The stock market is filled with many kinds of companies, each with a different level of complexity. Some sell simple products such as soda, while others provide banking services to consumers. Other companies deal in complex products such as tanks, fighter jets, or financial derivatives. The company we would like to profile in this article is a complex one, but it is one that we believe offers a great deal of upside potential for patient investors.
GSV Capital (GSVC) is a company that sits at the nexus between business development companies (its legal status) and a venture capital fund (what its portfolio would suggest). Its portfolio contains a who's who of the technology world's leading private companies, and the company offers a way for any investor to gain access to a portfolio that includes Twitter, Dropbox, Spotify, and Facebook (FB) (we will discuss the portfolio in more detail later in the article).
GSV Capital: Unhinged from the Fundamentals on Both Sides
GSV Capital's stock has been unable to find a proper equilibrium. From nearly the moment that the company announced its investment in Facebook (when Facebook was still private), shares became unhinged from reality, as investors rushed to find a way to invest in Facebook.
(click to enlarge)Shares of GSV Capital soared at the end of June 2011, when the company first invested in Facebook, and continued to soar right until Facebook's IPO on May 18, 2012. Since the Facebook IPO, however, GSV Capital has lost nearly half its value, as investors seem to think anything that has exposure to Facebook is a toxic asset.
(click to enlarge)The irony of all this is that Facebook constituted just 3.51% of GSV Capital's net assets as of the end of Q2 2012. When investments in other controversial social media companies [Zynga (ZNGA) and Groupon (GRPN)] are included, the total rises to 4.92%.
GSV Capital stock has become unhinged from its fundamentals. Part of that is due to the nuances of valuing the company's portfolio. That is the reason that GSV Capital provides an NAV value only once per quarter, when it releases its results. During the quarter, the company hires an independent valuation firm to examine and value the company's private investments (per GSV Capital's 10-Q filings). When calculating its NAV, GSV Capital does not simply "guesstimate" or provide whatever number it wants. Arriving at the proper NAV is a complex process, one that the company does not take lightly. And that NAV forms the crux of our bullish thesis.
How Much of a Discount is Too Much?
As of the end of Q2 2012, GSV Capital had an NAV of $13.81 per share. As of this writing, GSV Capital shares stood at $8.57, or 37.94% below NAV. According to a study from Princeton and The University of Texas, the average closed end fund (what GSV Capital essentially is) trades at a discount of 8% to NAV.
We can understand why GSV Capital's discount could be higher than 8%. The majority of the portfolio is held in illiquid, private companies, and investors may be unwilling to place too small of a discount on such a fund. That being said, we believe that a discount of almost 40% is unreasonable. GSV Capital's portfolio is not filled with tiny startups. It is filled with some of the world's leading private technology companies, such as Twitter, Dropbox, and Spotify, and the long-term prospects of its portfolio companies is bright, in our view. We delve into GSV Capital's portfolio below.
The Portfolio: Forget Facebook, Let's Invest in Twitter and Many Other New Prospects
Investors need to realize that when it comes to GSV Capital, Facebook, Groupon, and Zynga are not where the true opportunities lie. These companies have already gone public, and while we do believe that these companies have long-term upside potential (we are less certain of Zynga), they are not what investors in GSV Capital need to be focused on. GSV Capital's portfolio is filled with many more promising companies, and is anchored by Twitter.
Twitter, as of the end of Q2 2012, constituted 11.81% of GSV Capital's net assets. And Twitter is set for solid growth over the next 2 years. Revenues are estimated to reach $259 million in 2012, and analysts project revenues of $540 million in 2014. That is equivalent to a CAGR of 44.39% each year. However, sources close to Twitter report that the company's own internal estimates project 2014 revenues of $1 billion, nearly double that of what analysts expect. In addition, Twitter is working to expand its revenue base beyond the United States. Currently, analyst estimates indicate that 90% of Twitter's revenue is generated in the U.S. But it is set to fall to 83% by 2014. Investors should not underestimate Twitter's potential. Forrester Research analysts state that marketers have been "pleased" with Twitter's advertising products. Investors should not underestimate the potential of Twitter, nor extrapolate their own experiences with the platform to its profit potential. Twitter is not a platform for everyone. But, simply because you may not find it useful does not make it true for all users. There is no social media platform that can encompass the needs and wants of every single person. We doubt that even Facebook can offer a compelling reason to draw in every single person in this country (or any other market for that matter). But this does not detract from Twitter's investment potential. As long as Twitter creates a compelling platform for both users and advertisers, success will follow.
While Twitter comprises the core of GSV Capital's portfolio, there are many more companies that should be mentioned. Investors need to realize that GSV Capital does not invest in no-name Silicon Valley technology startups that will crash and burn in a few years. The company's portfolio consists of 40 companies, many of which are considered blue chips within the private company sector. A look at Business Insider's list of 2012's top 100 largest private technology companies, known as the Digital 100, shows that GSV Capital holds stakes in many of them. We break down several of those companies below, and the percentage of portfolio assets that GSV Capital has allocated to them below (net asset percentages are taken from the company's Q2 2012 earnings release)
- Twitter: #3 on the Digital 100, 11.81% of net assets
- Palantir: Software analytics company based in Palo Alto, #5 on the Digital 100, 1.51% of net assets.
- Dropbox: Cloud storage service, #6 on the Digital 100, 4.94% of net assets
- Spotify: Online music service, #15 on the Digital 100, investment made after the close of Q2 2012.
- ZocDoc: Online doctor finder, #29 on the Digital 100, 1.31% of net assets.
- Gilt Groupe: Online shopping, #31 on the Digital 100, 2.06% of net assets
GSV Capital does not invest in any available private company. It conducts due diligence on each investment, looking at the long-term opportunities and risks of each company. Furthermore, GSV Capital invests in companies that either become acquisition targets for larger companies, or IPO candidates. Silver Spring Networks, which constitutes 1.84% of GSV Capital's net assets, is in the process of going public. And Dropbox, one of the company's largest investments, is reported to have rebuffed an $800 million takeover offer from Apple (AAPL) that was personally offered by Steve Jobs. While that would represent a sizeable return for Dropbox's investors, sales are set to double in 2012, and many analysts expect an IPO filing from Dropbox in 2013 or 2014. As for Twitter, the company has likely learned a great deal from watching Facebook go public, and CEO Dick Costolo has publicly stated that an IPO "is not something we're focused on right now." He says that an IPO may be something that Twitter will pursue in the future. In our view, Twitter will go public at some point in time. The majority of private companies are either taken public or get sold to larger companies. Companies such as Bloomberg, Koch Industries, or Cargill are relatively rare exceptions to this rule.
GSV Capital's portfolio consists of many successful and growing companies, such as Twitter, Dropbox, Bloom Energy, and Palantir. And this stock allows investors of all types to invest in a sector previously accessible to only a select few.
Fee Structure: No Unusual Surprises
GSV Asset Management manages GSV Capital's portfolio, and as such GSV Capital pays investment management fees to the company. Michael Moe, who is also GSV Capital's founder and CEO, controls GSV Asset Management. Many critics of GSV Capital have seized on this, arguing that Michael Moe is simply using GSV Capital and its investors to suck exorbitant fees out of the company's coffers to line his own pockets.
However, GSV Capital's SEC filings tell a different story. For the second quarter of 2012, GSV Capital paid $1.126091 million in management fees to GSV Asset Management, which represents 0.42% of assets. Per the contract between the 2 parties, GSV Asset Management will be paid a base fee of 2% of gross assets, and an annual inventive fee "equal to the lesser of (i) 20% of the Company's realized capital gains during each calendar year, if any, calculated on an investment-by-investment basis, subject to a non-compounded preferred return, or "hurdle," and a "catch-up" feature, and (ii) 20% of the Company's realized capital gains, if any, on a cumulative basis from inception through the end of each calendar year, computed net of all realized capital losses and unrealized capital depreciation on a cumulative basis, less the aggregate amount of any previously paid incentive fees."
A management fee of 2% is standard for private equity and venture capital firms. Critics of GSV Capital dispute that the company is a venture capital fund. While GSV is not technically a VC fund, it buys shares of private companies at both the primary and secondary levels. As for incentive fees, GSV Capital must return at least 8% annually in order to qualify for that fee. And that 8% is not a gross rate, but rather a net rate. Ant if and when that rate is reached, shareholders will likely be pleased with their own returns as well. GSV Capital has paid out nothing in incentive fees so far (per the latest 10-Q filing), because those hurdles have not been met. And a 2% fee to gain access to a portfolio of the world's leading private technology companies is reasonable, in our view.
A discount to NAV, at this point in time, may be reasonable. After all, GSV Capital's portfolio is not easily valued on a day-to-day basis like that of most closed-end funds. But, a discount of almost 40% is too much. GSV Capital's portfolio consists of many leading high-growth technology companies, and is anchored by Twitter. In our view, GSV Capital needs to be seen from one of two prisms: either a short-term trading vehicle, or a long-term investment on the potential of Twitter, Dropbox, and other leading technology companies. Too many investors see GSV Capital as a way to create riches overnight, and that is the wrong way to approach an investment in this company in our view. You can either trade shares based on perceptions of an upcoming catalyst, such as the IPO or takeover of a portfolio company, or invest for the long-term based on the appeal and growth prospects of GSV Capital's portfolio companies. We have taken the latter approach, and have used drops in GSV Capital's stock as buying opportunities for the long-term. GSV Capital's shares have undergone a great deal of turmoil since the company went public. The shares have become unhinged from their fundamentals, first to the upside, and now to the downside. In our view, there is no reason that the stock should trade at a discount of almost 40%. In our view, that discount will close in the long-term GSV Capital moves past its investments in Facebook, Groupon, and Zynga and proves to the market that there is much more to the company, and much more to the investment portfolio. We believe that GSV Capital's best days are ahead of it, and that investors who add to or initiate positions in the company will be rewarded for their conviction in the long term.