This teaser solution was originally published on January 22, 2019, when we first saw the ad running. The ads have still been running in recent weeks, and we’re getting questions about it again, so we’re re-posting it here for your information. The ad has not changed, and my article below has not changed, though the stock is down about 30% from where it was then. I’ll add some quick updates at the end.
I don’t think I’ve ever written about Profits Run before, but they have an ad running now that got me intrigued… mostly because I’m always curious about the “next Warren Buffett” and “next Berkshire Hathaway” teases we see from time to time.
Here’s the intro that got my attention:
“This ‘Shocking’ $4 Stock Could Hand You A Lifetime of Retirement Riches… Starting Today
‘This stock is so shocking, I couldn’t believe it. Thank goodness I took a second look because what I’ve discovered could be like buying Berkshire Hathaway back in 1967.’
– Co-founder of Profits Run, Bill Poulos”
The service they’re trying to sell is called Premium Income Letter ($49/yr), which I’ve never heard of before… they describe it as “for people who want a safe and easy way to grow their portfolio with as little involvement as possible.”
Using “The $4 Stock That Could Fund Your Retirement” as their headline makes it seem like they were perhaps inspired by The Oxford Club’s incessant promotions for its “Retire on one $3 Stock” pitch, or hired the same copywriter, but maybe it’s just a coincidence… but I digress, you want to know what the stock is, right?
OK, let’s dig in and find you some answers.
Apparently it’s a stock that’s been around for a while… from the ad:
“Just like Berkshire Hathaway, which has a long history stretching as far back as 1839, it was founded back in 1994 to operate in a completely different sector.
“Back then it was founded as a telecommunications provider – acquiring licenses everywhere from Australia to the United Kingdom.”
And he draws the comparison to Berkshire’s founding, on the back of a failing textile mill:
“By the mid-2000s its main business of providing dial-up internet and long-distance phone services was quickly fading.
“Just like Berkshire Hathaway’s textile operations.
“It’s share price fared even worse. By the time the 2008 Financial Crisis arrived its stock had fallen by 99%.”
And then the “Warren Buffett” figure steps in…
“All this drama is what attracted the company’s CEO and major shareholder.
“Fresh on the heels of making billions in profits for his he and his hedge fund clients, he began looking for a new project.
“A relentless competitor that even had a stint as a professional hockey player decades before, he had always known the power of the ‘Buffett Blueprint’….
“he bought a controlling 40% interest and installed himself as CEO.”
And apparently this new CEO got them started snapping up new subsidiaries right and left… so now it’s a “diversified holding company” and has divisions that include…
- One of the largest steel fabricators in the country with contracts that include Apple’s massive “Spaceship” headquarters.
- A leading provider of service and installation for underwater cables.
- A life sciences division focused on “moonshots” that could generate over $100 million in value.
- Broadcasting assets that spanned over 130 markets.
- And of course,…
An insurance operation offering long-term care, life, and annuity products.
Poulos even says that “It wouldn’t be a stretch to say this tiny stock is a ‘Berkshire on Steroids.'”
And he thinks there is good news to come, partly due to a recent acquisition of a big insurance company…
“Once completed it will send this $4 stock’s investment portfolio up 153% overnight! ….
“Based on the company’s investment returns for 2017, I estimate that this company stands to make an additional $90 million dollars over the next 12 months!
“That’s because this acquisition brings a portfolio of $2.4 billion in cash and investments with it.
“If this company manages to just generate the same exact returns on this mountain of cash that it made last year from its much smaller insurance operations it will have managed to more than double its investment profits for FY 2019.”
And one more bit of hype for you — Poulos does cite Markel and Fairfax Financial as other “Buffett Blueprint” stocks that did extraordinarily well (I own large positions in all three of those companies, so that caught my eye)….
“Naturally, ‘Buffett Blueprint’ stocks don’t come along every day.
“And once you’ve found one, it takes decades for the huge gains that Berkshire, Markel, and Fairfax Financial have produced to come to fruition.
“My team and I spent countless hundreds of hours every year looking for the best trades for the thousands of individual investors just like you who come to our door at ‘Profits Run’ looking to learn how to invest profitably.
“We’ve never seen anything like this ‘Buffett Blueprint’ stock.”
OK…. so enough clues and teasing, what’s the stock? Thinkolator sez we’re being pitched HC2 Holdings (HCHC), the most recent conglomerate built by former hedge fund guy Philip Falcone.
Yes, Philip Falcone was a hockey player — he played varsity at Harvard in the mid-1980s, and briefly played professionally in Sweden, though he’s best-known as a hedge fund titan thanks to the blockbuster returns his Harbinger Capital had in the first decade of this century, including a big 2007 short on sub-prime mortgages… and as the one who was taken down by the SEC for securities fraud in 2012. He did pay some massive fines, and admit to things that raise plenty of questions with investors, but he seems to have come out of it OK. This is the Forbes description of Falcone from the last time he made the billionares list, in 2014:
“Former Harvard hockey star made $1.7 billion for himself and billions more for investors in his Harbinger Capital by shorting subprime in 2007. Had a rougher time of it lately. His next big gamble, LightSquared, filed for bankruptcy in 2012 amid claims it would interfere with GPS systems; now Falcone is battling Dish Network founder Charlie Ergen for control of the company’s still-valuable wireless spectrum. Banned from hedge fund business under 2013 consent agreement with the Securities and Exchange Commission, Falcone is turning publicly traded Harbinger Group into a mini-Berkshire Hathaway instead, with interests in everything from insurance to Rayovac batteries.”
He left Harbinger Group in 2014 to focus on the limited work he’s still allowed to do with Harbinger Capital in facilitating redemptions (though his ban from the hedge fund industry might be over now, I’m not sure, maybe he’s more involved in the hedge funds again), and, it was said at the time, to focus more on his second holding company, HC2, his second attempt to build a mini-Berkshire of sorts. Harbinger Capital also holds a minority stake in Ligado, the successor to Lightsquared, though I don’t know if Falcone is still involved. Harbinger Group last year merged with its major portfolio company Spectrum Brands (SPB), and now trades under that name… I don’t know what happened to HRG’s other investments, including its insurance subsidiaries.
And yes, HC2 did recently acquire a big new insurance portfolio, the long-term care assets of Humana, putting another $2.4 billion under management to go with its existing insurance run-off portfolio (totaling over $4 billion now).
The stock, however, has been uninspiring for most of its four years as a publicly traded company… and it has been particularly weak in the past few months, so what’s the story?
As I see it, the problem is both that Wall Street is a bit worried about long-term care insurance… and, of perhaps more immediate concern, that HC2 has a lot of debt and has to pay a high interest rate for that debt. Neither of those have been issues for the big conglomerates like Berkshire and Markel, at least not in recent decades (I don’t know what their balance sheets were like when they were smaller).
One hope for HC2 was that they would be able to refinance their debt maturing in 2019, on which they were paying a huge 11% interest rate, and therefore reduce operating costs and leverage… and that didn’t happen. They announced on November 14 that they were refinancing a big chunk of that debt at 11.5%… and selling it at a 1.25% discount, so the rate is actually even a bit higher, and the debt term is only three years. That wasn’t a full refinance, they’re also using some cash on hand and a convertible note offering of $55 million (at 7.5%), so the overall cost of debt will probably come down slightly… but not nearly as much as was hoped (Falcone said something in the August conference call that implied he thought they “deserved” to borrow at 5-6%, though he acknowledged they wouldn’t get it).
To give you some idea of the impression that bond investors have, the bonds they sold just a couple months ago now trade at a yield of almost 14%… and the convertibles at 7%. I haven’t looked at the details of those bonds, but if you think the company is not going to face a liquidity or existential crisis, 14% is an awfully nice annual return. Philip Falcone comes from a distressed debt background, so he obviously knows that HCHC looks kinda distressed right now — he has said that deleveraging is a priority, and they do have some assets that they’re monetizing or trying to monetize.
So that debt is probably the immediate reason for the recent stock price weakness — the bond market reminded stock investors that it doesn’t really trust HC2 enough to give them a lot of leeway, and the company is still sitting on a big pile of debt and a growing portfolio of liabilities on the insurance side.
The good thing, of course, is that they also get a lot of capital in their purchase of that Humana portfolio… and they seem to want to build that business up. This is an area of insurance that is a little scary to investors right now, though, which is why it doesn’t get the love that property and casualty insurance do — life insurance and annuity offerings are not so compelling if interest rates stay low, since it really pressures you to have strong investment returns to meet your future liabilities, and long-term care insurance has really hurt some providers in recent years. It was just about a year ago that GE announced they were taking a massive $6 billion loss from their long-term care insurance portfolio because they had misjudged the costs of claims.
That risk means there’s opportunity, of course — the fact that so many companies are being scared out of long-term care insurance means that there might be some bargain purchases to be had for companies like HC2 that want to build these businesses. I don’t know enough about the business to understand whether or not they’re getting bargain prices, including on the purchase of Humana’s long term care portfolio last year that really did expand HC2’s portfolio dramatically… but that doubling down on long term care insurance would be what worries me most about HC2 right now, followed by their extremely high cost of borrowing at a time when their stock price is so low that they’re probably not inclined to raise cash on the equity side of the ledger. It’s hard to compound value in relatively slow-growth industrial businesses if you’re borrowing money at 11%.
They have also had good stuff happen too, of course, one of their life sciences investments, BeneVir Biopharm, was sold to Janssen last year, which generated a nice one-time cash payment of $73 million and the potential for several hundred million more in milestone payments if all goes well (up to a billion, according to HC2). That was the last “great news” item for HC2, back in May when the deal was announced the stock went from $5 to almost $7, but then it drifted back down to below $5 before the disappointing debt/refinancing deal was announced and it fell to the $3 range, and dipped as low as $2.40 or so during the worst bit of market pessimism late last year before gradually recovering to the mid-$3s where it stands now.
The core business on the cash flow side seems to be DBM, their structural steel company that specializes in big projects — as the ad teased, it was involved in steel for Apple’s headquarters, and right now their big project is the new LA Rams football stadium. DBM is also acquiring GrayWolf, which is a maintenance/repair/installation company for heavy industry (chemicals, power, etc.), and they have high hopes that this will become a higher-margin and recurring service part of the business
And the other substantial non-insurance business is Global Marine, which provides marine services with a specialty in undersea cable — an area that’s always been important because of subsea telecom cables, but is seeing some resurgence because of offshore wind farms and the need for underwater power cables to bring that power onshore. That business is potentially up for sale, they’ve been evaluating alternatives. Their other businesses, in CNG distribution (for natural gas-fueled truck fleets) and local television broadcasting, are not currently big enough to have an impact on the income statement.
So it’s an interesting company, and it would love to become a “mini Berkshire,” but there’s also quite a bit of hair on it — principally high debt costs and the high liabilities of the long term care portfolio that give me a fair degree of uncertainty. The long term care portfolio liability is “ring fenced,” we’re told, so the holding company won’t be liable, but that doesn’t mean the portfolio will necessarily be profitable (they do get to charge an investment management fee to their insurance subsidiary, but whether or not they profit beyond that largely depends on the actuarial assumptions underlying the insurance contracts and the investment returns they get on the ~$4 billion portfolio).
I am not an expert on the LTC insurance stuff, not by a long shot, so I hesitate to opine on that — otherwise, it’s an interesting conglomerate, priced at a discount to book value, with some cyclical businesses that generate most of their actual operating earnings… and a controversial CEO who has proven his investing ability in the past. I can see why it would be tempting at new lows in the $3 range, given the huge leverage built into the company, and there is some pretty dramatic potential upside if the LTC stuff runs off profitably (or, at least, without major losses) and the biotech buyout continues to pay milestones… but the leverage means there’s also a much larger risk of a 100% loss than you’d think for a company tagged with that “mini Berkshire” name.
It’s your money, though, so it’s your opinion that matters — ready to roll the dice with Philip Falcone as he tries to build a conglomerate of substance? Think the debt is too scary, or enticed by the huge leverage the insurance portfolio and the debt provide? Let us know with a comment below.
P.S. 4/26/19: It’s been three months, and HCHC shares have kept falling to new all-time lows, it’s now a $100 million company riding on $2 billion of debt — though they now say their priority is reducing that debt to help improve their cash flow (since current dividends from subsidiaries don’t cover the interest cost). There has been a little bit of insider buying, the construction business seems to be doing well, and the stock’s metrics continue to look compelling as long as you ignore the debt… but, of course, the metrics look compelling mostly because that debt is a big deal, and we won’t know for a while just how smooth the “delevering” is going to be over the next couple years. You can see the transcript of their 2018 conference call here from mid-March to get some sense of where they think they are, and they’ll report the first quarter on May 7. I continue to not own shares in HCHC, which is really just a tiny equity tail being wagged by a giant debt dog, but that leverage means a change in sentiment or operational performance could have a big impact on the stock.
Disclosure: I own shares of Berkshire Hathaway, Markel, Fairfax Financial and Apple among the companies mentioned above. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s rules.