Things sometimes get pretty bad before activism appears not only viable but likely at Closed End Funds. An ever-developing picture looks to fit an investing style I study closely: Well Intentioned Closed End Fund Activism.
A dramatically reduced $8 offering price in SolarCity (SCTY) last evening is the latest "black eye" affecting shareholders of Kevin Landis' Business Development Company, The Firsthand Tech Value Fund (SVVC). The SCTY IPO was filed for the $13-$15 range but priced at $8. SVVC was valuing its pre-IPO investment at $17.22 per share, with 2% annualized fund management expenses accruing at the higher valuation. At the end of November, SCTY was SVVCs third largest (non-cash) holding.
Unfortunate pre-IPO investments and offerings appear nothing new for SVVC. SVVC was a pre-IPO investor and yet its cost basis for Facebook (FB), its largest holding, was $31.50. SVVC actually conducted its own unfortunate $118,800,000 stock offering amid the public's anticipation for FB's IPO. Perhaps in observance of bad governance since SVVC's own shareholders have exhibited even greater selling persistence than those of FB.
The most recent (quarterly) published SVVC NAV was $22.91. The market currently prices SVVC shares around 78-79 % of that level. The fund has been very heavily allocated to cash (still likely above 50%), although its (for this article) stated approach and publicly demonstrated pattern has been to decrease cash recently by about $10 million per month. The cash is not being deployed to accrete NAV by buying back discounted shares.
Background and Structure:
SVVC calls itself "a publicly traded venture capital fund." More generally, SVVC falls into a Closed End Fund ("CEF") sub-category referred to as a Business Development Company ("BDC"). The BDC subcategory often stands out among CEFs with extraordinary discounts to Net Asset Value ("NAV"). Although SVVC is not covered at popular CEF venues, devalued market values of other BDCs Equus Total Return Fund (EQS), Renn Global Entrepreneurs Fund (RCG) and Foxby Corp (FXBY) are easy to observe. (1, 2)
The most recently cited discounts for EQS, RCG and FXBY are 27.93%, 45.31%, and 28.57% respectively. One of reasons CEF investors often eschew BDCs is the higher perceived risk of corruption. Activism prospects in traditional CEFs conventionally provide for a price floor over time, but BDCs are perceived a greater risk to evade activism through "greenmail." Categorically, BDC's accounting valuations are often critiqued by potential investors as well.
SVVC was designed with a "staggered" board, also known as "classified." However unfortunate to shareholder rights, such board structure is generally an obstacle to shareholder activism because activists are required multiple proxy costs and wins to replace boardroom control.
Kevin Landis' presence as the President of SVVC
Even amid the environmental greed that accompanied Facebook's IPO, it is difficult to presume logical investors would have paid "the immediate and substantial dilution in Net Asset Value of approximately $8.37 per share" inherent in the SVVC offering absent a good story.
The owner, President and Chief Investment Officer of Firsthand Capital Management ("Firsthand") is Kevin Landis, SVVC's Chief Executive Officer and Chief Financial Officer. Landis' legacy has been his exceptional returns in the tech space during the 90s. However distant memories of the dot-com era may be, Landis' legacy still has allured some investors. Firsthand says it runs $125 million in open-ended funds including Firsthand Alternative Energy (ALTEX), Firsthand Technology Leaders (TLFQX), and Firsthand Technology Opportunities (TEFQX).
No signs of good stewardship
What goes without saying is that management gets paid on Assets Under Management ("AUM"), a hefty 2% in fact. There is also the prospect of incentive fees (much like a hedge fund, but without the customary redemption periods). The design appears to dramatically alienate shareholders from management's interests.
Observations of actual stewardship confirm these design/conflict-of-interest fears. Beyond easily looking at the 2% management expenses accrued with SCTY on SVVCs books at $17.22, it may be more telling to examine Firsthand's care for its SVVC shareholders' own value. SVVC has at times traded at discounts worse than 40% of its published NAV. It has never done a tender offer, nor otherwise bought back stock to accrete NAV.
One of the competitive advantages cited in SVVC's own offering was "Focusing on investments that can generate positive risk-adjusted returns." The NAV of SVVC as of September 30, 2012 was $23.05 comprised of close to $20 per share in cash. It does not take a genius to wonder "What investment could have superior risk-adjusted returns than immediately accreting NAV by tendering for or otherwise buying back $23.05 per share (currently trading around 80 cents on the dollar) below NAV?"
I interviewed Firsthand in regards to its culture and posture in researching this piece. The firm does not culturally view such accretion of NAV for shareholders as relevant. In my experience with the Closed End Fund space, this is quite telling.
It would appear that the absence of sensible governance choices to benefit shareholders has increasingly caused traditional investors to recognize reasons not to believe in management, and motivated further selling. It is hard to fault sellers among traditional investors.
What are shareholders hoping for?
Sure, some folks might hope that buzz for a Twitter IPO could someday make SVVC and its 108,400 share position in Twitter look sexy again (Sept 30, 2012). Of course, a challenge for normal investing may again be the absence of an exit strategy. Beyond the challenge of the 180 lockup to which SVVC was subject in the FB IPO, SVVC's shareholders rely on SVVCs own governance to affect its own market perceptions, NAV accretion, and market value. Disclosed and very likely ignored by many within SVVC's own offering is that there is no assurance of exit opportunities at or near NAV.
So over the longer term, smarter shareholders are likely focusing on hopes that either SVVC stewardship begins to care about shareholders' worth. Or more likely that the presence and effectiveness of a dissident shareholder results in progress that benefits all public shareholders. On September 27, 2012 Bulldog Investors filed a 13-D disclosing a 7.45% stake and intentions to communicate with management.
Asked about SVVC, Bulldog co-founder and principal Phil Goldstein's response was, "I think few shareholders are happy with either the performance of the fund or its discount." Phil's firm would risk the cost of soliciting proxy votes in a proxy battle, even so logically. Meanwhile, if SVVC's stewards don't evade progress with greenmail and don't address its cultural approach toward shareholder value, it may use SVVC shareholders' own capital to solicit against such logic.
The short list of possible positive outcomes of a bulldog activism effort could someday include one or more of: SVVC merger into Special Opportunities Fund (SPE), SVVC portfolio adjustments and merger into a Firsthand Mutual Fund, or a tender offer program. Done prior to a merger into SPE, a tender offer program could make SVVC a competitively viable product alongside VC hedge funds. The current stewardship of SVVC appears likely to eventually enable Bulldog to succeed with an outcome similar to these.
Disclosure: I am long SVVC.
Additional disclosure: I am likely to at some point add to or reduce my position in SVVC based on my perceptions of timeliness and risk. I am not a Registered Investment Advisor ("RIA"). I license personal trading data to an RIA, Covestor Ltd. My long range thesis is that Bulldog will succeed with Activism at SVVC.