There are certain times when market enthusiasm for initial public offerings (IPOs) reaches a crescendo of insanity and investors fortunate enough to "get in on the action" of a hot IPO are virtually assured of enormous short term returns. We had a whiff of that last Spring, leading up to the Facebook (FB) IPO. Friends of mine in the industry say they were deluged with requests to participate in the IPO by retail investors.
Some "astute" investors realized that they could indirectly own Facebook shares before the IPO by buying certain business development companies ((BDCs)) which had bought FB shares in the private market. The shares prices of these BDCs - GSV Capital (GSVC) and Firsthand Technology Value Fund (SVVC) - skyrocketed, and they each completed secondary offerings at prices well above net asset value (NAV). Unfortunately, the hangover was much worse than the party, and the shares of each of these BDCs sank like paralyzed falcons in the aftermath of the Facebook IPO debacle. The trajectory of the prices of these two stocks is a bit unseemly given the fact that, in each case, Facebook shares constitute a relatively small portion of their gross assets.
This article will try to pick up the pieces with respect to GSV Capital and Firsthand Technology Value Fund and analyze a third company, Keating Capital (KIPO), which is taking a different approach to pre-IPO investment. The chart below gives each company's Friday closing price, its latest NAV per share, and its latest cash per share.
1. Firsthand Technology Value Fund - I wrote about SVVC on July 19 when it was priced at $16.07 here. I recommended it because it was trading substantially below balance sheet cash at the time. Its pricing reflected a gross overreaction to the FB fiasco. SVVC had traded up in the 40's and dropped to the mid-teens even though its FB position was only worth $1.36 a share and was a very small part of its total value. It has since moved up and it has also used more of its cash to acquire assets, but it is still priced a bit below balance sheet cash so that an investor is essentially getting the securities it holds for free.
Like GSV Capital, it tends to buy the larger, better known private companies and seems to be willing to hold onto the stocks after the companies go public. Its largest positions are now Facebook, Twitter, and Solar City. SVVC focuses on investments in technology and clean tech companies and generally takes common equity positions. It seems to have been in no rush to deploy its "dry powder" so that a significant proportion of its investments are ahead of it. An activist group has taken a significant position, and will likely agitate for measures (perhaps including share repurchases) which will tend to push price up to the level of NAV. Given the discount, I still believe that this is a very attractive investment.
2. GSV Capital - GSV Capital probably got hit the hardest by the Facebook disillusionment and still trades way below NAV. Again, I believe this was an overreaction: GSVC came all the way down from the low 20's even though its FB position is only worth roughly 36 cents a share and is a very small part of its NAV. If you back out GSVC's cash, an investor is really paying $5.14 for assets with a fair value of $11.26.
I recently read that the value investor's formula involved paying 50 cents for a dollar's worth of assets. With GSV Capital, you actually do a little better. "GSV" actually stands for "Global Silicon Valley" and the company's strategy is based on the perception that promising companies are waiting longer to go public so that some of the best opportunities for growth abound in private marketplaces like SharesPost or SecondMarket, where employees of private companies or venture capital companies can sell shares in companies which have not yet gone public.
GSV Capital targets companies with market caps between $100 million and $ 1 billion but seems to hold shares in some companies that are quite a bit larger. GSVC does not buy exclusively in these markets but can also buy directly from private companies. GSVC's position in Facebook is by no means its largest holding. In fact, its FB holding is only worth $6.9 million, while it has a $36 million position in Twitter. It is always hard to evaluate equity in private companies and some discount to NAV may be justified. But GSVC is just too cheap at this price and is another attractive investment.
3. Keating Capital was actually the first company to employ the IPO-anticipation strategy making, its first investment in January 2010. In comparison with SVVC and GSVC, KIPO takes a different approach to IPO anticipation - described as pure private to public arbitrage and based on the premise that businesses are generally worth more as public companies than private companies.
KIPO invests in smaller (its revenue floor is only $10 million) and earlier stage companies where there is more potential for appreciation. It typically purchases preferred stock directly from the company -- usually as part of an investor group which injects capital into a growing operation. It has a target 36 month horizon on investments, looking for companies planning to file for an IPO in roughly 12 months, followed by a 6 month wait until the IPO, a 6 month lockup and then a 12 month period in which the price of the stock will hopefully appreciate leading to a sale at 2 times the entry cost.
Keating Capital generally includes "structurally protected appreciation" provisions in its preferred stock. These provisions protect KIPO from an IPO at a per share price below the target appreciation level by automatically providing Keating Capital with more shares so that its total position will equal the number of shares necessary to provide the targeted appreciation level. KIPO still faces the danger that the price of the stock will go down after the IPO or that no IPO will ever be executed. But it is at least protected from the danger of an IPO below its target appreciation level.
In general, Keating Capital has invested and will likely invest in smaller, somewhat earlier stage companies than GSVC and SVVC. It appears to be a sound strategy and it has investments in a number of companies which are at various stages of its 36 month target trajectory. The next few quarters should let us observe how the various investments fare as they move along the calendar. Priced at a substantial discount to NAV, KIPO is another attractive investment.
I wrote at the outset that there are times in the market when IPO fervor boils at white hot heat and investors are virtually willing to sell their souls to get in on IPOs. Alas, this is not one of those times. Although the IPO market appears to be reasonably healthy, it is not frothy or bubbly by past standards. The pricing of these three stocks reflects the sober, yield oriented mood of today's investor. There is no steady and established dividend yield and there is certainly some risk and thus the stocks are priced at bargain basement levels.
But as sure as the night follows the day, there will come a season of IPO frenzy with investors piled up against the entrance doors as deep as they were piled up on the exit ramps in September 2008. When that day comes, these stocks will be an epicenter of wild speculation and will be priced well above NAV. It may come next month, next year or next decade. And, unfortunately, in the meantime, these stocks do not pay regular dividends - although dividends will likely follow realized gains. At these prices, investors will probably do well with these stocks and could do very well indeed if some of the holdings take off on the upside.