By Britt Erica Tunick
In late 2006, Phil Falcone joined a handful of hedge fund managers in making what turned out to be a well-timed bet against the housing market. Not only did that wager send his flagship hedge fund returns soaring the next year, it also transformed Falcone into a hedge fund rock star. Seemingly overnight, the once-obscure distressed fund manager became one of the industry’s most recognizable names.
With billions of dollars at his disposal, Falcone’s Harbinger Capital Management grew bolder, as evidenced by an early 2008 activist play for the New York Times Co. A 19% stake in the celebrated newspaper company not surprisingly drew media scrutiny, as did his personal life, including the increasingly public profile of his wife—a former model—a pet potbellied pig and the purchase of a pricey Manhattan double-wide limestone townhouse once owned by former Penthouse publisher Bob Guccione. By November 2008, it was clear Falcone had made it into the industry elite: He was one of just five hedge fund managers—along with industry legends George Soros, Jim Simons, John Paulson and Ken Griffin—invited to testify before Congress about the role of hedge funds in the financial markets.
Like fame, however, Falcone’s outsize returns proved fleeting. Following his 2007 gain of 119%, in 2008 the Harbinger Capital Partners fund posted a yearly loss of 29.26%—raising questions about the firm’s sustainability and leading many investors to take their money and run. By January, Harbinger’s assets under management had plummeted to $7 billion from a mid-2008 high of $26.6 billion.
To prevent a firehouse sale of assets to meet redemption requests, Harbinger placed more than a third of its investments in a side pocket. Clients bemoaned the firm’s concentration in a handful of positions, such as Calpine and Salton, which seemed more like private equity and activist plays. To top it off, rumors spread in the market that Falcone had not come up with the idea for his subprime short but instead got it from Deutsche Bank, an accusation Harbinger vehemently denies.
Not one to run from difficulties, Falcone, 47, has worked hard to turn things around. Earlier this year, he bought his firm out from Harbert Management, the Birmingham, Ala., investment management firm that seeded Harbinger. He has also restructured his investment terms. And to allay concerns that rapid growth had left the firm understaffed and overly dependent upon him, he more than doubled Harbinger’s staff. Though still 8% below the high-water mark as of the end of September, Harbinger’s returns are inching back up (the fund netted 30% for the year through September) and has generated profits in positions in consumer products, metals and mining and satellite telecommunications. For the life of the fund through August, Harbinger’s flagship has averaged an annual gain of 21.12%. The firm is also addressing concerns about over-concentration by thinning out some of its largest holdings and has launched two new vehicles—a liquid distressed fund and a private-equity-style fund for investors with long-term staying power.
Falcone, who is currently fundraising, is keen to control the future of Harbinger and how it is perceived. In fact, less than 24 hours before a scheduled interview with AR magazine, he canceled, unnerved by media coverage of Harbinger’s recent investments in wireless telecom companies, which include plans to orchestrate a cross-border merger of SkyTerra Communications and Inmarsat, and a 25% stake in Augere Holdings. Falcone’s views of the future of the wireless industry are controversial and yet another reason why some clients remain skeptical. But for the most part, his efforts this year seem to have allayed concerns. Recent allocations include capital from investors that previously pulled money from the firm.
“He’s a very shrewd investor and he’s proved it ... until the latter part of 2008 he didn’t have two months that were down. He was very well hedged,” says one longtime Harbinger investor, adding that Falcone’s investment success reaches well beyond his subprime bet. “Phil’s put a lot of his own money into building up his back office and middle office. He’s brought in some really good people, whereas with a lot of other [managers], when they lost control of things they let a lot of people go,” he says, noting that Falcone has been quicker to address many of his problems than most of his peers. Unlike hedge funds that trimmed large staffs after last year’s losses, however, Falcone’s organization had always been lean, at one point managing $26.6 billion with just 24 people on staff.
Though relatively unknown until the early part of this decade, Falcone has been trading high-yield and distressed debt since 1985, when he was at Kidder Peabody. After a short stint with Gleacher Natwest in the late 1980s, followed by two years as the head of high-yield trading for Barclays Capital, Falcone set out to form his own hedge fund firm and crossed paths with Harbert, which was looking for a distressed portfolio to add to its burgeoning collection of strategies. Harbert seeded Falcone with $25 million, and Harbinger was launched in late June 2001.
“Phil wasn’t a big respected trader at the time. He was just another guy who wanted to launch a hedge fund and had a reasonable story,” says one longtime Harbinger investor, noting that it was Falcone’s conservative investment approach at that time that put him on a path to success. “When he launched in ’01 he wasn’t fully invested and he was smart enough to put some money into WorldCom. Then everyone loved him because he made money in ’02 and caught a portion of the rally. Everyone saw him as a defensive play from that point forward.”
One of few distressed fund managers to get through 2002 without losses, Falcone caught the attention of enough investors that by early 2004 he had attracted $3 billion in assets, at which point he closed the fund. But in 2005, when the debt of major auto players such as Ford Motor, General Motors and Delphi was downgraded, Falcone believed that a new distressed cycle was beginning and took in more money so he could pounce on new opportunities.
Harbinger steadily produced double-digit annual gains. During the flagship fund’s first six months of operation, it rose 14.20%, followed by returns of 16.80% in 2002, 27.50% in 2003, 10.58% in 2004, 13.34% in 2005 and 22% in 2006. By the end of 2006 assets under management had inched up to $5.3 billion and the firm had experienced just seven down months, with its worst loss a 1.06% decline in September 2006.
But triple-digit returns in 2007, coupled with Falcone’s personal payout of $1.7 billion, according to Alpha’s Rich List, transformed Harbinger into a universally recognized hedge fund name and thrust its trading activities into the spotlight. The attention didn’t come without problems.
Worried that outsize returns could not be sustained and in need of rebalancing their own portfolios, Harbinger’s investors took money off the table just as turbulent markets started taking their toll on the fund’s portfolio. Assets that had skyrocketed to $26.6 billion as of mid-2008 fell back to earth just as quickly. During the second half of 2008, the firm’s massive asset base became problematic, driving home the importance of having a smaller and more manageable portfolio.
In his search for overlooked opportunities, Falcone drifted away from his original emphasis on distressed debt to include a number of illiquid investments. Among the issues Harbinger suddenly faced was the likelihood that prices would move against the firm should it meaningfully exit any of its big positions. Faced with mounting redemption requests, and in an effort to protect ongoing investors from collateral damage caused by forced selling, Falcone side pocketed 37% of his portfolio.
Though Falcone waived all management fees on the side-pocketed holdings for the duration of the vehicle, some clients were displeased by the side pocket, which they have dubbed an “investor-level gate.” In hindsight, however, some investors now concede Falcone’s move to lock up the assets was the right one. “We were in the position where we didn’t want to redeem, and as remaining investors we didn’t want to suffer because of other guys’ redeeming,” says an investor for one European insurance company invested in Harbinger. “You can argue that [Falcone] shouldn’t have been in these types of investments to begin with and that he shouldn’t have had to side pocket, but given the way the portfolio was, it made sense.” He says Harbinger is transparent about its positions and that, unlike other firms that took similar measures last year, Harbinger’s decision to side pocket was not simply about holding clients’ assets hostage.
Harbinger has made a soft commitment to investors to liquidate the side pocket by the end of 2010 and has already reduced it to 30% of the firm’s holdings. Natural gas company Kelson Energy, Ferrous Resources and home appliance manufacturer Salton together account for about 70% of the vehicle’s assets.
Critics say Harbinger’s rapid asset growth spurred Falcone to stray too far from his core investment competency—distressed debt. “The bigger you get, sometimes the temptation is to take out bigger positions and to take more of an activist position in bigger names, and that’s sort of what he did over the course of ’07 and ’08. The problem is that when the assets leave and your assets under management go back down again, you can’t necessarily continue to do that and you become very concentrated,” says a longtime Harbinger investor. “He kind of morphed a little bit because there wasn’t a lot available in distressed, so he went with what was available.”
Harbinger wasn’t the only distressed debt fund to diversify into private equity-style bets. David Tepper’s Appaloosa Fund took a major position in Delphi and lost about 26% in 2008, while Steve Feinberg’s Cerberus Capital Management took a beating last year as well. In contrast, however, John Paulson’s Paulson & Co., which also made billions of dollars in 2007 betting against the housing market, did not stray far afield from his firm’s event-driven focus and has continued to churn out impressive gains. For the year through September, Paulson Credit Opportunities had gained 22.55%.
Harbinger’s peak-to-trough drawdown in 2008 was more dramatic than its 29% calendar-year loss. By mid-July 2008, Harbinger had climbed 42.80%, but went into free fall in part because it had assets caught up in the Lehman Brothers bankruptcy and because the temporary ban against shorting financial companies took a toll on its short book.
Possibly as a result of the sudden downturn, a rumor swept the market that Falcone’s bet against the subprime market wasn’t his own idea, but was instead brought to him by Greg Lippman, an analyst at Deutsche Bank. Lippman told AR magazine that he met with Harbinger and pitched Falcone the idea of shorting the subprime market and that Deutsche Bank did a lot of subprime work with Harbinger, but he does not know if it was an idea that the firm already had in the works. Investors also note that at the firm’s 2007 annual meeting at Manhattan’s St. Regis Hotel, Falcone himself acknowledged Lippman as having been instrumental in the trade.
Harbinger calls the rumor unfair and insulting. The firm says that Falcone began looking into shorting subprime mortgages long before he ever put a position on—and that it was an idea that grew out of the recognition that people were getting mortgages with little or no effort. At the same time, Harbinger says, Falcone was researching the home construction and home improvement industries and saw signs that they were beginning to falter. Even if the trade idea did come from Lippman, Falcone had the foresight and courage to make a bet that few others were willing to take—and profited handsomely.
Harbinger’s stake in Times Co. was less prescient, and might be viewed as a sign that egotism had taken over common sense, especially when the newspaper industry is in a seemingly irreversible decline. In January 2008, Harbinger spent about $500 million amassing a 19% interest in Times Co. and joined with hedge fund firm Firebrand Partners to argue for strategic change. It was a partnership the pair successfully parlayed into two seats on an expanded board. Initially the plan was to coax Times Co. to unload some of its peripheral holdings, such as stakes in the Boston Red Sox and a Nascar race team, and to encourage the media giant to focus on its Internet presence. Harbinger’s arguments were not convincing. In late September of this year, Harbinger sold 5 million shares of Times Co. at $8.25 each, well below the $14 to $20 range at which they were acquired. The firm still owns about 23.5 million Times Co. shares.
Harbinger does not view itself as an activist and argues that its private equity activities are a natural extension of distressed debt. “We don’t seek to be activists, we seek to be catalysts—meaning we want to unlock value in companies,” says Larry Clark, a 38-year-old managing director and director of investments for Harbinger since 2002. He is quick to emphasize that the firm takes a partnership approach with the majority of companies in which it takes stakes and has a good relationship with their management teams—factors Harbinger’s investors also pointed to as comforting.
Harbinger’s failed play for Times Co. has done little to discourage Falcone, as evidenced by his aggressive efforts in the wireless spectrum industry. For the past couple of years, Falcone has wanted to orchestrate a cross-border merger of SkyTerra, North America’s largest developer of mobile satellite communications services, which Harbinger has agreed to acquire for $280 million, with London-based global satellite provider Inmarsat. Harbinger also announced plans to acquire 25% of London-and Amsterdam-based broadband company Augere. As cell phone providers offer ever more complex and comprehensive services, Falcone is betting on what some view as a rather quixotic universal movement toward satellite cell phones that would offer seamless worldwide coverage. He wants to put together an international mobile satellite business to prepare for that evolution.
According to Clark, Harbinger relies on its core strength in credit analysis to study what a business is capable of and where it has come up short, as well as by having a view on how things can be fixed and a willingness to commit to a solution. Between 2005 and 2007, when a strong credit market meant limited bankruptcies and distressed opportunities, Clark says Harbinger sought out investment opportunities in companies with strong growth potential that have been mismanaged and overlooked.
“To the outside world that looked like activist investing, but in none of the situations were we simply interested in a quick flip ... our objective wasn’t to go and rattle somebody’s chain, it was to figure out why a company isn’t generating the same level of value for shareholders that we think it’s capable of,” says Clark.
Falcone’s bottom-up, research-intensive approach has proven effective over the years. Success stories include Harbinger’s $100 million purchase of the majority of General Chemical Industrial Products, a producer of soda ash that the firm sold to Tata Chemicals for $1 billion in March 2008. Harbinger made a similar play for Playtex Products in early 2007, but after the firm bought up 20% of the stock to launch a bid for the company—best known for making bras and feminine hygiene products—Energizer Holdings jumped in with a bid of its own. Though Harbinger lost in its effort to acquire Playtex, the value of its Playtex investment doubled by Energizer’s October 2007 acquisition.
Harbinger’s purchase of the debt of Salton—a manufacturer of home appliances and one of the major holdings in the firm’s side pocket—is also poised to reap rewards. Harbinger bought Salton’s debt when its bonds were trading in the 50s (they have since climbed up into the 70s) and, after converting them to equities, helped orchestrate the company’s December 2007 merger with Applica, a manufacturer of high-profile home appliances, including the Black & Decker brand, whose shares Harbinger acquired in January 2007.
“When we bought Applica, the market questioned our motives,” says David Maura, a vice president and director of investments for Harbinger who focuses on consumer products, agriculture and retail. At the time Harbinger made the bet, Maura says Applica had only $5 million in Ebidta (earnings before interest, depreciation, taxes and amortization) and about $150 million in debt. But after ousting Applica’s board and overhauling its management team, Harbinger helped the company eliminate its debt and build its Ebidta to $40 million in just 11 months. Meanwhile, Harbinger converted its Salton debt to equity and took advantage of majority ownership of both companies by folding Applica into Salton through a reverse merger.
Falcone took a backwoods route to his hedge fund career and the high-profile lifestyle he now leads in New York City. Raised in Chisholm, Minn., a small town in the heart of the iron range, Falcone grew up poor. The youngest of nine children supported by parents who barely got by, he lived in hand-me-down clothes and developed an appreciation for hard work at an early age. His father, a utility superintendant, never made more than $14,000 a year and left the family when Falcone was nine years old, forcing his mother to take a job at the local shirt factory to support her brood—facts Falcone proudly told members of Congress in November 2008 when he was summoned to testify at a hearing of the House Committee on Oversight and Government Reform regarding hedge funds and the financial markets.
A dedicated student and avid hockey player, Falcone dreamed of going professional and spent countless hours on the ice. His hard work on both counts paid off. When his high school hockey team went on a high-profile winning streak that caught the attention of college hockey coaches across the country, a recruiter from Harvard University invited him to study in Cambridge, Mass. Adjusting to an environment of previously unknown privilege, Falcone, by all accounts, was an extremely competitive and disciplined student—the same adjectives his peers use to describe him today.
After earning a degree in economics, Falcone realized his dream of becoming a professional hockey player—if ever so briefly. He spent a year playing for the Malmö Redhawks, a team in Sweden’s second highest hockey league, until a leg injury ended his career. Shifting gears, he headed to Wall Street where in 1985 he got a job at Kidder trading junk bonds. In 1990, Falcone and a friend from college pooled their money to buy AAB Manufacturing, a troubled consumer products company that made hair brushes, among other things.
The venture failed and, after AAB defaulted on its loans, Falcone, who had guaranteed them, once again found himself destitute. “I was so ‘financially challenged’ that the power in my apartment was shut off because I could not afford to pay the electric bill,” he told the committee. “That experience, as painful as it was, stayed with me over the years and taught me several valuable lessons that have had a profound impact upon my success as a hedge fund manager.”
The AAB experience is one that Falcone’s employees and investors believe has made him the extremely thorough and cautious investor he is today. But that conservatism does not extend to his personal life.
A world away from his Minnesota childhood, Falcone ranks number 296 in Forbes’ 2009 list of the world’s richest people with a reported net worth of $2.3 billion. In 2008, he was the fifth highest paid hedge fund manager, which earned him the invitation to testify at the House hearing.
Falcone and his wife, Lisa, a former model who grew up in Spanish Harlem, have not been shy trying to carve themselves a place among Manhattan’s high society. In a nod to his home state and his love of hockey, Falcone purchased a 40% stake in the Minnesota Wild NHL team. In early 2008, the Falcones bought Guccione’s East 67th Street townhouse—a 27-room mansion they share with their twin daughters, three dogs and pet pig. It is just one of three residences the couple owns between Manhattan and Long Island. The Falcones’ $49 million purchase marked the third highest price paid for a Manhattan townhouse at the time, according to extensive media coverage of the sale by the New York Observer, New York magazine and the New York Post.
The Falcones’ nouveau riche lifestyle has not gone without notice among Harbinger’s investors, some of whom view Lisa Falcone as a headline risk to her husband’s business. Lisa Falcone’s photo is featured on dozens of Websites and blogs, often commenting on her fashionable outfits, such as one black-and-gold outfit many have described as a garbage bag gone awry.
In June, she made headlines by making an impromptu pledge to the High Line, the newly opened park built on the ruins of a former elevated rail line on Manhattan’s West Side. Interrupting a speech by one of the park’s co-founders, Lisa Falcone said she would match the $10 million gift made by fashion designer Diane von Furstenberg and her media mogul husband, Barry Diller.
Though a Post article quoted Mrs. Falcone as saying her husband had been unhappy with the quick decision, Phil Falcone generated some press of his own when he jumped in front of other donors at the park’s ribbon-cutting ceremony. Shortly after the ceremony, the Times ran a profile of Mrs. Falcone as an emerging New York philanthropist, a piece that was criticized as an effort to mollify her husband, then one of the newspaper’s major shareholders.
“When you start showing your money, where is your focus?” says one Harbinger investor. “There’s a way to do it and a way not to.” Harbinger decries such comments as nothing more than tabloid gossip. “All Mrs. Falcone has done is give back by giving to charity, including $10 million to New York’s High Line,” a Harbinger Capital Partners spokesman says.
Although the Falcones’ lifestyle is perceived as a risk for Harbinger investors, Falcone’s steady track record until 2008 and his intense conviction have been enough to overshadow such concerns.
Harbinger’s loss in 2008 cost the firm more than two-thirds of its assets, but for Falcone the events of last year were also a learning experience—and one he seems to be using as a catalyst for change. When Harbinger began reporting losses, leading to an exodus of investors, Falcone recognized the damage done by fair-weather limited partners. Added to that, Harbinger faced investor skepticism regarding its infrastructure, independent oversight and liquidity terms as well as concern about the portfolio’s highly concentrated positions. Falcone has since addressed all of these issues.
“Harbinger is a better firm for their past. They’re survivors,” says Scott Carter, head of North American sales and capital introduction for Deutsche Bank’s prime brokerage unit, which counts Harbinger as a client. “Like many funds, their investment style drifted, but they’re focused again on their core competency—credit investing.”
Last fall, Falcone began the process of taking over the marketing of his own funds, hiring Dana Auslander, a managing director and head of business development for Harbinger away from the Blackstone Group as Harbinger’s first non-investment staffer. Earlier this year, he followed up by buying control of his firm from Harbert, a move that will allow him to bring all back-office and support functions under one roof for the first time.
Until the buyout, all of Harbinger’s non-investment functions, from marketing to accounting, were handled by Harbert from its Birmingham headquarters. In Harbinger’s early years, the arrangement—typical for most seeding platforms—benefited the fund because it freed Falcone from day-to-day administrative tasks so he could focus on investing. As Harbinger grew, the arrangement became somewhat problematic. Harbert’s willingness to take on all sorts of investors meant that some were ill-suited and unwilling to put up with Harbinger’s extreme volatility.
Harbinger says Falcone had no say over the investors who could or couldn’t participate in his funds. In addition, some Harbinger investors were not completely confident of the firm’s infrastructure and risk controls. In AR ‘s initial Hedge Fund Report Card, an investor ranking of the industry’s largest firms based on criteria including alignment of interests, independent oversight, alpha generation, transparency, infrastructure and liquidity terms, Harbinger ranked 28th out of the 31 firms in the initial ranking—a score kept down by comments about the firm’s rapid decline in assets and its small infrastructure.
Investors who have visited Harbert’s Birmingham operation say that the back-office functions are solid, but they also say some questions were raised because of the physical distance between the two firms and the thinking that an Alabama operation would be unlikely to match the capacity and sophistication of services available in a financial center like New York.
“It was always one of the things we were concerned about with Harbinger, that so much of the economics and the organization were controlled by groups not directly engaged in its management,” says an institutional investor who has been invested in Harbinger for several years. “I think it’s a good thing that management now controls that organization .... Phil is going to run his business, both the investment and operation sides, the same way he invests—with conviction.” This person points to some of Falcone’s recent hires as a sign that he is aware he cannot do everything himself. In the past year, Falcone has more than doubled Harbinger’s staff from 24 to 56 people, including 28 on the investment team. Some of the high-profile hires include chief operating officer Peter Jenson, who formerly served as Citadel Investment Group’s controller, and head of strategies Omar Asali, who was previously co-head of Goldman Sachs’ hedge fund strategies.
Falcone’s seeding arrangement with Harbert did not include a provision that allowed him to buy out the firm, but both parties were comfortable with the move. “It was just a maturation of the relationship to the point where we thought it made sense for both parties to be independent,” says Mike Luce, Harbert’s chief operating officer. “Phil is a brilliant investor, and it was a very successful run for both of us. But we’re not looking back,” Luce adds, noting that his firm’s selection to seed Falcone was based on his strong work ethic as well as a gut feeling on the part of Harbert’s management team.
Despite the separation, Harbert maintains a significant investment in Harbinger’s funds. Harbert will continue providing Harbinger with transition services such as accounting for a year after the split to give Falcone time to build adequate support of his own. External providers include Harbinger’s administrator, IBIS Capital Management, as well as seven prime brokers: Barclays, Bank of America-Merrill Lynch, BNP Paribas, Deutsche Bank, Goldman Sachs, JPMorgan and Morgan Stanley. Though Harbinger severed its prime brokerage relationship with Lehman Brothers, the firm still has $250 million in claims associated with derivatives contracts tied to the firm’s bankruptcy.
In the wake of Harbinger’s newfound independence, one of the biggest changes has been an overhaul of its investor terms and the makeup of its investor base. In April, Harbinger made it easier for investors to exit the fund, boosting an investor-level gate to 25% from 20% while increasing its management fees to a standard 1.5% across the board—an increase from the 1% and 20% fee structure the firm’s onshore investors previously paid.
After last year’s fickle investors fled, Harbinger created a scorecard for ranking potential investors on a scale of one through five based on factors such as an individual’s redemption likelihood, the degree that they appear to be chasing returns and their ability to be strategic. “We do a lot of co-invests and things that are off the beaten path,” says Auslander. “We invest strategically and tactically, so we try to focus on investors who can understand all the relevant investment criteria.” If investors don’t meet its new criteria, she says, the firm won’t even meet with them.
Harbinger would like its investment base to comprise 30% U.S. funds of funds and family offices, 20% sovereign wealth funds, 20% U.S. corporate and public pension plans, 15% foreign pension plans, 10% endowments and foundations and 5% categorized as Harbinger affiliates. The firm is actively avoiding European funds of funds, the investor class that pulled the most money in 2008.
To align investors’ interests with Harbinger’s investment activities—and to collect performance fees this year, when it is uncertain the flagship will climb above its high-water mark—the firm recently launched two funds whose liquidity terms match their investment objectives. Harbinger’s new Global Opportunities Breakaway Fund, structured as a five-year closed-end hybrid private equity fund, houses M&A and other illiquid investments. The Credit Distressed Blue Line Fund is a liquid, high-yield portfolio that marks a return to Falcone’s distressed roots. That credit fund will specialize in the firm’s core industry strength: consumer products, power and transmission, cable and media, pipelines, telecom and wireless, satellites, industrials, airlines, paper and packaging and home building.
Investors also have the option to allocate to Harbinger Capital Partners Special Situations Fund, a more concentrated portfolio that focuses on value- and event-based investment opportunities. Investors in the flagship Harbinger Capital Partners may opt out of any new private equity investments, the satellite phone position being the only such deal at the moment.
By better matching assets and liabilities, Harbinger wants to eliminate concerns about concentrated and illiquid positions. Harbinger is now working to reduce the size of some of its larger holdings. Falcone has sold half of his 16% holding in Australian mining company Fortescue Metals Group, an investment that has made Harbinger billions of dollars and which was its largest holding until earlier this year. More recently, Harbinger has also begun paring down its holdings in Calpine, an independent power producer that houses one of the country’s largest geothermal power portfolios. Even after Harbinger sold 20.7 million shares, Calpine remains the firm’s single largest public holding. (The firm owns 87.5 million shares, more than 20% of the outstanding shares.)
Harbinger began building a position in Calpine in late 2005 when the company filed for bankruptcy after taking on too much debt. At that time, Falcone began buying secured bonds, which later converted into stock that has generated substantial returns. However, when natural gas prices fell to between $2 and $3 per cubic foot last year down from $14, and oil prices per barrel plummeted to $35 from $138, Calpine’s stock took a similar nosedive, accounting for a large part of Harbinger’s 2008 losses. Still, Harbinger remains committed to the company, convinced that the stock is still undervalued. Calpine is just one of several global materials companies that Harbinger has invested in, a sector that Falcone believes will grow significantly in the near future.
“When it becomes more apparent that carbon legislation is going to be passed, companies like Calpine—owners of the largest unregulated fleet of clean, efficient, gas-fired power plants and zero emissions geothermal power plants—will benefit,” says James McGinnis, 46, a managing director and director of investments who joined Harbinger last May. McGinnis has known Falcone since college and is considered, along with Clark, one of Falcone’s two “number two” men.
So far, the new approach seems to be working. Credit Distressed Blue Line Fund has netted 44.62% since its April launch. On the fund-raising front, Harbinger has attracted nearly $700 million in new commitments this year.
Falcone plans to limit his assets to between $12 billion and $14 billion, determined to avoid last year’s problem of having too much money to invest. The flagship is being capped at $10 billion, with plans to repatriate money if the portfolio’s returns exceed that level. Investments in Credit Distressed Blue Line Fund will run throughout the upcoming distressed cycle, which Harbinger expects to last roughly three years. Accordingly, the fund is slated to terminate on April 1, 2012. Harbinger also has more cash in its portfolios and has reduced leverage overall.
Most of Harbinger’s current leverage is expressed by shorting credit default swaps, with the majority of capital devoted to the firm’s highest conviction position of the moment: A bet on the failure of mortgage insurers such as MTG Mortgage Group, PMI Mortgage Insurance and Radian Mortgage. Though the thesis has yet to pay off, Falcone is convinced that the business of mortgage insurers will prove unsustainable—an opinion many of his investors now support. Says a client at one Canadian institution: “He thinks they’re worth nothing, and I tend to agree. Why would you insure or put a wrap on anything the government is so involved in? And since these businesses don’t insure at a municipal level, I don’t know what their business is going forward.”
According to investors, Falcone’s bet against mortgage insurers represents as much as half of his short book, currently a drag on the portfolio. Those close to Falcone describe a methodical investor who turns over every rock before making an investment and who will spend as much as four months researching even companies of which he is certain. “While he’s somebody that likes to take action, he’s also very patient,” says McGinnis.
Despite Falcone’s absence, a quick visit to Harbinger’s stark new Park Avenue digs makes it clear that he is at the core of all the firm’s activities. Unlike most trading floors, where employees are seated in parallel rows, the traders’ desks at Harbinger are organized more like the tables at a wedding reception, angled toward the desk Falcone occupies whenever he is not traveling on business. Nary an artwork or other adornment is in sight.
Most investors still view Falcone and Harbinger as being one and the same, given that Falcone has the final say on all investment decisions. That factor is a concern for Harbinger and may be one reason why the firm made a number of its top executives available for this story even after Falcone pulled out. The firm says investment ideas and research come out of collaboration. “Our investment philosophy is very simple. We study, often for months, the fundamentals of companies to identify those that are undervalued or overvalued, and we act decisively when opportunities present themselves,” Falcone told the Congressional hearing. “It is not magic. My analysts perform thorough due diligence, rather than relying on ratings agencies or other research reports—like many of the reports that improperly valued securitized mortgage products over the past few years.”
Falcone’s importance is recognized by a key-man clause that gives investors 90 days to redeem in the event that the founder is no longer at the helm. A spokesman for Harbinger says Harbinger has a succession plan but is not willing to provide details, while several Harbinger investors say it is unclear who would step into Falcone’s shoes should he leave. “Investing in Harbinger is investing in Philip Falcone. He is really the key man in this firm and obviously you have to feel comfortable with him,” says an investor representing a European insurance company.
Falcone’s high profile tends to leave people with strong opinions. Though his publicity-happy wife has made Falcone the subject of his fair share of criticism, those closest to him describe an individual who has never lost sight of his roots and who, despite his success, works as hard today as he did early in his career. These employees say Falcone constantly reminds them to invest every dollar as if it were their own mother’s.
“The most sensational thing about him, and we don’t like it, is his personal life,” says one Harbinger investor, pointing to his purchase of the Guccione mansion. “He has more money than God,” says the investor, noting that Falcone is no longer driven by the need to make his fortune. “As a former hockey player, it’s about wanting to win. And after last year, I think he’s got a chip on his shoulder. I hope he does.”
FACT FILE: HARBINGER CAPITAL MANAGEMENT
Assets under management: $8.1 billion
Founder: Phil Falcone
Founded: June 2001
Office: New York
Flagship: Harbinger Capital Partners (21% annualized)
