A fairly quiet week in Gumshoedom — we’ve also got a new column from Dr. KSS today, which you can see here, and what follows is my “Friday File” thoughts on a few investments I’ve written about recently.
I spoke with Sven Weber, manager of the SharesPost 100 Fund (PRIVX) on the phone earlier this week, and I thought I’d report back to you about our conversation. The fund contacted me a week or two ago, after seeing some of my recent comments updating my thoughts about this investment… and, perhaps more importantly, about the irresponsible “promises” made by the Money Map Folks in promoting this as a “secret” VC Fund that you could partner with, through a special Money Map deal, and “have the potential to transform $2,600 into $520,000.” So while I’m generally reluctant to talk to CEOs or get sucked into conversations with the many promoters who call me (who’s got time to be lied to over the phone?), I did make some time for SharesPost.
Weber was a perfectly lovely guy to chat with, he started out by thanking me for the trust I had put in him and the management team even though I’m a very small shareholder in the fund (I invested at the minimum after I first wrote about this six months or so ago, largely out of curiosity). And he was very complimentary of the work we had done in explaining the realities of the fund and digging into their filings, as opposed, I interpreted, to the hype-show put on by Michael Robinson a few times of the last six months as he’s been touting the potential for your “partnership” in this VC firm to generate mammoth returns (he didn’t name names when speaking disdainfully about misleading media coverage).
So let me summarize where he thinks the fund is, and where he thinks they’re going… we’ll start with a little background.
The SharesPost 100 Fund is an interval mutual fund, which means you can’t sell shares back to them every day (they offer redemption quarterly, with a maximum of 5% of the shares promised to be able to liquidate each quarter). They are designed to offer access to a diversified portfolio of late-stage venture capital investments that are within a few years, most likely, of either going public or being acquired — “late stage” to them means that they are looking for companies that have real revenue, revenue growth, and a sustainable business, and their target investments are the companies in the SharesPost 100 — the index that they put together of the top late stage venture companies in the country (though they’ll never own all of them, and wouldn’t want to buy some of them — Uber, for example, is on the list but will likely remain far out of reach both in terms of accessibility of shares and acceptable valuation). Ideally, I think, all of their stocks would be 3-5 years from an “exit” but not yet well-known enough, or close enough to an IPO, to have ridiculous private market valuations — they’re looking to capture value from companies that are growing fast but are already reasonably established businesses, not moonshots out of a kid’s dorm room.
The shares are offered through advisors and brokers, with an up-front sales load, and they come with a total annual expense ratio of 2.5% (which isn’t actually enough for them to run the fund yet, but it’s getting there — they’ve contractually agreed to keep the fee at this level for a few years, so the managers haven’t actually earned the 1.9% advisory fee they’re owed yet. Hopefully if the fund has grown quite a bit the fee will be sustaining… more on that in a moment). The minimum investment is $2,500, and it’s quoted in most brokerage platforms but is not likely to be available through many fund supermarkets (perhaps due to the restrictions on redemption, I didn’t ask Weber about that part of their distribution, which is handled by an outside firm).
When I wrote about the fund back in April, I had a few concerns — that they might have trouble getting a piece of good investments given all the venture capital competition, that they might not grow to a sustainable size (it’s expensive to make all these private deals, much more so than investing in public company stocks, and venture funds that work well tend to be large enough to spread that expense across a large asset base), and that you’re effectively tying up your money if things go south quickly, since if everyone wanted to sell at once there would be caps on redemptions.
When it comes to building the fund, they are still getting interesting-looking investments at a decent clip. Weber said that they think their sweet spot is adding 1-2 new investments per month and also adding to existing investments, and that the maximum size of the fund will probably, for practical purposes, be about 60-70 positions, most of which will be from the SharesPost 100 list. The guidelines for the fund say that 85% of the value of the fund should be in SharesPost 100 companies, but they do have some flexibility to go outside that list — either for an opportunity to buy into an up and coming company that isn’t quite in their “top 100” yet, or simply to hold on to a company that has dropped off the list so they can be strategic about their timing when they sell.
They’ve been raising their assets under management nicely over the year, they ended 2014 with $19 million and now have about $65 million under management, invested in 31 companies — thanks largely to a strong first and second quarter, which was probably driven to some degree by the attention from Michael Robinson (and, perhaps, from Stock Gumshoe). So although Weber was clearly uncomfortable with some of the media characterizations of the company and the aggressive returns hinted at (he didn’t specifically say that he didn’t like Robinson’s coverage by name, but I assume that was the coverage that made him uncomfortable), it undoubtedly helped the asset base to grow. They also got some mainstream media attention, including an appearance by Weber on CNBC and, just last month, a mention in the Wall Street Journal. They have had two “exits,” neither at windfall profits, and seem likely to have two more shortly that will also probably have muted returns at best (Good Technology, which has a deal to be acquired by Blackberry, and Sunrun, which has gone public).
Weber said that they have also, as of recent months, been focusing more on preferred stock, and that this will start to show in their reports — which means, to some extent, that they’re growing up a little… preferred stock often has much better terms than common stock when you’re talking about venture investing, with protection built in for early investors, and provides some bit of buffer against market movement. He was careful to note that they will continue to invest throughout the capital structure, and that common stock in venture companies isn’t necessarily bad or worse than preferred stock for every firm.
And when I asked him about the overvaluation problem in Silicon Valley among startups, with nearly 100 “unicorns” now roaming the streets (“unicorn” is a term for a private startup with a $1 billion+ valuation, so named because they used to be extremely rare), he was pretty clear in saying both that those valuations aren’t real (they’re based on advantaged investments in preferred stock by early investors, not on what real market value would be to a common stockholder), and that the headline stocks that get all the attention are the most overvalued… there’s still a lot of opportunity, he says, in smaller growth companies that most of us haven’t ever heard of.
To give us a positive spin on the market being crushed over the last couple months, he said that the market correction has really helped to control expectations among share sellers — which means that the SharesPost 100 Fund has a bit of an advantage, finally, because insiders who want to sell shares of private companies (early investors, early employees, ex-employees) aren’t as likely to be dreaming of $50 billion IPOs. That’s a boon, on balance, since they’re really more focused on building the portfolio in these early days than on exits, even though that market weakness is trickling down through the fund and helping to net asset value per share to drop a little.
I also asked him how they find their investments — whether they’re buying mostly small stakes from ex-employees who come to them, working directly with the companies in funding rounds, or something else. He quickly made clear that there’s no way to do this kind of investing without direct involvement with the companies themselves, even if you’re not buying the shares from the company. Transactions in a private company always have to go through the company, so even with small investments (like the teensy chunk they own of DocuSign, for example, presumably bought from a DocuSign employee who needed some liquidity), it should help to build connections and learn more about the fundamentals of private companies. Even if it’s a former employee who’s selling shares the company still has to facilitate that and approve it, and the company is the only real source of reliable info. Not everyone is willing to share information with SharesPost or is happy to have them buying shares, but most companies are very open in dealing with SharesPost, he said, and happy to partner with them on transferring shares or letting them be a participant in providing “liquidity” for their shareholder employees — partly because there is some reputational advantage to being in the SharesPost 100 list, which Weber said has sometimes been referred to as a de facto index of promising venture capital companies. Some companies have even issued press releases when the SharesPost 100 Fund has bought, or when their company has been added to the SharesPost 100 list.
He said that their advantage is in starting with a “positive list” — they have compiled the SharesPost 100 list of attractive private companies, which is updated each quarter, and that gives them a target list of companies that they know have some appeal, and they can contact those companies and their shareholders consistently to look for opportunities. That doesn’t mean they’ll ever own all 100, the top 20% are typically too richly valued for them to consider buying (like some of those unicorns — Uber comes to mind), and there will always be some that have some serious issues, as well as the next crop that’s moving up their rankings into the “top 100”.
One concern I have is with the sustainability of the fund, and Weber did agree that it’s hard to sustain and challenging to manage — that’s partly because though they’re much closer to break-even now that they have $60+ million under management, they also have to balance that growth in AUM with the fact that adding more companies for coverage means gradually building their own headcount as well. He thinks they’ll run near breakeven for a while, which is encouraging, but that they also need to grow big enough that there’s more than one manager and some analysts — more than one Sven Weber who can be making contacts and connections with these companies. From my look at their June report, I interpret “breakeven” to mean that Weber’s group is not getting an advisory fee yet and is still eating some portion of the expenses, that 2.5% management fee is covering most of the fund’s direct expenses but not the 1.9% advisory fee. This limitation on expenses for the fund extends now through next May, it has been extended at least once, and the fund managers do have the right to be reimbursed for past money earned but not received under the expense limitation agreement over the past few years (though only if the total fee, including that reimbursement, would still be under 2.5%). I think they’re going to need 2-3X this level of assets, something in the $200 million range, before SharesPost makes any money managing the fund.
And I asked him if he’d have trouble investing another $30 million if it came into the fund suddenly — he said no, that they’re ready and he thinks the opportunities will continue to be there to invest, and that they’re finding they can move up in scale without difficulty so far — they’re looking to often make deals of $2-3 million per company now, whereas a year ago when they were launching it might have been $500,000 per company. They added Sugar CRM to their website as the latest investment while I was on the phone with him, by the way, and that reminded him that he wanted to mention a problem with my earlier look at the large cash balance of the fund — I saw the big cash balance in their last annual report and thought that might mean they’re having some trouble deploying capital, but he countered that it’s important to understand the substantial lag time of investing in private companies. It’s more like what you and I might be experienced with in buying real estate — you don’t make an offer and close on your new shares in a weekend, you start a deal and make an agreement and then it might take 60 days for the cash to actually change hands.
Their real cash balance is substantially lower than it appears, because much of the cash is committed to deals that are in the works. As each deal is finalized, the logo of the company pops up on the list of investments on their website — there were about 20 companies on the list back in April, and there are 31 today, and the cash pile waiting to be invested (or for deals to be closed) has grown as well, going from $4 million at the end of 2014 to $20 million in June.
For those who are asking if it’s possible to buy directly without paying a sales load, Sven said it is — that such is a requirement of funds that are registered like theirs, if you don’t go through a broker you don’t pay a sales load. And yes, contrary to what I speculated, all of the sales load does go to the brokers — the fund doesn’t get any of it, regardless of who you buy through and even if you buy seemingly “direct” by making a purchase through the link on their website (which goes to their distributor). Any “deal” that the Money Map folks had would have been an artificial one –they give a “discount” on their newsletter and consider that reimbursement for the sales load, perhaps, or they simply tell you how to buy direct without a load.
Weber did say that it’s not as easy to buy without a sales load, but that the prospectus does give you the address to send an investment in directly. I haven’t tried this, but you can if you like — the instructions are on page 44 of the prospectus here. That would be my inclination if I were making an investment, to buy direct and not think about the money for a couple years and see if they can indeed post returns that are both non-correlated with the market and strong enough to justify the management fees — I do have a bit more faith in the fund after speaking with him, partly because of the candor with which he spoke and the fact that he didn’t make blue-sky promises about 1,000% returns… and partly because they’re in a much stronger position now than they were six months ago
And on that note, let’s see where they stand now:
They have indeed been growing the number of investments in the fund — there were 18 companies in the fund at the end of 2014, 25 as of June 30, and there are 31 today. So Weber’s being truthful when he says they’re on a track of adding 1-2 investments per month, that’s been fairly consistent since the inception of the fund. Total assets went from $19 million at the end of last year to $55 million at the end of June, and Weber said that the inflows of new capital have slowed since the strong start of the year, but that they are still growing and that total assets under management are now about $60 million. He also mentioned that preferred stock is more of a focus now, and that may well be — but it’s not in the reports as of the end of June, preferred stock holdings had grown, then, but not as fast as common stock holdings, so the percentage of the fund invested in preferred stock dropped from 21% to about 15%. Presumably that’s turned somewhat now if his comments were accurate, but we won’t see the detailed quarterly filings.
The growth in asset value has been from both new investments and add-on investments in existing companies — so Kabam, the gaming company, is still their largest holding and they haven’t added to that, but Good Technology, a security firm which they had a token position of $136,000 in at the end of 2014 was their second largest holding in June, with a $3+ million position. You can also get some indication from their website of changes that have occurred since the June filing, since they list their positions in order of size — and the value of their Good Technology position dropped substantially, at least in relative terms, from June to September (we’d like to think that’s because they sold some, but more likely it’s because Blackberry is buying Good for less than folks thought their private market value was a few months ago… there’s some interesting commentary about that here), and many of their larger positions are now new holdings, reinforcing the fact that they’re generally making larger transactions now — added to the list since the end of June have been Soundhound, Sungevity and Spotify among their top dozen positions, and they’ve also added smaller holdings in Dataminr, Tintri, and SugarCRM… DocuSign remains their tiniest position.
There’s quite a bit of transparency in the fund, but not a lot of transparency in the companies they hold — so to a large degree it’s still a black box, and you have to have faith in management to operate the fund and value the companies. As long as you think of it as a different asset class, as being a venture investment that you’re tying up for a while, and that your goal is to get reasonable returns similar to the stock market but not directly correlated to the stock market over longer periods of time, it’s an interesting fund for smaller investors. The risk of loss is quite high, particularly if there’s a protracted bear market where private companies don’t have an opportunity to “exit” to the public markets or get acquired at nice premium valuations, but it is at least diversified — something that’s hard to find for relatively small investors in startups. I wouldn’t want it to be more than 3-5% of my portfolio, and it’s less than 1% now — and no matter what Michael Robinson says, be mindful that this is not an overnight millionaire-maker… they are diversified, so big gains from one of their positions will have a muted impact, and it’s an open fund so you can always buy it at whatever the NAV is, there’s no “rush” to get in, and it’s not trading at any kind of short-lived discount or anything like that. Take some deep breaths, read up on the fund, and make your own call.
Speaking of private equity and venture funding, I note that we also saw another royalty buyout at Grenville Strategic Royalty (GRC.V, GRVFF OTC in the US) this week. Grenville is sort of like a venture fund, in that they provide expansion capital for small businesses, though they’re generally businesses with local and regional ambitions and not “global brand name” companies like Spotify. Retailers, computer consultants, security companies, family businesses that need funding but don’t want to dilute shareholders — that’s their niche. They provide funding up front, and get it back in the firm of a top-line gross sales royalty of generally 2-4% — the funding is expensive for the “borrower” (these aren’t really loans), since the royalty is designed to repay the original investment in four years at the then-current sales trajectory, but it’s “hands off” — Grenville doesn’t tell them how to run their business, or get a seat on the board, or put restrictions on their balance sheet or operations, and they allow for the royalty to be bought back (at a profit, naturally).
As you might guess from a high return like that, they’re taking some risks with their customers — some of the royalties won’t work and the customer will default because the company falters in some way. That’s why Grenville fell a few months ago — their “credit quality” fell considerably last quarter. But on the positive side, they’re also seeing “private equity upside” because when their companies are sold or get a windfall, the first thing they want to do is buy back that royalty — and the terms on buying back the royalties are very lucrative for Grenville. So they have had a couple writedowns in their first couple years, and, as I wrote about six weeks ago, their credit quality has dropped. But I also did buy some more not long after that, so I have a decent position in Grenville shares (and a few warrants)… there isn’t big news about Grenville, but the incremental indications continue to be that their plan is working, with royalty buyout profits helping to cover for writedowns and late royalty payments.
The latest deal that came this week is smaller than their previous buyouts, but still a nice return. They advanced $1 million to DS Handling about a year ago, and have received about $250,000 in royalties to date and just had the company buy back the royalty for about $1.4 million, so that’s a 65% return in a year. The test will come if a bad economy accelerates writedowns and the buyouts don’t come to help balance that on the other side, but so far they’ve been able to build a pretty diversified portfolio, across sectors and in both the US and Canada, with less than half of their companies being what Grenville calls “cyclical.” So, I’m pleased to see them continuing to get decent “exits,” and pretty confident that the dividend (currently 7.5%, which seems pretty high — though it’s lower than the average big BDC yield now) should be sustainable… even though I’ll be watching each quarter closely to see what they say about credit quality and cash flow.
I also mentioned Capital Southwest (CSWC) and their spinoff of their appealing CSW Industrials (CSWI) division a few weeks ago — the spin has now happened, and CSWI is now trading. The spun-off company has not dropped in price, unfortunately, though I continue to hope that it will — it’s trading now at a decent price, not necessarily cheap yet unless they’re growing faster than peers (which they have been, though one hesitates to count on that). CSWI has an enterprise value right now of about $540 million, and the pro forma EBITDA, according to their presentations announcing the spinoff, is about $60 million. So they’re trading at an EV/EBITDA ratio of about 9 — that’s pretty good for a growing company with strong margins that has some strong niche products in specialty chemicals, lubricants, coatings, etc., but it’s not really cheaper than most of their also-reasonably-attractive peers.
CSWI is still a bet that they might be able to accelerate their growth now that they’re not tied to the Capital Southwest BDC-like structure, and with the outside chance that one of the big players (like Berkshire Hathaway’s Lubrizol, for example), might want to pay a premium to acquire them (that seems like it would have been more likely pre-spin, but there’s always a chance… and maybe the company really wanted to keep control and not create a big taxable event). I still like the stock and think it’s the kind of company I’d like to own, a niche industrial rollup with strong fundamentals, but I’d really like to see a spinoff discount on these shares — the one that’s going down is actually CSWC, which is transitioning to a lending-focused BDC and getting away from equity investing, so maybe that’s where the spinoff discount comes, in the smaller “parent” company that’s really changing its business. We’ll see. I’m keeping CSWI on my watchlist.
Otherwise, I haven’t done a lot — I did sell some near-term puts on Iconix (ICON), which I’ve written (very poorly timed articles) about a couple times. I think we’re close to a washout level with them, assuming that any SEC questions they’re continuing to deal with are really about classifying offshore sales and recognizing revenue and not about actual fraud, which is how I interpret the situation — so while I wouldn’t want to make a big commitment to the company, I like the new (interim) management and see a lot of buzz about the Peanuts movie and I’m willing to take the other side for folks who are frantic about buying downside protection — I sold the November $12.50 puts for about a dollar, which provides close to 10% income for two months (roughly, I put $1,250 at risk per contract in a commitment to buy the shares if they fall to that point and, in exchange, collected $100 up front for each contract).
I would not suggest this to anyone else, of course — I’m not running an options trading service, mostly because I’m not very good at it and use options mostly as a way to speculate on dumb ideas and get paid to make “stink bid” offers for companies I like by selling puts… and, of course, because options trading services almost always disappoint once they have more than a dozen subscribers, because individual stock options are very risky and usually illiquid. There’s a substantial risk of loss here, particularly because ICON could (as we’ve seen) release overnight news that craters the stock, but my sentiment is that the drop in ICON is overdone and this trade is similar to what I did with selling puts on Disney (a much, much better company, of course)… a way to generate some income when you’re thinking about trying to buy falling stocks but would rather commit at a lower price.
That’s what’s happening with me today. Enjoy your weekend!