Investors love the idea of a “back door” — they want to be able to get in on something before everybody else, to get a taste of the big time without having to wait in line behind the velvet rope — and Wyatt Investment Research is using that notion to help convince people to subscribe to Ian Wyatt’s Million Dollar Portfolio ($495/year is the current discount price, though here they’re pitching a four-year deal at $995).
Wyatt has used this “backdoor IPO” or “secret IPO” pitch before — and similar teases come in from other publishers whenever there’s any feeling about a “hot” IPO coming that investors might want to get a taste of. He ran a similar ad before the Snapchat IPO early this year, for example (I didn’t write about that one), and we’ve seen plenty of past pitches that hinted at getting in early on IPOs like Facebook or Twitter… or buying in well before an IPO is even announced in the case of “big name” and persistently private firms like Palantir or Uber.
So what’s the hook this time? Mostly it has been connected to Netflix in the versions of the ad I’ve seen — either “buy this company that Netflix invested in” or “buy the next Netflix”, with those two references being to Spotify (which is a subscription streaming service for music, kind of like Netflix is for TV and movies) and Roku (which started as essentially a Netflix spinoff that makes hardware to stream video, roughly similar to the Google Chromecast, Amazon Fire Stick or Apple TV, though they also sell content and advertising on their streams), both of which are likely to be publicly traded soon.
The story about Spotify, from Wyatt’s “webcast” ad, is that it’s a great company that’s bigger than competitor Apple Music, with 140 million users — 50 million of which pay $10 a month, giving Spotify annual revenue of $3 billion.
And he says that Spotify is looking to do a “direct listing” instead of an IPO, which is certainly a possibility — there was a WSJ article about that on April 9, it would essentially mean that they only list their existing shares, without the “O” part of the IPO (since they don’t need money, they wouldn’t sell any shares — which would save a lot of money in fees, because they wouldn’t need underwriters and wouldn’t have to pitch themselves to potential institutional buyers).
Functionally, though, it’s pretty much the same for us small individual investors — we wouldn’t get an allocation to a hot IPO offering anyway, we would most likely just have to decide whether or not to buy the shares once they’re trading. The shares were last “formally” valued at $8.5 billion, but that was two years ago in their last venture funding round, and the company is likely to be valued at somewhere between $10-13.5 billion according to the estimates I’ve seen. That’s more or less what Wyatt says in his presentation, too.
There’s a more recent update on the Spotify “direct listing” plan, which scares Wall Street and has regulators paying close attention — you can see some more recent commentary on that from Bloomberg a few weeks ago here.
Wyatt talks about the rumor that Spotify will be listing as soon as September, which I suppose is possible, and they’ve got all their ducks in a row now (principally that means they’ve signed long-term licensing deals with all the major music publishers, with the most recent one being Warner Music in late August)… and they are the least worrisome of the streaming music companies, with a lot less drama than Pandora or Soundcloud, and with a strong and growing paid user base.
It’s still a challenging model in some ways, but so is Netflix — and that has worked out pretty well. The challenge is that a huge percentage of revenue has to go to the content owners in the form of royalties, and to cover the costs of hosting and providing seamless and high-quality streaming, so there isn’t anything left over for investors. That’s probably OK as long as growth is rapid, which it has been (they’ve tripled the paid user base in a few years), but it means that future growth sentiment and some analysis of the scalability of the business will be the key determinant of their success, not proven economics or profits — the per-song-played royalties are not going to drop as they grow, so they need a much larger revenue base with more users to let that small gross margin (the difference between the cost of the music and the amount they’re receiving from subscribers) be enough to cover R&D, reinvestment, overhead and, someday, profits.
And while not selling shares in an IPO is positive for shareholders, since it keeps the share count down, it’s still true that the point of a public listing, for relatively mature tech companies, is twofold: Raise lots of cash to grow (not so many of them need to go public for that these days); or provide a liquid marketplace for shares of your company so that employees can sell, since stock is a huge part of compensation for tech companies, and salaries alone are not often enough to sustain someone living in silicon valley, which is among the most expensive environments in the world. (Though it’s a catch-22, of course, it’s the crazy compensation that has made silicon valley so expensive, another case of basic economics — too much money chasing too few homes and too few providers of basic services).
That’s a general “tech stock” comment, by the way, not Spotify-specific — Spotify is not really a silicon valley company, their headquarters are in Stockholm and their big US center is in New York, in one of the new World Trade Center buildings… also not cheap places, to be sure.
So even if they don’t sell shares in the offering, I expect there will be a steady stream of insider sales as soon as that is a possibility. Not necessarily negative, but public listings exist to provide liquidity and it’s almost certain that employees will take advantage of that.
And the other one, Roku, is pitched by Wyatt as the “the tiny IPO that could crush Comcast and DirecTV” — which will always result in cheers, because everyone hates their cable company. The list of “most hated companies in America” is always a who’s who of cable and telecom.
Roku is a provider of streaming video hardware and software, Netflix was their early funder and spun them out so they wouldn’t be competing directly with Apple TV and Google Chromecast and the like. Like all streaming hardware, Roku works with Netflix and Hulu and all the major providers (though Google, Amazon and Apple add on their own proprietary stuff to their hardware as well). They have 15.1 million users, have raised $208 million, and Wyatt says they have an estimated valuation of $1-1.5 billion.
Wyatt also says that documents they’ve filed with the SEC are incomplete so far, but the rumor is that the IPO will happen within the next few weeks. This will likely be a “real” IPO, with the company raising money for growth, but we’ll see.
What Wyatt is pitching is not direct access to Roku or Spotify, but that “back door” or “secret” access… so how do you build a portfolio of 100+ Pre-IPOs?
Well, his “secret backdoor” is.. Publicly traded investmetns that own equity stakes in these private companies.
THey have liquidity, you can buy and sell anytime, they own 30-50 investments each so you get some diversification, and the professionals who choose these do their due diligence. So, to paraphrase Wyatt, you get diversification, safety and security (compared to buying these private companies yourself, at least — though most of us wouldn’t have the access to do that anyway).
And he says there are three investments of this sort that he recommends… so what are they?
He offers up a closed-end fund, a business development company (BDC), and a mutual fund. These are our hints:
# 1 — the Closed-end Fund. He says it was founded in 2011, invests $200+ million in 22 companies, and had recent wins in pre-public investments including Facebook (FB), up 144%, Twitter (TWTR), up 193%, SolarCity up 157%.
And he says they have a history of paying big dividends — 12% in 2014 and 12.7% in 2015.
What else? We’re told that the founder is buying, that it trades on Nasdaq, and that it owns shares in Roku… along with a bunch of other private companies including Cloudera, EQX Capital, Hera, Hightail, Silicon Genesis, and more.
So who is it? This one is Firsthand Technology Value Fund (SVVC), which does indeed hold all those investments… though most of those named ones are not among their top holdings, and some of them, like Roku, are worth substantially less than SVVC’s cost at this point (according to their own value estimates). They also trade at a very steep discount to their net asset value, though estimating that NAV is always a bit of an art since, well, these companies don’t trade publicly. As of the end of the last quarter their net asset value per soare was $18.81, and the stock is trading at about $7.70, so it’s certainly available at a steep discount to what they think it’s worth.
Roku won’t change that much — it’s only 1.2% of their net assets right now, according to the chart they maintain here, they only invested $2.3 million in the company and it’s only worth $1.7 million now, so it’s pretty small potatoes even for this small fund. The prospects for larger companies like Pivotal Systems, Intraop Medical and Qmat will be much more important for SVVC, though I don’t know anything about those companies.
And yes, they do not pay a regular dividend but they have paid a few distributions, mostly in 2014 (presumably thanks to the Twitter or Facebook “exits,” though I haven’t checked the details). They’ve not paid a dividend or distribution since, though the good news is that those distributions improved the total return over the past three years — instead of losing 68%, you lost only 59%. The fund has always traded at a discount, excepting a brief period of euphoria in 2012 when we were all revved up about Facebook and Twitter, but for quite a while it was a respectable 10-25% discount instead of the 60-70% discount it has traded at much of the past two years. Sentiment is pretty ugly about the valuations of pre-public companies… at least, the ones that smaller funds like this buy who are later in their development cycle and a long way from the dorm room or garage that hatched the idea.
“Secret IPO” company #2 is a BDC, founded in 2010 by a Silicon Valley banker, yet another early investor in FB and TWTR, it apparently owns 37 pre-IPO companies, with $300 million invested, and also trades on Nasdaq. Wyatt’s target price is, he says, “100% upside,” because it trades at a 50% discount to the NAV (SVVC, the one above, is at a 60% discount to NAV, for whatever that’s worth).
So who is that? This is the one that actually does own Spotify shares — along with Palantir, Dropbox, General Assembly, JAMF software and others in the list of 37. And it’s also one that I’ve written about and suggested in the past (with poor results)… this is GSV Capital (GSVC), which is similar to Firsthand Value but is structured as business development company (meaning it’s a pass-through entity — any earnings it generates must be passed through as dividends, sort of like a REIT… though they haven’t earned a lot lately).
Spotify is actually a major holding in GSVC’s portfolio, at 7% — you can see their top holdings here. They have a shareholder letter here from earlier this year that explains their strategy, and, yes, they trade at not much more than half the NAV of about $200 million. Palantir and Spotify will be important in helping GSVC’s results, if they go public at huge premiums and rise in value after that (GSVC often holds their newly public companies for a while, and as insiders they’re often subject to the lockup period of six months or so if they don’t sell during the IPO), but the bigger impact would be a change in sentiment that causes investors to want to pay something closer to “fair value” for these private investments — I thought we’d see that before Snap’s IPO, but that didn’t happen.
Maybe that sentiment change will in the future, but sentiment is really hard to predict, and both GSVC and SVVC have had some pretty big writedowns in the valuation of many of their investee companies over the years so the actual NAV can certainly drop as well.
And number 3 is a mutual fund, Wyatt says it was founded by a Softbank executive who managed $1.5 billion, that it investes in late stage VC-backed tech companies and has 37 pre-IPO investments, including an investment in Spotify, and has a $2,500 minimum investment.
Some of the other portfolio companies include Lyft, DocuSign, Spruce, SoFi, OpenX, Spotify, Rockyou, PubMatic, SoundHound, Chartboost, INRIX, MEtabiota, and others… so that means he’s pitching the SharesPost 100 Fund (PRIVX). This is indeed a mutual fund, with a high expense ratio and a metered sales policy (you can request sales of your shares only once a quarter, and those sales can be limited). I actually have a small investment in PRIVX that I opened out of curiosity a few years ago, it is largely unchanged in value since then.
The downside here, as well as the upside, is that PRIVX is a mutual fund so it trades at net asset value — there’s no discount like there is with GSVC or SVVC, so it’s not going to pop dramatically higher because of an improvement in sentiment… but it also hasn’t fallen to 40% of NAV today like SVVC. I haven’t looked through their recent reports, but I’ll try to do so and update the Irregulars on that one — haven’t paid much attention to it for a while.
And that’s the story… yes, you can get in early on some of these pre-IPO investments, but you can’t pick and choose your favorites and just buy Spotify or Roku, so your exposure to any one company is pretty limited. And right now, investor sentiment is low so those publicly-traded vehicles that own private companies are trading at a steep discount to their estimated NAV, though, as we’ve seen on occasion, they can sometimes be at even steeper discounts.
Sound like the kind of “backdoor” you might like? Let us know with a comment below.
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