“Be a $7 Venture Capitalist …” High Dividend Superstar

By Travis Johnson, Stock Gumshoe, January 13, 2009

This one comes in from Carla Pasternak and Paul Tracy, who are apparently now co-editors of the StreetAuthority’s High-Yield Investing newsletter. We’ve looked at this letter several times before, and one of the marketing tools they use is the “Income Security of the Month” — just FYI, at a quick glance it looks like January’s pick of the month is the same as December’s, which you can read about here. The yield hasn’t changed much.

But that’s not what we’re looking at today — today we’ve got more of a straightforward teaser ad that tells us they’ve got a handful of great high-income picks for us, if only you’ll subscribe to their newsletter (currently about $150/year).

So this teaser includes several other high-income picks, and I’m going to take a look at one of the interesting ones this morning … if folks like these kinds of goodies, I can probably come back around and sniff out some of the others in the future.

“Be a $7 Venture Capitalist and Pocket a Hefty 20.2% Dividend”

There’s a nice spiel about how venture capital is the true wealth-maker in this country, using perhaps the best venture capital investment ever, Google, as an example of a company that went from a student research project, to a venture capital recipient, to an IPO and a rapid ascent to megacap territory in just over a decade. Not a bad story, but of course it doesn’t happen very often.

“That’s just one example, but you can thank venture capitalists for your computer, cell phone, solar panel and countless other inventions that have made our lives better… and ground-floor investors filthy rich.

“Back in the day, if you wanted a piece of the action, all you needed to do was write your own million-dollar check. Not possible for 99.99% of investors. But today, you can buy your way into the exclusive world of venture capitalists for about $7.”

That’s a frequent promise of the teaser ad, of course — that us wee investors can join the big guys in the smoke-filled rooms and get a piece of the “real” action. How do we do it?

Well, in their words …

“All you need to do is buy stock in a business development company or BDC. What are they? Simply put: They’re public firms whose stock trades like any other stock on any exchange. But they invest in a unique portfolio of stocks and bonds of small/mid-size private companies destined for greatness. In essence, they’re a reincarnation of the old venture capitalist firms retooled for a new century.”

Ah, OK — Business Development Companies are, of course, real. Most of the bigger ones serve as alternative financing sources for small and medium sized businesses — companies that need to borrow money to grow, but who aren’t big enough to issue bonds at a decent rate and aren’t small enough to borrow from the local bank. Most of these companies, like American Capital and Allied Capital and Gladstone Capital, have been terrible money-losers this year and have been significantly worse investments than the broader market, though many of them did extremely well for many years before the credit crunch.

The one we’re looking at today, however, is not one of those more familiar names … back to their words:

“… Its current yield is a dazzling 20.2% with a dividend payout for 2008 of $1.36 a share! … This BDC I’m anxious to tell you about has loaned $1.3 billion to 120 different life science and technology firms since its inception in 2003. Its specialty is biotech startups — an industry that uses cutting-edge technology to develop new drugs. It’s one of the few corners of the market that’s looking healthy right now — even robust. Even in today’s tight credit markets, this company has secured $300 million in credit and continues to build a profitable portfolio of biotech and other technology-related business.

“Despite the worldwide slowdown, this firm … is expected to see double-digit earnings next year. Sales have increased five-fold since going public in 2005. It also made some huge gains — 30%-plus — when one of its companies went public last year.”

“… As an added safety feature, their credit risk is spread over 100 companies loaning about $5-6 million per company.

The company has been listed on the NASDAQ for three years, we’re told … so what is it?

The Thinkolator can tell us right away …

Hercules Technology Growth Capital (HTGC)

The stock currently trades for just about $8 a share, and the current dividend amount is 34 cents per quarter, which does indeed add up a $1.36 annual dividend if they maintain the current rate, a rate that did go up in 2008 (from the prior 30 cents/quarter). Since the shares have gone up from the $7 area to the current $8 since they did the research for this ad the yield is down a bit, but it’s a still-impressive 17%.

So … do you want a piece of this one? From what I can tell the information in the ad is accurate, they do indeed focus on technology and life sciences companies that are already working with venture capital and trying to grow. Their list of portfolio investments includes twenty or so biotech companies along with others in medical devices, communication technology, software, semiconductors, and a few other high tech fields. You can see the list of all of their current partners/investees here.

Hercules has apparently tried over the last year or so to adjust their portfolio and strategy for a more uncertain time — in their case, that means issuing loans instead of equity investments in their portfolio companies (which means they do get more income onto the books), deleveraging at the corporate level, and focusing on firms that are “later stage” venture investments. While their recent results appear to have been quite solid, I don’t know the firm in great detail and I don’t know if they’ve been as successful as they claim in this regard. They did have net income that came close to being as high as their dividend for the last quarter, so while a few cents of that dividend is not actually coming from portfolio income it may well be sustainable.

This does look like an interesting investment, though it has been a little bit more correlated to the movements of the broader markets than I would have guessed. In the long run, Hercules will probably — like most venture capital investors — depend on occasionally having their companies go public with a nice big boom, or get bought out by other companies, so that they can make up for the many failed investments they will probably continue to make. Right now the market is obviously not ready to absorb any new IPOs, but at some point that will probably return. And Pasternak and Tracy’s focus on their biotech strength is probably not accidental, since that sector has indeed shown some resilience, and great new discoveries will probably continue to be profitable regardless of the overall market sentiment.

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So what do you think? Ready to be an early stage investor in companies that invent new medicines, or develop ways to make video games faster, or sell baby gear more efficiently? It certainly looks less frightening than some of the other Business Development Companies who are terrified of rising defaults in a recession, but that’s perhaps faint praise. If you dig into the Hercules portfolio, let us know if you like what you see.