BDC Review Redux Part VIII: The Pre-IPO BDCs

Includes: FB, GSVC, SVVC, XRDC
by: Philip Mause

Last year, I wrote a series of 9 articles reviewing Business Development Companies (NYSEARCA:BDCS). The series was popular so, this Fall, I have been updating the earlier articles with a "Redux" series - the first seven of which have already been published in Seeking Alpha. The Redux series uses Roman numerals - each Redux article is designed to provide a current analysis of the BDCs analyzed in the article bearing a corresponding Arabic number last year. Thus, Redux Part VIII corresponds to the original Part 8 article last year. There is one possibly confusing twist that I should explain. Last year, in Part 8, I reviewed GSV Capital (NASDAQ:GSVC), Fidus (NASDAQ:FDUS) and Oxford Lane Capital (NASDAQ:OXLC). Since then, I discovered that Keating Capital (KIPO) and Firsthand Technology Value Fund (NASDAQ:SVVC) have entered the market and are following strategies similar to GSVC. For that reason, I am deviating a bit from my pattern here. In Redux Part VIII (this article) I am not exactly mirroring the group of BDCs I covered in Part 8 when it first appeared on September 12, 2011. Instead, I am analyzing GSVC, SVVC, and KIPO in this article - Part VIII - because they all follow a similar strategy and raise similar issues. I will analyze FDUS and OXLC, as well as at least one other company in Redux Part IX, which will hopefully appear in a few days.

This article is devoted to three BDCs that have staked out a rather unusual strategy. They acquire equity interests in companies that have reached the stage of development just short of the issuance of an Initial Public Offering (NYSEARCA:IPO) - hence, the "Pre-IPO BDCs". These BDCs each hold shares (usually a special form of preferred stock) in a number of companies - usually in the technology space. The strategy is based upon an expectation that, once the company becomes publicly traded, the value of its shares will increase. These companies thereby give retail investors an opportunity to participate in pre-IPO companies - an opportunity which would usually be foreclosed to the average retail investor.

The companies look and perform very much like equity closed end funds and they are, in fact, organized under the 1940 Act. However, each of their financial statements indicates that they have elected to be regulated as business development companies. For that reason, I believe it is appropriate to include them in this series. On the other hand, they are very different from the normal BDC which makes loans to small and middle sized businesses. They certainly are not in the position to make regular dividend payments out of cash flow. Profits and cash flow are very uneven and generally depend upon whether the companies they invest in go public (or are taken over). For that reason, they probably do not belong in a portfolio oriented to reliable dividend yield.

The pricing of these stocks has also tended to be quite volatile. Two of them held Facebook (NASDAQ:FB) shares before the IPO and were touted as vehicles for investors to use to participate in the FB IPO bonanza. Since there were not many other ways to get in on the FB gold rush, lots of investors piled in and the shares of the BDCs skyrocketed. When the IPO fizzled, the BDC shares returned to Earth and then proceeded to create a deep crater where they now sit. In reality, FB shares were a relatively small share of the portfolio of each of the two BDCs and, in my opinion, that may create a buying opportunity.

After the name of each company, I will provide the symbol, Thursday's closing price, the NAV as of the most recently released data and the share price as a percentage of the NAV.

1. GSV Capital (7.90) (13.81) (57%) - GSVC traded at $14.77 when I wrote the first article on September 12, 2011, and completed a secondary offering at $16.25 in May of this year shortly before the Facebook IPO fiasco. There are obviously a lot of unhappy campers. As of the most recently available financials, GSVC still has roughly $4 a share cash, so investors are (in a sense) paying roughly $3.90 for $9.81 worth of assets. The problem is that the assets are largely in the form of non-public securities and these can be illiquid and hard to value. Still, the discount seems excessive. GSVC still holds FB shares and also has positions in Twitter, Zynga and all sorts of other cutting edge companies with campy names. If some of these complete successful IPOs, it could lead to appreciation in NAV and, perhaps more importantly, a change in the investor sentiment toward this kind of strategy. Investors could start to realize that they guys may not always win, but they don't always lose either.

2. Firsthand Technology Value Fund (18.14) (23.05) (79%) - I wrote SVVC up on July 19 when it was trading at 16.07 in this article. SVVC is very similar to GSVC with a very important difference. SVVC still has a lot of "dry powder" - $19.52 of cash as of its last report (it is likely that some of this has been invested since). However, it is striking that this stock has persistently traded for LESS THAN NET BALANCE SHEET CASH! And I am not aware of any repatriation issue which might justify a discount. SVVC has FB shares and also has positions in Twitter, Zynga, Intevac, and Solar City. It has traded as high as 45 earlier this year and completed a secondary offering at $27 a share on April 19. An activist group called "Bulldog" (I am sure due to its tenacity) has invested and announced its intention to urge management to take action to close up the discount to NAV. If it heeds the admonitions of its canine investor, it may buy back shares at the current price. Of course, selling at $27 a share and buying back a few months later at $18 a share is very profitable but is unlikely to be the kind of strategy which could be replicated every 12 months.

3. Keating Capital (6.32) (8.23) (77%) - KIPO is a relative newcomer to the BDC scene which I found out about after I closed out the series last year. It seems to invest in a somewhat different set of companies from GSVC and SVVC. It apparently does not hold any FB shares and seems to have eschewed some of the other popular names. NAV may be understated because after the end of the last reporting period, a holding called Lifelock went public and, by my reckoning, the net effect on KIPO's NAV is probably a positive 20 cents or so per share. Their intention is to stay relatively fully invested and redeploy cash as prior investments close out. I do not really see any compelling reason for this size of a discount to NAV here.

Once, over a couple of beers, I had a heart to heart conversation with my father and asked him if he had any regrets. His response surprised me but he said he wished he would have pulled together money from whatever source he could find and plowed it into every IPO that his friend (who was a big customer at Lehman) offered to get him in on. In those days, IPOs were often made available only to favored customers of the brokerage houses and investors could often do very well very quickly. That frothy, "how can I get in on this gold rush", atmosphere has reappeared from time to time - most recently this Spring with the FB IPO. The market traveled from euphoria to revulsion in a matter of minutes and irrationally high prices turned almost instantaneously into irrationally low prices. I think that all three of these are reasonable buys here and the first two have been especially unfairly tarred by guilt of association with FB. I also think that the mispricing of these three tells us something important about the market.

These stocks are not the kinds of stocks to be trading well below NAV at the frothy top of an overly exuberant market. Their pricing highlights the extreme negativity and suspicion which still characterizes the equity market and holds the prices of solid companies at levels so low that they have dividend yields higher than the interest rate on thirty year Treasuries. These stocks may serve "a canary in the coal mine" function in signaling extremes in optimism and pessimism. Investors are fickle. There will almost certainly come a time when these stocks are overpriced because of the public enthusiasm for IPOs and the frustration at not being able to "get in early." That, of course, will be the time to sell.

Disclosure: I am long SVVC, GSVC. 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.