GSVC Capital: Value Investing Via Options

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 |  About: GSV Capital (GSVC), Includes: FB
by: Sir Perfluis

GSV Capital (NASDAQ:GSVC) is a publicly traded company that invests in high-potential private businesses - principally through participation in secondary markets. By investing in these businesses through a public entity, GSV enables non-accredited investors to own pieces of private businesses they could not otherwise access. Its full list of holdings, as of March 31, is readily available on pages 7-9 of the latest 10-Q.

GSV came onto the map, for many investors, when it very publicly purchased shares in Facebook (NASDAQ:FB) (see here). This was during the height of the recent IPO mania; shares popped 40% on the day, and subsequently traded at a significant premium to net asset value. Well, the expected Facebook IPO has occurred, and to underwhelming investor interest. There has been speculation that the underwriting syndicate had to purchase shares in the open market to prevent shares from breaching the $38 price on the first day of trading (here). GSVC, recently hyped as a backdoor play on the Facebook IPO, tanked by over 18% on Friday and by another 9.8% on Monday. The lower-than-expected trading price for Facebook shares played a role, certainly, in the declines - but more significantly, I suspect it casts public doubt on valuations for Venture Capital-backed companies across the board. We have recently been conditioned to expect rapid price appreciation on 'hot' IPOs right out of the gate (here and here)…but if private investors can't count on post-IPO gains, what are these high-profile companies worth? Many may not be worth what was paid for them in secondary markets (as Pre-IPO restricted holders of Groupon (NASDAQ:GRPN) may have discovered). And if this is the case, how can a premium to NAV be justified for a company like GSV (especially if it was purchased as a play on a successful Facebook IPO)? Does it even deserve to trade at its net asset value?

I don't know. But as you will see, whether or not the company deserves to trade at NAV is a relatively unimportant consideration. Let's break down GSV's asset and liability base (taken from the latest 10-Q statement, and adjusted for changes in the price of public holdings).

*Adjustments due to the fact that publicly traded holdings can be easily adjusted to reflect the difference between the current public valuation and the expressed valuation in the latest 10-Q.

The "Cash from IPO" figure represents additional cash added to the balance sheet through a secondary offering concluded on May 7, (before the Facebook IPO, and while GSVC still traded at a premium to book value). It includes an estimated 7% underwriting discount from the gross proceeds of $112.1 million. This is the same discount applied to the company's previous secondary offering, which occurred on February 10. (This information can be found on page 13 of the most recent 10-Q.)

As of Monday's close, GSV had a market cap of $229 million, with 19,320,100 shares outstanding (courtesy of the recent secondary). In comparison to the total NAV (intentionally excluding certain immaterial assets) of $273 million, it would appear that the market is valuing the non-cash/equivalents assets at 44 cents on the dollar.

(click to enlarge)Click to enlarge

While this is below the NAV, I see no significant margin of safety here, given the high valuations that tend to be placed on VC-backed companies, and the potential for impairment if actual growth does not hit expectations (though I do consider shares of GSVC to be undervalued at these levels). I would not recommend a long position in the stock (although I certainly would not recommend going short, either).

However, GSVC's significant option premium provides another alternative. Consider the July 12.5-strike put options, which closed Monday with a $1.85-$2.00 bid-ask. Selling this option leaves you with these alternatives:

  1. GSVC stock is above $12.50 at expiration and we collect the $1.85 premium (assuming a sale at the ask price); this equates to a 15.6% return on Monday's closing price of $11.86 over ~2 months.
  2. GSVC stock trades below $12.50 on expiration day, and we are put the stock. We now own the stock at an effective price of $10.65 per share ($12.50 - $1.85) - 52 cents per share above the company's cash and money-market holdings. We will be getting most of the private investments for free.

I like this: we either make 15.6% (on notional exposure) in ~2 months or we end up owning shares at a price that values the current investment portfolio for 57 cents a share - approximately 13% of the book value.

I may not be a Facebook owner at $33+…but I'd be a massive buyer at $4.44/share (at 13.14% of Monday's $33.81 closing price). Heads I win…tails I win.

Now, this is not a zero-risk proposition; the company will be able to exit its current public investment in Groupon (should management choose to do so) before the puts expire, as the lockup periods expired on May 1 (from page 12 of the latest 10-Q). The proceeds from these investments may be paid in dividends back to shareholders, and any resultant share price decline will be detrimental to put sellers. However, as of the last 10-Q, Groupon constituted only .82% of net assets (and it has since declined further as the stock price has declined from $17.09 to Monday's close of $12.39).

There is also one more important risk consideration: The recent capital raise was undertaken in order to acquire additional shares in private companies. The management team may decide to pay astronomical multiples for shares in private entities to the detriment of shareholders. There is management execution risk here - although I think mitigated somewhat by the underwhelming Facebook IPO, which may dampen enthusiasm and put downward pressure on private company valuations, and the relatively near-term option expiration (which reduces the risk that a substantial portion of the company's cash will be utilized while put sellers still have capital at risk).

These are not insignificant risk factors. However, I believe that put sellers, at these levels, are more than adequately compensated for the limited risks being taken - assuming that one is willing to hold what would be a significantly undervalued company for enough time to allow fair value to reassert itself, should GSVC's share price remains below the strike price at expiration.

Disclosure: Author is long GSVC through a short put option position.