Equus Total Return: A Solar Inverter Play for Free!

By Saj Karsan

Equus Total Return (EQS) is a closed-end fund that trades at a 42% discount to its net asset value [NAV]. The fund invests primarily in both debt and equity instruments of small-caps and private companies. Each quarter, management must report the fair value of its net assets, but the stock market value of Equus is much lower than that of its net assets. Here's a chart showing Equus' discount to its net assets for the last five years:


As we can see, Equus is used to trading at a discount to its NAV, but recent negativity across the US market has taken it to even newer lows relative to what it owns.

One of Equus' key holdings (in fact, it makes up almost one third of its portfolio) is an equity position in Infinia Corporation. Infinia is a company aspiring to mass produce a low-cost solar power converter. The fair value of one of Equus' investments in Infinia (based on follow-up venture capital investments) recently jumped from $3 million to over $20 million, as the company demonstrated a prototype late last year that converts solar energy into electricity at twice the efficiency and at a lower cost than existing products.

One way to look at a purchase of Equus' stock at this discount level is that for the price of one share at $6.90, you're getting all of its other assets (which are worth about $8.30/sh) for a slight discount, and on top of that you're getting the investment in Infinia (valued at $3.50/sh) for free! Of course, before jumping in blindly you'll want to make sure you read Equus' latest reports along with its financial statements and their notes, as we've discussed here.

In reading these reports, I found that Equus does carry some debt on its balance sheet, which is somewhat rare for a fund. This has the effect of amplifying any changes in the values of their investments, both to the upside and the downside (the effect of leverage).

Furthermore, most of the investments are in companies that aren't public, and therefore Equus is not as liquid as those funds that invest only in the stock market (undoubtedly, this liquidity premium contributes to the larger than average historical discount we see in the chart above). The lack of market quotations also makes it more difficult for management to value each of its holdings. Infinia is one such example, as it doesn't trade on the stock market and so it's not available for an individual investor to buy. Although the drawback is that Equus' investments are illiquid, it provides an investor the opportunity to get into a company like Infinia when it would otherwise be limited to venture capital firms.

The discount is a bonus that makes this an intriguing play from a value investing point of view.

Saj Karsan is a guest contributor on AltEnergyStocks.com. Saj is a value investor at Barel-Karsan, and can be regularly found writing for Barel-Karsan's blog.
 

DISCLOSURE: The author does have not a position in EQS

Comments

[fxtrader07:]

interesting idea.
However, looking at the history of this etf it has a negative return excluding distríbutions since 1993 and only a slightly positive (about 2-3% p.a.) including them.
What disturbs me here - and most likely is the major reason for this mediocre performance is the HUGE annual management fee of a whopping , if not outright obscene 5.48%. yes you read that right. management of the fund pays itself a hefty 5.48% every year.
As I see it, it's a vehicle purely designed to enrich the fund management company. Buyers beware.

2008 Jul 28 03:42 AM

[gembree:]

The above commenter is precisely right. I am interested in hearing how Mr. Morand justifies omitting the single most important fact about the stock.

2008 Jul 28 09:43 AM

[TinyTim:]

Inverters converters. let's at least get the tech terminology correct. Inverters are for converting solar PV DC to AC power. With semicon technology & current electronic designs, it would be nigh impossible to double efficiency of an inverter.
Converters on the other hand, simply convert energy (in this case - solar thermal) to some other energy. Infineon is a sterling engine company. Sterlings have been around since the 1800's & there are several other companies out there (Philips was even looking at them years ago). Engines typically convert one type of energy (car IC-chemical, sterling-heat) into mechanical energy. The mechanical typically gets converted to electricity in a rotary generator/alternator. As you might imagine, there's plenty of room to improve efficiency in this 2-stage process.
With the phyics out of the way, these guys must be real proud of themselves to be looking for 5.48%.

2008 Jul 28 01:14 PM

[Owen:]

Good point, fxtrader07. I've looked at this CEF before, and was disturbed by the high management fee and low returns even more than I was with the valuation of their private holdings. In fact, even if you added back the obscene 5.5% management fee, the fund would still underperform the S&P since inception. The only justification to invest in EQS is if you have reason to believe the fund will soon be turned into an open-ended mutual fund, at which point NAV and price will coincide. In all other cases, any perceived discount to NAV will eventually be eaten up by fees and an underperforming portfolio.

If past performance of this fund teaches us anything, it is that their NAV will, in time, drop to match today's share price of $7.15, rather than the price rising to match today's NAV of $12. The discount is likely to stay at the historical levels of 25-45% as long as the assets are difficult to price, and as long as the bulk of the gains go to management rather than shareholders.

2008 Jul 28 03:26 PM

[scfranklin94:]

From their financials, EQS's expenses and overhead have remained constant at just under $6 million while revenues have declined. Stay away.

2008 Jul 29 09:51 AM

[tirereviews:]

FWIW, the management fee is now around 2% as of the 11/14/08 10-Q. I'm considering a position in EQS even though their top few holdings don't seem to be immune at all to this downturn -- so I'm going by value here. I am somewhat encouraged by their willingness (forced?) mark-down of the Creekstone Florida holdings, from $4.1M to zero! The NAV still seems to have held up and the 60%+ discount is still there.

Leveraging is fine (or rather, was), and EQS has a portfolio similar to smaller BDCs like MVC and CODI. MVC has a total mgmt fee of around 4% according to ETFConnect, while CODI has a fee of 2% annually. I've been somewaht burned with the larger ones like ACAS and AINV this year.

2008 Dec 19 01:53 PM