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Keating Capital, Inc. (KIPO)

Q4 2012 Earnings Conference Call

February 19, 2013 4:00 p.m.ET


Margie Blackwell – Investor Relations Director

Tim Keating – CEO


Walter Keating – UBS Financial

Thomas Pfister – RedChip Companies

Ed Woo – Ascendiant Capital

Margie Blackwell

Good afternoon and welcome to Keating Capital’s Quarterly Earnings Call being held on February 19, 2013. This call will discuss Keating Capital’s results for the period ended December 31, 2012. As a reminder, this call is being recorded and will be available for replay until our next quarterly conference call which is tentatively scheduled for April 26, 2013.

I’m Margie Blackwell, the Investor Relations Director for Keating Capital. Let me remind you of the following two points. First, we issued a very detailed financial results press release that includes all of the important financial information and metrics for the quarter and year ended December 31, 2012. And second the slide to be presented during this call which then still contains comprehensive and detailed financial information are posted on the investor relations sections of our website at

Now, let me begin by reading our disclaimer about forward looking statements. Before we begin, we would like to remind you that various statements that we may make during this afternoon’s call will include forward-looking statements as defined under applicable securities laws. Management’s assumptions, expectations and opinions reflected in those segments are subject to risks and uncertainties that may cause actual results and/or performance to differ materially for many future results performance or achievements discussed in or implied by such forward-looking statements. And the company can give no assurance that they will prove to be correct. Those risks and uncertainties are described in the company’s earnings release and it’s filings with the Securities and Exchange Commission.

And with that, I’ll turn it over to Tim Keating, the CEO of Keating Capital.

Tim Keating

Margie, thank you. Good afternoon everyone. I’m also joined on this call by Rick Schweiger, our Chief Financial Officer. Rick is in France and in cellphone so he is probably going to be mainly in listening mode. And I’ll do most of the communicating today.

So, let me begin with the review of the two key operational highlights for the fourth quarter which were one, the completion of the LifeLock IPO and two, the distribution of $0.03 per share in net realized capital gains generated in 2012. Here are the details, number one, the LifeLock IPO.

On October 2, 2012, LifeLock, a leading provider of proactive identity theft protection services for consumers and identity risk assessment and fraud protection services for enterprises, priced at $140 million IPO at $9 per share and shares began trading on the next day in the New York Stock Exchange under the ticker symbol LOCK. Approximately seven months following our investment compared to our targeted timeframe of 18 months.

As of December 31, 2012, we owned 944,513 shares of LifeLock common stock, which were marked at a price of $7.32 per share representing a 10% discount for LifeLock’s year end market price of $8.13. Our cost basis is $5.29 per share. We generally apply a 10% discount for lack of marketability to positions where a portfolio company is completed in IPO but we’re still subject to a customary 180-day underwriter’s lockup as was the case with LifeLock.

Our lockup for LifeLock expires on April 2, 2013, at which time we’re free to sell our position. We typically do not begin selling automatically upon exploration of the lockup period, instead we expect to sell our positions over a period of time typically during the 12 months following the exploration of our lockup, although we may sell more rapidly or more than more block transactions.

Now, number two, the cash distribution of $0.03 per share. On December 6, 2012, we declared a cash distribution of $0.03 per share. The distribution was paid on December 26, 2012 to stockholders of record as of December 14, 2012. The aggregate cash distribution of $282,203 represented a distribution of our net realized capital gains for 2012. The net realized capital gains for 2012 were comprised of realized gains of $403,631 from our disposition of 65,000 shares of Solazyme, reduced by losses of $121,428 from the disposition of our entire position of 160,000 shares of NeoPhotonics.

As of December 31, 2012, we continue to own 147,927 shares of Solazyme’s common stock which were valued at Solazyme’s yearend market price of $7.86 per share compared to an average cost basis of $10.18 per share. We believe that Solazyme has been meeting most of its stated milestones and we continue to be a patient investor in Solazyme.

Now let me turn to a quick financial overview. As a reminder, on February 15, 2013, we issued a press release that included all of the important financial information and metrics for the quarter and year-ended December 31, 2012. Therefore, I will restrict my comments now to a few key highlights only.

First, as of December 31, 2012, we held investments in 19 portfolio companies where the fair-value of approximately $65 million and approximately $8.9 million in cash and equivalents. We are fully invested based on our currently available funds and it is our policy to retain approximately $10 million in cash and equivalents to fund our future operating expenses. Although the amount we retain may vary depending on our operating expenses and the timing of our purchase and sales of portfolio company investments.

Second, decrease in NAV, in the fourth quarter, our net asset value decreased from $8.14 to $8 even per share, a decrease of $0.14 per share. The four components that drive the changes in our net asset value each quarter are one, net investment losses, affectively our operating expenses. Two, realized gains or losses, three, the change in unrealized appreciation, depreciation on our investments and four, cash distributions paid to stockholders. Let me explain each in turn.

First, we had a net investment loss again, effectively our operating expenses including base management fees and accrued incentive fees of approximately $861,000 or a loss of $0.09 per share. Our operating expenses excluding base management fees and accrued incentive fees were approximately $506,000 in the fourth quarter.

Second, we had no realized gains or losses during the fourth quarter since we did not dispose of any portfolio company positions during the quarter. Third, we had a net decrease in unrealized depreciation on our portfolio company investments of approximately $140,000 or a decrease of $0.02 per share. And fourth, we paid a cash distribution – three years since we launched Keating Capital as the first of its kind public fund exclusively dedicated to pre-IPO investing. Throughout these last three years, we have focused our stockholder communications on what we do and how we do it. Now, we think it is important to focus on and reinforce effectively the all important why that underlines our investment philosophy.

This three-year milestone (audio gap) generally two times or more than private companies with similar financial attributes. We further believe that a private to public valuation arbitrage opportunity maybe available by providing growth capital to private companies seeking to go public and then benefiting from the transformation value associated with becoming public as they complete IPOs. Finally, we believe that when steps are taken to mitigate the risk associated with pre-IPO investments, there is a potential for both higher absolute returns and attractive risk adjusted returns.

Accordingly, our investment strategy is focused on making investments in innovative emerging growth companies that are committed to incapable of becoming public. Effectively, we have an IPO, event driven strategy, and we have to generate returns by accepting the risk of owning illiquid securities of later stage private companies, naturally the process of transforming from private to public ownership is subject to the uncertainties of the IPO process.

If this process happened quickly and with certainty, we believe that it would be less of an illiquidity discount enhanced less return potential available to us when we invest. Instead the process takes time and is subject to market conditions and we therefore incorporate an expected three-year average holding period for each portfolio company into our model.

In spite of the volatility of Keating Capital stock price in the second half of 2012, we believe we have created a valuable portfolio. How do we reach that conclusion? First, as of December 31, 2012, we had net unrealized depreciation of portfolio of approximately $3.2 million, meaning the aggregate fair value of our investments is $3.2 million higher than our aggregate cost basis.

Second, in December 2012, we paid a dividend of $0.03 per share which represented our 2012 net realized gain of approximately $282,000 through the distribution date and which we believe begins to evidence and validate our private to public valuation arbitrage strategy.

While we realized a 12% loss in our NeoPhotonics investment, we had an average return on our disposed shares of Solazyme of 1.7 times our investment over the 20 to 24 months we held these shares. And third, as of December 31, 2012, we have been provided some structural protection with respect to investments in eight of our 17 private portfolio companies.

Our structural protections include six private portfolio company investments with conversion rights upon an IPO which result in our receiving shares of common stock at a discount to the IPO price upon conversion at the time of the IPO. And two private portfolio company investments with warrants that would result in our receiving additional shares for a nominal exercise price at the time of IPO depending on the IPO price.

Our structural protection in these eight private portfolio companies as of December 31, 2012 can be summarized as follows. First, they had an aggregate cost basis of $32 million and a fair-value of $36 million, representing 55% of our investment portfolio has measured by fair-value. Second, in the event, each of these companies complete on IPO, these structural protections entitle us to receive shares of common stock at the time of the IPO with the weighted average aggregate value of 1.79 times our investment cost.

And finally, if each of these eight portfolio companies completed in IPO, it would result in an increase in our unrealized appreciation of $21.2 million at the time of the IPO. We urge you to review our form 10-K for additional information on and risks related to our structural protection. Of course in calculating rate of return, the two inputs into the equation are return and time.

So, now let me address the holding periods of our portfolio companies. The headline here is that approximately 34% of our portfolio by value has held as a holding period under 12 months. As of December 31, 2012, the average holding period of our 19 portfolio companies with 16.5 months from our investment day, and the weighted average holding period based on the fair-value of holding period of each of our portfolio companies securities as of December 31, 2012 was 13.5 months. Again the weighted average 13.5 months.

As of December 31, 2012, we had six private portfolio companies which have been on our portfolio less than 12 months representing $22 million in aggregate fair value or approximately 34% of our invested portfolio as measured by fair-value. This includes investments of $5 million a piece and three portfolio companies in the first half of 2012.

With three years of history since our first investment in January 2010, we have now made a total of 20 investments. During this time, five portfolio companies have filed registration statements to go public of which three companies have successfully completed IPOs, one has withdrawn it’s registration statement and one has postponed it’s IPO due to market conditions.

Although for a variety of reasons it is now clear that a number of companies in our portfolio are taking longer to go public than our targeted timeframe, our portfolio nevertheless has a dollar – had a dollar weighted average holding period that is only roughly one third of it’s way through our three-year expected holding period. Overtime, we expect more IPO exits to occur which we believe will deliver an acceptable return and the potential for annual cash dividends.

In closing, I want to remind you how we seek to create long-term value for stockholders. We operate a private-to-public valuation arbitrage strategy, seeking the profit from the potential value increase when a private company completes an IPO. We attempt to buy privately, sell publicly and capture the difference.

Our goal is to make investments that create the potential a for a 2x return once the company is publicly traded and assuming our typical investment rising up to 36 months. To mitigate our downside risk and accounts from market fluctuations and volatility, we seek structural protections whenever possible. In short, we believe our model is on track and working according to plan.

With that, I will turn it back to Margie. Margie?

Margie Blackwell

We will now turn the call to Q&A. As a reminder, we are accepting all verbal questions and we ask that you follow the operator’s instructions if you would like to ask a question. Operator?

Question-and-Answer Session


(Operator Instructions). And our first question comes from the line of Walter Keating with UBS Financial. Please proceed with your question.

Walter Keating – UBS Financial

Hi Tim. I had a question for you regarding LifeLock. Since, the stock has currently up around the 10.25 area, you remarked that the market given the fact that you’re getting only about more than a month away from they unlocked on that. When that – back actually is correct, you somewhere around here at $0.30 to $0.33 per share on the net asset value, is that the correct calculation?

Tim Keating

Yes, Walter, let me go through the number for you. And I apologize because I did not have LifeLock’s closing price at my fingertips.

Walter Keating – UBS Financial


Tim Keating

10.25. So, yeah, so here is the math. So, first of all our cost basis is $5.29 a share and just as a reminder we have approximately 944,000 shares in our position and that was $5 million investment that provided for a 70% structural protection at the time of the IPO. So, as of year-end we had marked the position at $7.32 per share and just to clarify LifeLock’s closing price as of year-end was $8.13 per share, so our policy generally is to take a 10% haircut or discountable active marketability.

So, now fast forward, so the difference between today’s stock price of $10.25 and the mark of $7.32 and I’m just going to round it and call that roughly $3 a share multiplied by roughly the 944,000 shares we have outstanding is the incremental increase to net asset value between the mark as of year-end, and today based on the closing price not subject to discount. So, yes, we are sitting on an increase in value of approximately $2.7 million.

The exploration of the lockup period is April 2, occasionally when the lockup exploration falls in the issuer’s blackout period it may extend for periods up to 30 days. But for all instance and purposes by the end of April, we should be able to exit or begin exiting our LifeLock position and your math is correct. So if you take that $2.7 million approximately of incremental gain and divide it by the approximately 9.2 million shares outstanding, you come close to a roughly $0.30 number. And again, that’s the incremental appreciation attributable to LifeLock between yearend and today’s closing price. But again not taking any discounts for lack of marketability.

Walter Keating – UBS Financial

Okay. Thank you.

Tim Keating

You’re welcome.


(Operator Instructions). And our next question comes from the line of Thomas Pfister with RedChip Companies. Please proceed with your question.

Thomas Pfister – RedChip Companies

Hi Tim, congratulations on a good year here. Could you maybe give us an overview of maybe what do you guys think the climate is currently for IPOs I guess in the software market or the Cleantech market?

Thomas Pfister – RedChip Companies

Sure. What I’ll do is, let me break that question up into two pieces because it’s actually very different answers. The IPO market is extremely strong right now, just a couple data points to put these rewards in context.

Over the last decade we’ve had about 130 IPOs or so per year. 2012 was statistically very average year, we had about 128 IPOs depending on what you include in that measures. And more importantly the average return from IPO date to end of year was about 20% with roughly two out of every three IPOs performing positively by yearend. So, a very strong market measured by percentage of winners versus losers and also measured by after-market return at plus 20%, average by number of IPOs.

And then more specifically the three factors that really drive the IPO market are number one, the volatility index and generally if you look back over the last three years, 80% of the IPOs have been priced when the VIX index has been 15 to 25. We are rock-bottom lows in the volatility index and that boards extremely well for the IPO market. And then the other two variables that drive the IPO activity are the overall state of the equity market which of course is positive in 2013, roughly 7% or whatever it is following a roughly 14% gain in 2012. And then the third factor is how IPOs perform which I mention is pretty good. So, those three factors were all pointing very favorably.

January was a very strong month in terms of issuance and I don’t have the facts at my fingertips but I think it was the strongest January we’ve had in some number of years. So, generally the software and I think now to get to your specific answer, the software business has been very, very good, particularly enterprise software, that’s a very hot area. Last year, there were a number of really top performing IPOs several that were up about plus 100% generally in the enterprise software space.

Cleantech is a totally different story and based on data which I don’t again have at my fingertips, there have only been three Cleantechs, excuse me, three Cleantech IPOs since 2010 of about 25 or so that actually have positive performance and those are Tesla, a company called Elster and then finally Solar City which was a very recent IPO.

So, the IPO market for Cleantech companies is clearly challenged. And I think we’re going to need a couple of other companies like Solar City to do well before it becomes safe for more Cleantech companies to come to go public.

Thomas Pfister – RedChip Companies

Yeah, thanks for the level of detail there Tim. And then if you don’t mind I have just one other question here. Given some of the markets that are strung up like I guess exchanges like second market, where certain investors have been allowed to I guess invest in privately held companies on a like a secondary stock exchange. Do you think that’s had any impact on evaluations of your private companies or companies that eventually go private to public?

Tim Keating

I suspect it has, so for those listeners who may not be familiar, there are two primary exchanges that facilitate stock transactions by typically by employees and management to new investors and those are second market and shares post. And there has been a great feel of activity on those two private company marketplaces over the last few years. And as a further reminder, most of the transactions that occur there are sellers of common stock and then buyers of common stock.

So, we tend to invest in preferred stock and as general rule do not invest in common stock unless it’s the issuer’s most senior securities. But you’ve had some very high profile private companies, most notably Facebook which was the vast majority of the private company activity on those two platforms.

And we do believe that valuation have been driven up on private company marketplaces. And really the result is or the cause is you’ve got an imbalance between demand and supply and specifically there aren’t that many shares available to be sold on those platforms from employees or former management. And yet, for some of these high profile private companies, there is sometimes insatiable demand.

And so, I think if you look at Facebook as an example in the private company marketplace, I believe the stock peaked all the way up perhaps anywhere around $40 a share. And then they ended up going public after raising the IPO price to about $38 a share. And so, we’ve seen, and then of course the stock is, wherever it is about $30 a share. And now, so we’ve seen that phenomenon with several other high profile, highly publicized private companies.

And so, as a result of that yes, we do think that valuations have increased as a result of that phenomenon. And we tend to avoid those high profile, highly publicized private companies. And furthermore, we tend to focus on companies with enterprise values under a $1 billion. So, yes, I think there is a risk that’s certain of these highly publicized high profile private companies can get valuations that run ahead of themselves which of course doesn’t say that they’re not great companies, they are. It’s just that the valuations have to make sense in order for the investor to be able to generate a return.

Thomas Pfister – RedChip Companies

Thanks for the answer. I really appreciate it and again congratulations on the excellent year.

Tim Keating

Thank you.


And our next question comes from the line of Ed Woo – Ascendiant Capital. Please proceed with your question.

Ed Woo – Ascendiant Capital

Yeah Tim, I know, you mentioned on the call that some of these other companies, IPOs maybe a little bit more scratched. What is your outlook over the next six to nine months, do you still think it’s going to be about maybe five or six companies going down this path?

Tim Keating

Ed, the real challenge that we’ve had perversely has been the Jobs Act. And not to get too arcane here but the Jobs Act was passed into law, or actually signed into law by the President on April 5, 2012. And as a result of the Jobs Act, our private companies now have the ability to file confidentially.

And they are doing so in two ways, some companies file registration statements confidentially and then they remain confidential about their filings, and then other people file confidentially but state that they have file confidentially. So, in either case there is no – the financial, the registration statement is not available to the public, it’s just a function of whether the issuer has elected to disclose the fact that it’s made a confidential filing or not.

So, I know that’s kind of arcane but its rigged havoc on people who track the IPO market because we used to have a very visible pipeline as to the number of companies that have filed, how long they have been in registration etcetera. And so, it’s made it extremely difficult for us because we have access to information but the companies have not – in certain cases stated for the record that they intend to go public. So, because we are subject to confidentiality agreements with these companies we’ve really had to remain silent about what the expected timing is. And normally for example just to pick two bright source energy and course air components where the two companies that had filed to go public which did not complete their IPOs in 2012 for different reasons.

And so, now with those guys no longer in – now in a rear-view mirror, we do have companies that are making progress towards filing for an IPO and unfortunately we’re really handcuffed in terms of what we can say with respect to the pipeline. So, I hope that we will be able to get some additional information out in the marketplace.

So, there are a few other comments that I’d like to make. And one of the slides that Margie had up showed are holding company analysis based on certain discreet events such as a registration statement publicly and filed with the SEC, the completion of IPOs, the disposition of our investment. And we referred all these things as lagging indicators which we believe a number of our portfolio companies continue to prepare for make progress towards an IPO.

There are also a variety of leading indicators which include some of the following for example, adding a new member to the senior management particularly a CFO with public company experience, meeting with investment banking firms and conducting a backup to select underwriters, testing the waters by meeting with perspective institutional investors and that’s some of the regulations have been loosened up under the Jobs Act, determining and then achieving the key operating milestones that need to be met to increase the probability to successful IPO, holding an IPO organizational meeting to begin preparation for the IPO process and then drafting the IPO registration soon.

So, those are all leading indicators that we monitor in our quarterly update calls with the management of our portfolio companies. And really I think probably the best I can say is that based on our assessment of these leading indicators, we believe that several of our portfolio companies are making progress toward an IPO that is consistent with our targeted timeframes and holding periods.

Ed Woo – Ascendiant Capital

Great. And just a follow-up on, you mean, you mentioned that the current IPO market as well as to be strong. Do you see anything that could potentially change that over the next year?

Tim Keating

The number one factor that could derail the IPO market would be a spike in the VIX or Volatility Index. So, if we got to a reading above 25, and I suppose there is any number of crisis that could trigger that that would be the first thing that would derail the IPO market. And then, I think the second factor would be of the equity market quickly reversed and turned South in a hurry, that would be problematic. And then, third, if IPOs begin to not perform well, that would be also a cause for concern.

I think of the three concerns right now my biggest would be a spike in the volatility index because that really is the primary driver. And I think the underwriting firms or the firms involved in underwriting to their grade credit have been extremely disciplined about taking companies public over the last year and a quarter year and half. So you haven’t seen a large number of companies spectacularly decline, in fact you’ve seen some companies do very well.

So, I think the number one gage for us is that VIX or Volatility Index and with it a rock-bottom lows right now that augers very well for the IPO market.

Ed Woo – Ascendiant Capital

Great. Well, thank you and good luck.

Tim Keating

Thanks Ed.


(Operator Instructions). And we appear to have no further questions on the phone line at this time.

Margie Blackwell

Thank you for that. That will conclude our call for today. And we want to thank everyone for joining us. Our next conference call has been tentatively scheduled for April 26, 2013 following the filing of our Q1 2013 results. We look forward to your continued interest in Keating Capital. Thank you.

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