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Bram de Haas
Articles (316)  | Author's Website |

A Deeply Undervalued Holding Company After Recent Market Turmoil

Interesting play of a company run by a hedge fund manager

November 30, 2018 | About:

HC2 Holdings Inc. (NYSE:HCHC) is a diversified holding company run by the former hedge fund manager Phil Falcone. It is in essence an investment vehicle that seeks to buy and grow businesses to generate attractive returns.The company owns a diverse set of businesses in industries such as construction, marine services, energy, telecommunications, life sciences, broadcasting, isurance and others.

I would argue that construction and marine services are the most important from an ongoing Ebitda standpoint. The life sciences division is very important from a value standpoint.

Financial strength

The balance sheet isn't exactly HC2's strong suit. The company carries over $500 million in long-term debt. That's high compared to both equity value and Ebitda. However, the company also just refinanced its debt and issued some convertibles (press releases here, here and here). Because I also believe the asset values of the company are wildly understated, I like management and maturities were just pushed back, I am comfortable with this amount of leverage.

Management

Falcone enjoyed quite a successful career as a hedge fund manager. In 2013 Forbes listed him among the 40 highest-earning hedge fund managers. You do not get up there by being a complete slouch.

However, Falcone ultimately ended up running this publicly traded vehicle after the Securities and Exchange Commission got him for siphoning off $113.2 million of Harbinger (his hedge fund) assets to pay his taxes and fo pay out customer redemptions to favored clients. In addition, he admitted having manipulated the bond price of MAAX Holdings.

Falcone bought up all of the outstanding bonds. Subsequently, Falcone demanded Goldman Sachs (GS) settle all outstanding MAAX transactions. If I understand his move correctly, Goldman had been shorting (or allowing shorts of) MAAX bonds. Because Falcone now owned the bonds, he was able to revoke the right to lend them out. That means the bonds had to be delivered back to him. However, none were available because he bought (nearly?) all of them. This forces the party with the short position to buy bonds in the market at any price.

I am convinced Falcone is a smart and savvy capital allocator, but the SEC settlement is definitely something one needs to be aware of. I am not sure about the circumstances, but obviously it is not OK to pay your taxes with fund money or give favored clients redemption priority. Even if that may make sense from a business perspective.

The rest of the team is also pretty impressive, as far as I can tell from resumes, given this is a $150 million market cap company.

Valuation

I chose to write up HC2 right now because it recently got killed in the market. The reason it got killed, besides volatile market conditions, was the refinancings that were not as favorable as people expected them to be.

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Its market cap is now $141 million. The company has about $500 million in net debt. Enterprise value should be around $650 million at this time. That's a large enterprise value if we merely look at unadjusted metrics. However, if we look closer to discover how its Ebitda is generated, we see the following:

The picture emerges that its core operations are actually highly profitable, but the company is not doing so well because it is investing in early-stage operations, insurance and the capital-intensive broadcasting business. Theoretically it could kill off all the investments and trade at 8x EV/Ebitda.

Curiously, HC2 Holdings invested $8 million into Benevir to acquire 76% of the shares. This subsidiary then sold one of its therapies to Johnson & Johnson (NYSE:JNJ) for $1.04 billion. This happened in the second quarter of 2018, and somehow I think Benevir, which was once valued around $12 million, did not go and spend it all within two quarters.

HC2 owns a significant interest that reflects well over $700 million in value just because of the cash there. That is more than the entire company its market cap. In additio,n this company is led by two individuals who have now created a series of billion-dollar therapies that they have sold. That's exactly the kind of teams you want to bankroll and be associated with.

Outlook

Don't expect this company to become big-time profitable. I believe Falcone will continue to aggressively grow the value of the company by reinvesting cash. He will try to keep earnings down to keep taxes low. The company will likely also remain leveraged as long as "real value" exceeds the book value. True leverage is actually not as threatening as it appears on a short glance. I think Falcone will continue to manage the company based on his perception of values and normalized Ebitda levels.

Disclosure: Author is long HCHC.

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio.

Visit Bram de Haas's Website


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