July 25, 2014 - 8:50am EST by
2014 2015
Price: 3.90 EPS $0.00 $0.00
Shares Out. (in M): 17 P/E 0.0x 0.0x
Market Cap (in $M): 67 P/FCF 0.0x 0.0x
Net Debt (in $M): 11 EBIT 0 0
TEV (in $M): 78 TEV/EBIT 0.0x 0.0x

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  • NOLs
  • Holding Company
  • Steel Fabrication
  • Insider Ownership
  • M&A Catalyst


HC2 Holdings (HC2) is a compelling long investment at current levels. The defunct old business will no longer matter going forward as Phil Falcone tries to resurrect both his career and HC2. To accomplish that monumental goal, Falcone took a 40% stake in PTGI, changed the name to HC2 Holdings, and purchased 65% of Schuff International in a tender offer with the controlling owner. Previous write-ups on PTGI and SHFK go into great detail about the dealings, and failings, of both businesses. I encourage readers to seek out those pieces to better understand the history of both companies.

Acquisition of Schuff

On 5/30/2014 HC2 Holdings announced the acquisition of 2.7 million shares of Schuff International for $31.50/share.  The total consideration for these shares was $85 million and was funded via $30 million of Series A Convertibles ($4.25 strike), $6 million of common stock, and an $80 million capacity-18 month term loan. Three groups participated in the securities purchase agreement: Hudson Bay Capital Management, Benefit Street Partners and DG Capital Management. The table below shows the capitalization.

Table 1. Capitalization of HCHC

In Millions, except per share


Shares Outstanding 03/31/2014 (A)


Add $6 million secondary (B)


Current Shares Outstanding (A)+(B)


Convertible Proceeds


Conversion Price/share


Class A-1 Warrants Proceeds (3.291M shares)


Class A-2 Warrants Proceeds (4.386M shares)


Fully Converted Share Count @ $4.25/share



The Term Loan was used to fund the acquisition. Between the convertible proceeds, secondary, cash already on the balance sheet, estimated warrant proceeds, and BLACKIRON escrow, HCHC has at least $94 million of cash ready for investment. I am confident that acquiring more Schuff is a near-term goal for HCHC. Management has told me that there are a few ways they are considering increasing their stake, although no specifics were given. The logic behind further share purchases is simple; HCHC has $241 million NOLs, with $116 million not subject to 382 limitations, so getting Schuff on their income statement would be very beneficial.

As detailed in several other VIC posts, Schuff is a good business, and as mpk pointed out in his post, backlog as of 12/31/2013 stood at $426 million, higher than 2007 ($416.5 million). While the business has changed a little, it hasn’t changed enough to upset the earnings potential. The table below shows my earnings estimates for Schuff in 2014.  Given the lack of disclosure and difficulty communicating with Schuff’s management, I had to make some broad assumptions.



Table 2. Earnings Estimates

2014 Model








Gross Margin




Gross Profit








Interest Expense









Net Income




It would be great if Schuff could get consolidated as soon as possible, 80% of operating profit under the base scenario would lead to $41.8 million of profit going to HCHC, a good portion of it sheltered from taxes. Even if HCHC fails to consolidate Schuff's earnings on their income statement for tax purposes, there should still be upside. Schuff is, to put it lightly, not so good with shareholder communication. I believe that one of the many reasons Schuff shares remain undervalued is due to poor communication. If management of HCHC cannot acquire another 15% of Schuff shares, I believe they will start promoting the company more to hopefully drive shares higher. Perhaps they will issue a dividend, who knows. A quick glance at Canam and Schuff shows the valuation delta.

Table 3. Valuation for Canam Vs. Schuff


2013 EBITDA(M)








A little publicity will go a long way towards closing the valuation gap. However, I don’t think a long-term investor would panic if the gap remained. A bigger gap means more buying opportunities for HCHC.

Other Stuff

Currently, there are two other segments in HCHC, medical and media/telecom. The former is early stage venture capital style investments. Without an idea for the projects being pursued or potential revenue, I will assume that this segment has no value and, for all practical purposes, a negative value.

The media/telecom segment has the legacy assets from Primus, and now consists solely of International Carrier Services (ICS). This segment is very low margin and not particularly attractive. Management has told me that margins should expand with some technology investments and headcount reductions. I’m not sure how much it would cost to really expand margins, but I suspect that Falcone and company will do so in a smart manner. They recognize that this is not a growth engine and it’s unlikely that ICS will suddenly become a cash cow. I have assumed that this segment is worth zero right now.

Other assets include the cash on the balance sheet and, of course, the NOLs. I estimate cash at more than $94 million and there are $241 million of NOLs.  Cash and NOLs are two ingredients that management will use to hit their incentive targets.

NAV Based Compensation

I believe that the compensation agreement is a key part to driving shareholder value. Management gets a 12% cut of YoY NAV increases, with some adjustments and a high-water mark. This compensation is awarded with cash (40%) and equity (60%). Management is incentivized to make NAV grow over the long-term and do so in the interests of common shareholders. No surprise here with Falcone owning 40% of the shares.

With this kind of compensation and insider ownership, I wouldn’t be surprised to see any number of value creating activities outside of the simple or the obvious.

Potential Acquisitions

I notice that investors often confuse accuracy with precision. To avoid that, I will try to accomplish neither and will hopefully show that an investment in HCHC can lack all precision but should do well, implying some weak form of accuracy.  

Investors of HCHC get Schuff, $94 million in cash, ownership of a crappy business that may get better, and a pile of NOLs. On a pro forma basis, the term loan requires $17.5 million of cash to be held on the balance sheet. I’ll round this up to $25 million to account for working capital. That leaves investors with $69 million of cash that can go towards acquisitions. I think it makes sense to acquire at least another 15% of Schuff, therefore I’ll assume that HC2 will pay $35/share for another 600,000 shares of Schuff. This will require $21 million of cash.

That leaves investors with $48 million ($69M-$21M) that can be deployed towards acquisitions. The table below shows some possible numbers.

Table 4. Possible Acquisition Scenarios

In Millions




Cash Deployed








Total Funds




EV/EBITDA of Purchased Company




EBITDA of Purchased Company




Interest Expense at 8%




Cash Generated before CapEx




I have assumed zero taxes, since Falcone probably has a team of lawyers who are smart enough to figure out how to utilize NOLs in an efficient manner. It’s been done before and is happening elsewhere (WMIH, BIOF, ALJJ, maybe MYRX someday). The final cash earnings from a potential acquisition will obviously depend on capital expenditures, which I could guess at, but the table above at least gets us in the ballpark.

Finally, people far smarter than me will be able to determine an exact NOL/share value. However, I don’t think it’s pertinent to the thesis. Clearly, the numbers above are guesses but it doesn’t take much imagination to see the upside present in shares with proper capital allocation. Downside is protected by the ownership of Schuff and cash that exceeds the term loan.


I believe that an investment in HCHC is pretty straightforward, even with the muddied past. Investors today are betting that Phil Falcone and his team of lawyers can take advantage of the huge NOL bank. These NOLs, the current ownership in Schuff, and $94 million in estimated cash provide ample downside protection for investors with the knowledge that any of the three could drive fair value considerably higher. While HCHC only owns 65% of Schuff currently, there could be several levers to pull that would increase ownership, allowing HCHC to consolidate Schuff on their income statement for tax purposes.  As more information percolates to the surface I expect HCHC shares will rerate higher. Exact upside will be determined as cash is deployed towards acquisitions.
Note: Net debt is calculated as follows: $80M term loan, $30M convert proceeds, $6M secondary proceeds, $13M cash currently on the balance sheet, and $20M escrow that should have been released. I did not include the warrant proceeds.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


Getting ownership of Schuff over 80%
Using cash for more acquisitions
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