I have been looking at GSV Capital (GSVC) for some time now and although it is extremely hard to discern the actual intrinsic value of their portfolio (cloudy...), I believe it has enough potential to deliver strong returns (...with a chance of meatballs!).
Below, I will detail the investment case for GSVC. First up, some background for the uninitiated.
What is GSV Capital?
GSV Capital is a publicly traded liquid vehicle that seeks to invest in the fastest-growing private companies in the world. According to their website:
Investors used to have access to emerging, rapidly growing companies with big potential earlier in the life-cycle-jumping in on IPOs at $100 million or $300 million market cap.
The median market cap of companies going public has skyrocketed nearly eight-fold, to over $1 billion from $130 million during the '90s. And the characteristics of IPO companies have evolved, too. Among other things, now they tend to wait longer before making the move.
Essentially, it was created to allow investors access to these private companies with a market cap of between $100 million and $1 billion. You can think of it as a closed-end mutual fund that invests in medium-stage start-ups all the way through to IPO and beyond.
It is run by Michael Moe, who is both CEO and CIO, and who has an impressive background as a growth investor, being one of the first research analysts to identify Starbucks as a huge opportunity after its IPO in 1992 and later becoming the Director for Global Growth Research at Merrill Lynch.
Why is it so cheap?
Following the disastrous IPO of Facebook (FB) in May 2012, when its share price plunged more than 25% in the first month alone, GSV Capital, which at that time has 6.69% of net asset tied up in Facebook, was similarly thrown off a cliff. It dropped from $19.45 to approximately $10 by June 2012 and continued to trade downwards.
It dropped even more than Facebook itself did!
To be fair, GSV Capital was trading at a premium to NAV ($13.81 as at the end of 2Q 2012) in the run-up to Facebook's IPO amidst the hype, but the damage from the fallout was mostly psychological. Investors lost confidence in the valuations being given to private tech companies as a whole and this caused GSV Capital to trade at a significant discount to NAV ever since. It is still currently trading at more than 35% discount to NAV. Another reason why it's so cheap is that there is little transparency in how the fair value of its assets is being derived, but we'll get to that later.
Poor track record
GSV Capital's track record has not been pretty, reporting a decreasing NAV every quarter since inception. I hated many of the earlier purchases and I have also not been able to reconcile some of their statements.
- The investment in Zynga (ZNGA) came in the form of a structured note with PJB Fund LLC. Basically, it's a $4 million swap that allows GSV Capital to lock in Zynga's share prices for purchase at a later date. Unfortunately, Zynga proved incapable of replicating massive hits like Farmville and tanked. From the swap, GSVC realized a loss of $1.38 million (it's the only realized loss to date). Zynga continued to falter, and as of December 2012, it has resulted in $1.74 million in additional unrealized losses. It comprises 0.5% of current NAV.
- GSV Capital bought over $2 million worth of Groupon (GRPN) shares in an investment which Michael Moe himself admitted to have regretted. It was 2.78% of portfolio at the time of purchase. They have not sold off a single share and continue to sit on an unrealized loss of $1.74 million. It is 0.15% of the current portfolio.
- I am actually sympathetic to GSV Capital regarding its most vaunted acquisition, Facebook. Representing about 9% of portfolio at the end of 2011, they might have overpaid a little for it at approximately $29.92 per share. However, it must be noted that Facebook was the rising star in the technology world and a fund touting itself as a gateway to high-growth private companies simply cannot miss out on it. They also had a lock-up period on share sales, which prevented them from cashing out right after the IPO. To be honest, the fund has lost less than $1 million on this investment(unrealised) and that's very reasonable. I am also positive on the future of Facebook.
- In the latest Annual Report, GSV Capital explained their decrease in net assets on page 51, saying, "For the year ended December 31, 2012, we had a net change in unrealized depreciation of $10,170,850, or $0.63 per share. The change in unrealized depreciation is primarily a result of our investments in Top Hat 430, Inc., Silver Spring Networks, Inc., Gilt Groupe, Inc., Zynga, Inc., and Facebook, Inc." Here, I point you specifically to the investment in Top Hat 430, Inc. The fund made two investments in Top Hat - $4 million on 13 Apr 2012 and $150,000 on 2 Nov 2012. In the same report, under the consolidated schedule of investments, Top Hat's fair value is stated to be $0. It seemed curious that having made an investment as late as Nov 2012, it would write off the entire investment within a month. The management is either not very good in stock-picking, or I am missing something here.
- Strategic Sports Solutions, LLC, it is definitely missing in the latest Annual Report. According to the 3Q 2012 quarterly report, GSV Capital invested about $500,000 in this company on 31 Aug 2012. Assuming that it has not been divested (and no word of it was mentioned in the annual report), it should exist within the consolidated schedule of investments. It does not. I have emailed GSV Capital regarding this and am awaiting their reply.
Having listened in on the recent earnings call, I agree with another SA member, Illuminati Investments, that the management seemed very reluctant to repurchase and retire GSVC shares to bolster share prices. There is an inherent conflict of interests in doing so as this will reduce the amount of management fees being paid out to GSV Asset Management, which is essentially Michael Moe and Co. Obviously, the situation makes it difficult for the rest of the shareholders to trust that management will perform its fiduciary function to act in shareholders' interest.
Personally, I believe the management will refrain from performing share repurchases, but that they will attempt to boost share prices in other ways to reduce the pressure on themselves. For one, there has been numerous insider buying over the last few months as share prices dipped to below $8. Mr Moe now owns 12,600 shares of GSVC (Note that he began purchasing when prices was about $8.75 last September). This indicates that he believes the stock is undervalued or, at the very least, wants to provide some form of catalyst to spur the stock performance. Both are positive.
Also, in the same earnings call, Michael Moe said:
There is a lot of good news going on with the portfolio companies, and we need to be better at [indicating] that, so people know what's going on and give them -- understand really the perfect things that are going on in the portfolio that we have created.
We think it's important for us to be in front of people telling the story, having understand what's underneath the hood, then understand the valuation discrepancy kind of [things].
He has backed this up with effort, speaking at two conferences in the weeks following the earnings call, leading me to believe that there is a renewed vigor to close the NAV discount.
One negative is that the aforementioned asset management fee is bleeding the company. With NAV decreasing by about $0.30 per share each quarter, GSVC better hit a home run soon.
What it owns
It is hard to value GSV because it is hard to value its stable of companies, especially since they do not have to present financial information. Nevertheless, I'm going to briefly give my view on some of their largest holdings.
- Twitter, a $33 million investment, occupies 14.3% of the portfolio. It is a difficult stock to own, because an investor first have to be approved by Twitter, and they don't just approve anyone. I believe this alludes to the access that GSVC has in the VC world. GSVC initially invested in Twitter valuing it at around $8.28 billion. Subsequent investments were made at closer to the $9 billion valuation. You will have to keep track of Twitter valuations yourself, but currently, it is guesstimated to be from $9 ~ $11 billion according to various news articles. This might increase come IPO. Certainly, it has had a much more successful route to monetization than Facebook. From a WSJ article, " Today, with a relatively immature set of products, Twitter is collecting an estimated $4 for each of its 200 million-plus monthly active users. Ad budgets are moving increasingly to social outlets-a secular shift that should easily push this number higher." That's more than $800 million in revenue per year, which means it's currently valued at slightly more than 10X P/E and seems pretty reasonable. GSVC's fair value estimate currently puts its ROI on Twitter at 9.46%, the highest among its investments.
- Palantir Technologies comprises 8.34% of portfolio at $21 million. Of all the companies GSVC has a stake in, I like this the most. It is a low-profile big data company that solves technical problems ranging from combating terrorism to identifying fraud. Oh, and in its spare time, it helps out in relief efforts for disasters like Hurricane Sandy(using its terrorist tracking technology). Most of all, I believe in this company because of it's culture. For a taste of it, just refer to this Forbes article. This is a company primed for success because it has a clear mission and dedicated employees. Of course, having a culture like this means that Palantir is not hurrying to expand or IPO anytime soon, so that's a slight negative.
- The third largest investment within the portfolio is Violin Memory. I can't speak much about this because I don't really understand how its product works. But it does seem to be a leader in its field of flash memory with prominent backers like Toshiba, Juniper Networks, GE Asset Management and SAP Ventures. Anyhow, it is the holding that is looking most likely to be acquired or to conduct an IPO soon. I estimate that GSVC bought in on Violin Memory at around a $800 million valuation, and as of the latest filing, it is still being valued at purchase cost.
- Although Dropbox is a key player in the 'cloud computing' space that is all the rage right now, I am somewhat skeptical of it's ability to diversify its revenue sources and rise above its competitors, including Box and SugarSync. That is not to say it is not trying, as a recent Techcunch post pointed out. It is another of GSV Capital's company that might be looking to IPO this year. GSVC first invested in Dropbox at around a $4 billion valuation and this is another of its holding reporting a positive ROI at 5.72%.
Where it will go from here
Although I find some of the management's investment less than stellar, as well as several discrepancies here and there, I remain bullish on this stock. There is a good chance that the NAV discount gap will close or that the NAV itself will rise, or both.
To close the NAV gap, what this stock need is a catalyst, and a blockbuster IPO(not the Facebook kind) will certainly help boost its profile and confidence among investors. In 2013, I believe there will be quite a few IPO within its stable of companies. Silver Spring Networks, which just went public, is trading above the IPO level. The fact that it is not even a particularly enticing company simply shows the strength of the IPO market now. When asked recently at the 25th Annual Roth Conference what top investment he thinks will go public in the coming year, CEO Michael Moe said,
If you look at our top investments and we make our best guesstimate unless we have specific knowledge when we think companies go public, what I'll say is everybody in that list and with the exception of Palantir is Palantir has got a different mindset. We expected potentially 2014 maybe earlier. With what's going on in the IPO market, I think many of those companies could go sooner.
And I think, many of them would in 2013, which again I think is a good catalyst for our stock.
Earlier on in the conference, he also alluded to the strength of the IPO market:
In terms of the catalyst for our stock the discount is very extreme, but there's no reason why discounts can't stay for a period of time. We think the catalyst for the stock we have that discount evaporate is that many of these companies we think could be public in the relatively near-term. I think a lot of the reasons we believe that is, when you look at what's going on in the IPO market today is the healthiest IPO market that we've seen in years in terms of pricing and aftermarket performance.
Even if the company going public tanked like Facebook eventually did, as long as it creates a hype, there will be plenty of opportunities for investors now to exit profitably.
Next, I feel that many of the top holdings has an intrinsic value greater than the stated fair value. The fair value of many holdings have not been adjusted because in many cases, GSVC participated in the most recent round of funding(which could be more than a year back) and there has not been any further funding round that would prompt a revaluation of the company. Also, since that time, the companies have been enjoying tremendous revenue growth, as attested by Michael Moe in the same Roth Conference,
If you look at overall portfolio 47 positions, the average revenue growth was about 80%. If you look at our top-10 positions, it's even higher than that. Twitter is growing well in excess of 100% per year, Palantir over 100% per year and so forth. Dropbox is experiencing hyper growth and these are all companies that we have meaningful positions in that we think represent tremendous upside for our investors.
All in all, given the uncertainty regarding many of the private companies, as well as questions with the management, I would be hesitant to throw a fortune into this. Nevertheless, I maintain a positive outlook and hold a small amount of GSVC in my portfolio. My price target would be $14 or when the NAV discount is around 10%. I look forward to discussing it at length with other SA members.