Most hedge funds chose not to put illiquid private equity investments directly into their hedge funds after getting burned on those investments during the financial crisis of 2008. Not so Philip Falcone, whose Harbinger Capital Partners was forced at that time to put more than a third of its portfolio into a side pocket that still has not been fully liquidated.
And now Falcone has a huge private equity bet right in his dwindling flagship hedge fund. About 98% of his $3.4 billion flagship fund’s net asset value is in telecom, telecom services and cellular telecom positions, the bulk of which is private. The valuation of those positions is so uncertain that Harbinger Capital Partners could be nursing heavier losses than it is reporting, according to investors. Through mid-August, the fund lost 13%, a number that could be double that amount because of leverage, some fear.
The main worry is that Harbinger is exaggerating the value of its stake in LightSquared, an emerging wholesale-only wireless broadband network based in Reston, Va., that makes up a huge chunk of Falcone’s total investments. Harbinger bought SkyTerra, then a publicly traded company, last fall and renamed it LightSquared. The company said that Harbinger has contributed $2.9 billion in assets and that it has another $1.75 billion in debt and equity and financing.
Harbinger has long been criticized for its concentrated positions, and the problem has only gotten worse. At the end of the second quarter, the firm reported to investors that the flagship’s top five positions made up 113% of the fund’s NAV. These included Harbinger Global Wireless (which includes LightSquared); Inmarsat, SPDR gold ETFS, Spectrum Brands, and TerreStar, in that order.
At the time, Harbinger said that $1.15 billion was in satellite telecom, $2 billion in telecom services, and $240 million in cellular telecom. That accounted for about half of the long exposure, but because the fund is leveraged, it made up 98% of its total NAV, according to the letter. Harbinger didn’t break out its the value it assigned to Lightsquared, but it could fall in both satellite telecom and telecom services and is likely to account for the lion’s share. Harbinger recently received a $400 million loan from Swiss bank UBS partially backed by the hedge fund’s ownership of LightSquared.
Harbinger’s assets peaked at $24 billion in 2008, but as its overall size has shrunk to $9 billion, the telecom bets are disproportionately large. “Harbinger is going to have outflows of investor capital the more it becomes a single purpose thing,” said one investor who has slowly been redeeming. In 2009, Harbinger instituted an investor-level gate that allows investors to take out up to 25% of their capital each quarter. New investors were also subject to a one-year lockup.
Moreover, the total assets include $2 billion in the side pocket created after the crash of 2008 to house illiquid investments. Harbinger placed some 37% of its flagship in that special purpose vehicle, which it promised to liquidate by the end of 2010. Investors are waiting for a second distribution.
Private investments like Harbinger’s communications industry wagers are inherently difficult to value. Falcone is relying on the estimated worth of spectrum granted to LightSquared, which is likely at least $3 billion to $5 billion, according to a recent Reuters report. The spectrum value could be hard to ascertain, however, since federal regulatory policy in this area is evolving.
Still, such a bet on the future might be fine for private equity firms, investors say. But they worry that Falcone is straying from his distressed-focused hedge fund mandate. “It will either pay off big time or be a disaster,” said one investor.
If Harbinger does want to dabble in private equity, it shouldn’t make such a concentrated, illiquid bet in its main fund, argue investors. Instead, some believe the LightSquared position should be confined to a side pocket, which would limit investor exposure. Other funds, like Farallon Capital Management and Eton Park Capital Management, put illiquid private investments in side pockets. Activists have also often created SPVs for extremely large investments.
Or Harbinger could admit that it is a private equity fund and change the liquidity terms to accommodate the change. For example, Cerberus Capital Management has gone to much longer lockups in its hedge funds to counter criticism it received after investors discovered the hedge fund was full of private equity bets at the end of 2008.
A spokesman for Harbinger did not return a call requesting comment.
—Staff reports