Pre-IPO BDCs Are Trading At Big Discounts To NAV

by: Philip Mause

Certain business development companies (BDCs) specialize in acquiring equity of companies about to go public. These BDCs typically acquire the equity in one of two ways - either directly from the company about to go public itself in a private transaction or in a non-public secondary market. Because the stock of companies which have not yet gone public is not generally available for purchase by typical retail investors, these BDCs offer investors an opportunity to participate in investments otherwise unavailable to them.

I have analyzed recently filed financial statements of Firsthand Technology (NASDAQ:SVVC), GSV Capital (NASDAQ:GSVC), Keating Capital (KIPO) and Harris & Harris (NASDAQ:TINY). The tables below provide Thursday's closing price, the latest net asset value per share (NAV), the discount to NAV, balance sheet cash per share, and the discount of the non-cash assets to enterprise value (price minus balance sheet cash). All information is based on SEC filings of the relevant companies.

Price NAV Discount Net Cash Discount
SVVC $18.53 $23.38 21% $15.77 64%
GSVC $7.64 $13.07 42% $1.40 47%
KIPO $5.86 $8.00 27% $.94 30%
TINY $3.07 $4.13 26% $.45


All calculations were based on financial statements filed at the end of 2012 with the exception of SVVC whose numbers are based on the monthly net asset report filed at the end of March 2013. By the way, SVVC deserves a gold star for the monthly NAV updates: updating this information provides an investor with very useful and actionable data. The other three companies should consider adopting that practice.

The first discount in the table is the difference between the NAV and the price; the second discount (in the far right hand column of the table) backs out the balance sheet cash by subtracting balance sheet cash from both the price per share and the net asset value. The balance sheet cash of these companies is not likely to be subject to the argument that it should be discounted due to anticipated repatriation costs; for that reason, I consider the methodology to be reasonable. Thus, the discount in the far right column of the table provides the discount the market is giving to the non-cash assets (essentially equity in non-public companies and recent IPO companies) on the balance sheet.

In each case, the BDC holds primarily equity (in some cases in the form of preferred stock) in various small companies some of which have already gone public. The event which called many people's attention to these stocks was the Facebook (NASDAQ:FB) IPO. Leading up to the IPO, there was a frenzied atmosphere in which investors seemed to be frothing at the mouth to get in on the action. SVVC and GSVC each had large FB positions prior to the IPO and were seen as an indirect way to "front run" the IPO and make a bundle as soon as FB went public and the stock soared. Unfortunately, the IPO fizzled and SVVC and GSVC have been in the dog house ever since - trading well below NAV. SVVC maintains a large cash position so that an investor is really paying only $2.76 for the $7.61 of non-cash assets on the balance sheet. GSVC's largest position now is Twitter - which makes up about 14% of its NAV. If Twitter really takes off, it could push GSVC up as well.

KIPO follows a very different strategy investing in smaller companies not generally represented in the non-public secondary markets. Its goal is to invest in a company about to go public and then monetize its position relatively quickly. Many of its investments are in the form of preferred stock with a special "structural protection" provision that effectively increases the number of shares KIPO receives if the new company goes public at a price below an agreed upon level. This protects KIPO from at least one of the risks associated with the pre-IPO strategy. There are other risks - KIPO generally must hold its shares for a lock up period and there is always a danger that the price will decline before KIPO can monetize its investment. However, KIPO has succeeded in reducing at least one significant risk factor.

TINY has been around for a while and focuses on nanotechnology companies (thus, the symbol). It has a large investment (14% of TINY's NAV) in one particular company, Solazyme (SZYM). An investor can track the price action in SZYM and bring TINY's NAV up to date; however, there is no assurance that other developments may not also affect NAV. SZYM has not done anything exciting since the last TINY financial report (it was trading at $7.86 on December 31, 2012, and closed Thursday at $7.51), but if SZYM were to make a big move, a nimble investor might be able to capture some of the gain by loading up on TINY. TINY also holds some debt instruments as assets but it primarily holds preferred stock and common equity.

The subdued enthusiasm of investors for these four stocks suggests to me that we are not exactly in the kind of "frothy," "irrational exuberance" market psychology I remember so well from the late 1990's and, to a lesser extent, at various points in the 60's and 70's. IPOs are going forward, but there is certainly not the frenzied effort to get in on "the next big thing" that characterizes a dangerous market top. I think that this is for the best. We are in a dividend yield driven bull market in which investors have a "show me the money" mentality that looks with jaundiced eyes at such things as "balance sheet cash" and comes up with creative rationales for deciding that a dollar is only worth 80 cents. A healthy wall of worry.

Although the discounts to NAV may persist for quite a while and may even increase, I think that these stocks offer an interesting risk/reward trade off. I would advise buying all four to diversify, but I do not think that this is a "back up the truck," "table pounding" buy recommendation situation. Instead, I think that a patient investor will do well with these and, at these prices, has a considerably better probability of having a pleasant surprise on the upside than having a nasty downside surprise.

Disclosure: I am long GSVC, SVVC, TINY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.