The announcement of Twitter's plans to go public sent the markets buzzing (twittering?) yesterday. It also resulted in a huge after hours pop in shares of publicly traded venture capital firm GSV Capital (GSVC), which counts an investment in Twitter as its top holding, making up about 15% of the firm's NAV (Net Asset Value). The rise to above $14 has finally put the shares trading above their last reported NAV of $12.87, although this figure is probably understated given the recent rise in Facebook (FB) and inferred rise in some of their other similar holdings.
While the impending Twitter IPO might continue the upward momentum in GSVC's shares for a bit longer, I believe investors would be better served using this strength to exit the company instead. The main reason for this is that GSVC has such a poor track record in creating shareholder value. They have underperformed the market nearly every quarter, seeing NAV decline from a high of $13.57 right after their own 2011 IPO and the stock performing even worse, often languishing well below NAV.
While I recommended the shares last year when this was the case, I also repeatedly railed for them to do a buyback while it was trading well below net asset value. Instead of employing this no-brainer strategy of essentially buying the same companies at a huge discount, management stubbornly clung to their strategy of investing all their cash in relatively late stage companies like Coursera and Jawbone, even though there was almost no mathematical way to realize the same return a buyback would have brought.
The reason for this seems straightforward: management did not want to do anything that could potentially reduce their assets under management, since this determines how much they are paid under the typical 2 (percent of assets) and 20 (percent of profits) fee structure common to hedge funds and private equity firms.
However, at GSVC, this has been more like straight 2 percent fees since there have been no sustained profits. Even though their potential incentive fees are based on a complex formula that takes more than three pages to describe in their annual report, they have never managed to actually achieve any of these lofty goals. The result is that the base fee, when coupled with other management fees that effectively doubles the overall expense ratio, becomes a continuous drag on "earnings" that has contributed to the slow erosion in the firm's NAV.
Finally, the last straw for me was the recent $60 million offering of convertible notes to a select few institutional investors, despite management proclamations that they had no plans to do a capital raise as recently as just over a month ago. In the Q&A session of their most recent earnings call, CEO Michael Moe explicitly stated: "We will not be doing an equity offering". This sweatheart deal offers to pay an interest rate of 5.25% until 2018, when the notes are convertible to common shares. Note to Mr. Moe: this is equivalent to an equity offering!
He went on to say "We're looking to do smart things that are accretive for our shareholders". Instead, this impeccably timed deal basically forces current shareholders to subsidize the profits of a chosen few big investors for the right to be diluted in the future, especially since it was done right before the latest rise in stock price. At the current conversion rate of 61.5091 shares of GSVC common stock per $1,000 principal amount of Notes, this is equivalent to an initial conversion price of approximately $16.26 per share of common stock. If the stock continues to rise above this value, this will add another 3.7 million shares to the float.
The proceeds of this offering are also immediately reduced by $9.5 million "to acquire government securities to be pledged for the exclusive benefit of the holders of the Notes" for some reason. Even if management is able to use their investing acumen to double the remaining $50 million and add $100 million to the NAV, $4 million and $3.15 million of this will go to management fees and interest, respectively, PER YEAR, or over $35 million before 2018. Coupled with the corresponding reduction in NAV per share through dilution, this would actually barely be breakeven for current shareholders. This bears repeating: this deal is not "accretive" to current shareholders even if management doubles the proceeds of it!
In conclusion, I think the market will quickly get over the giddiness related to the pending Twitter IPO when they dig into the usurious details of this latest offering. Also, you might not want to be around for a possible repeat performance of what happened to them in the aftermath of the botched Facebook IPO, when GSVC traded above NAV in anticipation, did an equity offering, and then plummeted in concert shortly thereafter. Even though the Twitter IPO will probably be more successful, it's not clear that current shareholders will benefit as much as management or preferred investors, so I'd steer clear at these prices.