NOL in place (which does not expire for 5 to 10 years), this equates to over $1 in FCF in interest savings. SPB will use incremental cash flow to pay down debt (which should fall from 5x EBITDA to ~2x by 2015), increase its dividend (established at 25c/quarter earlier this year) and make further acquisitions.

Looking out to 2015, SPB will generate $800MM EBITDA with only $1.7B in net debt. Applying a peer multiple 9.5x EV/EBITDA, we arrive at a $112 target price for SPB, 12 to 18 months from today. On a FCF basis, SPB currently trades at a 13% yield on our 2015E estimate of $8.50/share. If we adjust for NOLs and fully tax FCF, it is trading for ~10% yield. This compares to a 6.5% FCF yield on 2015E estimates for SPB’s peer group (which we define as CENT, SMG, ENR, CLX, CHD, TUP, FBHS, NWL, and JAH.) Again, applying a peer multiple FCF yield gets a stock in the $115 range.

HRG was formed by Phil Falcone thru a SPAC as a way to create “permanent capital” for his hedge fund. HRG wound up owning a large chunk of SPB via the bankruptcy process when SPB got over-leveraged in the mid-2000s. Today, HRG consists of:

-          30.9mm shares of SPB

-          7mm shares of North America Energy Partners (NOA)

-          3.5mm shares of Exco Resources (XCO)

-          A privately held life insurance company (Fidelity & Guaranty Life or “FGL”)

-          An energy JV

-          2 asset fixed income asset management firms

The market price (or book value, in the case of privately held) of these holdings is as follows:

 Spectrum Brands: 27.8MM shares @ $63.86/shares = $1.973B / 206MM shares = $9.58 per share

 Fidelity & Guaranty Life: Book value of $1.11B / 206MM shares =  $5.39/share

 NOA & EXCO shares and Asset Managers: $0.50/share

 Energy MLP: Book value of $249MM / 206MM shares = $1.21/share

 Harbinger Debt: $700MM = ($3.40)/share

 Total NAV = $13.40/share

 Current Stock Price = $11.15/share 

This math illustrates taht HRG trades at a 17% discount to its NAV. It's worth noting that all of the above values are convservative. With FGL set to come public in the next few months, it should garner a small premium to book, but we are valuing it at book for now. Same holds true for the energy MLP, which would get a much higher than book multiple in a sale or public listing. But the real driver here is that we think SPB is really worth something north of $100/share. At a $115 target price, HRG's 30.9MM SPG shares are wroth $3.5B, or $17.25 per HRG share and boosting HRG NAV to $21/share.

The next question is: what makes this discount to NAV go away?

• The market is nervous about being involved with Falcone. He did a lot of bad things as a hedge fund manager, and the SEC has punished him thru a fine and a five year ban from the securities industry. In no way, shape or form are HRG’s assets at risk b/c of the association with Falcone. 

• However, Falcone must wind down Harbinger Capital Partners over the next 2 years – and HRC owns 51% of HRG. These shares may be sold off piecemeal, distributed to LPs or placed in an offering. Any of those events may cause a short term dislocation in HRG stock price, but long term is good for the liquidity of the stock.

• HRG has filed for an IPO of Fidelity & Guaranty Life – a 2014 IPO will give increased clarity to FGL’s value

• HRG has a $50MM share buyback in place that they may start executing on at any time

Catalyst