“Secret Loophole into Silicon Valley’s ‘Most Valuable Private Company'”

by Travis Johnson, Stock Gumshoe | February 12, 2015 2:12 pm

Solving the latest teaser pitch from Robert Wiliams' True Alpha... can you get rich from the "PayPal Mafia?"

That headline comes to us from Wall Street Daily[1], soliciting subscribers for Robert Williams[2]’ True Alpha[3], and it’s one of the more attention-getting strategies that newsletter use to pitch ideas: Getting in early.

Sometimes “early” means buying a stock before a catalyst is widely known, sometimes it means just buying before your investing friends have heard of a company — which is exciting enough, because that makes you feel smarter and cooler than other investors (and really, if that wasn’t part of the appeal we’d all just be buying index funds… and most of us would probably be getting better results than we get speculating in individual stocks).

But sometimes it’s even more “early” than that — a pitch that you can buy a stock before it’s even public, joining the billionaire-maker ranks of the venture capitalists who put in ‘seed money’ when the next Mark Zuckerberg or Michael Dell[4] is still skipping classes and working long hours to build a business in his college dorm room.

We see such teases from time to time — sometimes newsletters tease that you can buy exposure to a hidden asset by buying a public company before a catalyst or a spinoff, like buying Yahoo[5] to get exposure to Alibaba well before the IPO[6], sometimes they hint about some of the real “pre-IPO” investing that is now possible in many companies (though a terrible idea for most investors), but more often, as I suspect is the case today, the spiel is about a publicly traded entity or fund that has venture-like investments in a bunch of different companies.

There are some mutual funds[7] that routinely allocate a small portion of the fund to pre-ipo investments, and even one fund I know of that specifically buys a diversified group of venture-backed companies called the SharesPost 100 Fund[8] (PRIVX… it’s expensive, though — 5.75% front load and high annual fee near 2%). That’s interesting, particularly given the fact that successful companies are staying private for longer these days… but it’s probably not the investment Wall Street Daily is teasing to access a specific “most valuable private company,” so let’s see what they’re teasing:

“A $9 billion IPO payday is in the works…

“Act within the next 87 days to “get in” at the pre-IPO price of $1.15 or miss out completely….

“Companies like Airbnb, Dropbox[9] and Uber[10] (among others) are all expected to go public soon.

“When they do, they’ll hand venture capital backers up to 1,000 times their investment, according to the latest data from CrunchBase.

“That’s not a typo.

“A mere $10,000 investment in each of these companies could be worth $10 million.

“You’d expect that everyday investors like you and me would be completely locked out of this IPO profit bonanza.

“But I’m here today to tell you otherwise…

“Startling Discovery Unlocks Key to Silicon Valley Riches.”

Sexy, right? $10,000 to $10 million? You could finally get that Tesla you’ve been eying, or, you know, actually send the kids to college or retire or something more prosaic. Of course, companies don’t go up in value 1,000 times just by going public — being “pre-IPO” isn’t everything, particularly for firms that get pretty large before they enter the public markets (folks who bought FB a year or so before the IPO are doing OK now, but they were losing money for a while there in that first year of trading), you need to be in pre- pre- pre-IPO, when the venture capital firms are putting in $1 million for a couple seats on the board and 10% ownership of a company that might someday be worth billions.

Of course, those pre- pre- pre-IPO investments usually don’t work. For every Uber, there are (at least) dozens of failures that quietly burn through their seed money, fail to develop a product or make a real business case, and eventually run out of backers and disappear. That’s why the headline numbers are so spectacular when you see someone who got in early on Facebook and made thousoands of times their money… that person may have had ten other investments that year, and probably eight of them went bankrupt. It may be paternalistic to say that investors shouldn’t be involved in venture capital unless they’re “accredited” (meaning, they’re so rich they can afford to lose their investment… and so experienced that they won’t be shocked to lose it), but to some extent it’s true — venture-backed companies are huge risks, and the risk gets bigger (or, at least, harder to quantify) if you’re not in the boardroom or on the phone with the founders every month.

Back to the point, though, what are the rest of our clues? The WSD[11] folks talk about a “secret loophole” in the SEC filings that lets you invest with the “most successful venture capital investors of all time.” Here’s more from the ad:

“Partnering With the Greatest Wealth Creators in History

“I’m talking about a group of venture capitalists that turn practically every company they invest in into gold[12].

“Their list of winners stretches all the way back to 2002.

“And it includes the most well-known and successful companies in the market today…

• Facebook
• Tesla
• LinkedIn [13]/li>
• YouTube
• Yelp
• PayPal….

“By virtue of their track record, your success is almost guaranteed if you can invest alongside them, right?

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“… the loophole allows you to get a stake in certain companies at the same prices the venture capitalists paid. At pre-IPO prices.”

So what’s that “most valuable private company” they talk about, the one we can get into now at “pre-IPO prices?” Here are their clues on that front…

“Right now, there’s an opportunity to invest in what The Wall Street Journal and The New York Times estimate is one of the most valuable private tech companies in Silicon Valley.

“It’s an internet-based startup, doubling in size every year.

“It counts the most secretive agencies of the U.S. government, as well as the biggest banks in the world – including Morgan Stanley and J.P. Morgan – as customers.

“It’s Silicon Valley’s largest corporate tenant, occupying 250,000 square feet of downtown buildings….

“… the company’s months, possibly weeks away from being one of the most successful Silicon Valley IPOs in history….

“Today, I want to share with you my research into this remarkable and time-sensitive opportunity.

“It reveals an obscure, but perfectly legal and easy-to-access loophole that allows you to invest in stakes of Silicon Valley’s most valuable private startup.

“At what amounts to pre-IPO prices of $1.15.”

Does $1.15 mean anything to you? Of course not! Sure, it “sounds cheap” — but unless you know the market capitalization or the number of shares, the share price doesn’t do you any good… it’s just a way to give you the impression that you’re getting a bargain.

And, of course, you have to “act quickly” — newsletter ads don’t work unless they give you some sense of urgency, since if you take the time and mull it over for a few weeks of course you’re not going to fall for the hype. It’s the same reason car salesmen do everything but hold you prisoner once you walk into a dealership or test-drive a car, they know their best chance of selling to you is RIGHT NOW, when you’ve still got the glint of the shiny hubcaps in your eye.

The “urgency” this time is that you have to get in on the “pre-IPO” window… here’s how they put it:

“The best window of opportunity opens and closes in advance of each wealth explosion in Silicon Valley.

“In many instances, you can actually cash out your winnings before the company goes public.

“I know that sounds too good to be true.

“But that’s precisely what happened leading up to Facebook’s IPO in 2012.

“This pre-IPO opportunity opened and closed, handing tuned-in investors a 60% gain in only 25 days.”

They show charts of this happening for both Facebook and Twitter, with this “pre-IPO” investment spiking before the IPO of each of those companies as you got in on the “loophole.”

And beyond saying that you can get in for $1.15, they go on to talk more about the venture capitalists who you can follow into this company, and others, the “PayPal Mafia”. That’s a colorful way of describing the PayPal millionaires and billionaires who have become known, in a few cases, for the huge returns they’ve generated following the windfalls they received when eBay bought PayPal. And apparently this secret company we can now buy into was founded by the “Don” of the “PayPal Mafia” and is already worth — as a still-private company — $9 billion.

Which means it’s time to feed all that into the Mighty, Mighty Thinkolator… so we can now tell you that yes, the “Don” of the “PayPal Mafia” is Peter Thiel[14], who was one of the very earliest investors in Facebook when Mark Zuckerberg was still too young to buy a beer.

And the data-mining and sifting company he helped to found is Palantir, which is indeed one of the largest private companies in Silicon Valley (and counts intelligence agencies like the CIA among its customers and its early investors). It’s a fascinating and fairly secretive “big data[15]” analysis company, there’s a good article about them here[16].

And that means the investment we’re being pitched here is GSV Capital (GSVC)[17], a business development company (BDC) that specializes in venture capital investments. And, yes, GSVC was a pre-IPO investor in both Twitter and Facebook, and did see its shares spike before those stocks came public — though the “loophole” of buying pre-IPO that they show in the ad actually came before the filings were made or the IPO dates known, they show a chart with GSVC’s price in the first half of 2012 and the “loophole” was in early January — by the time FB had actually filed their S-1 to start the IPO process moving, on February 1, GSVC was alreadyd in the high teens, and they actually hit their all-time high price of $20.45 on February 3 of that year (the stock is right around $10 today).

Newsletters have certainly teased GSV Capital before, we wrote about a similar pitch last Summer[18] from Penny Stock Fortunes[19] that also cited Palantir’s value as a reason to buy and become “silicon valley rich” by December (the stock is essentially unchanged since then), and it was pitched as a backdoor into both Facebook and Twitter when those IPOs were widely anticipated (the two big lumps on GSVC’s long-term stock chart are from the Facebook IPO in early 2012 and the Twitter IPO in late 2013. (Penny Stock Fortunes is still running the same ad, by the way, though now it’s your chance to be “Silicon Valley Rich” by June, 2015.)

These days, Palantir is anticipated by some as perhaps the next “hot” IPO to get attention, though I haven’t seen any indication that Palantir will go public anytime soon — other than the fact that they are continuously expanding and raising more money. Their CEO consistently says he doesn’t want to go public[20], and there’s no particular reason for them to do so unless their employees are clamoring for it (often companies that don’t need to go public to get funding do need to go public eventually to give their highly valued early employees, who’ve been paid relatively little but earned a lot of equity, a way to rationally sell some of their shares).

Palantir is about 10.8% of GSV Capital’s portfolio, making it their second largest holding after Twitter (TWTR)[21], at 22.5%. So yes, in some ways you could say that buying a share of GSVC for $10.15 is like buying a piece of GSVC for $1.09 (10.8% of $10.15) — though GSVC usually trades at a substantial discount to the NAV of their portfolio, so the math gets a little silly at some point. As of September, GSV’s “net assets per share” stood at about $15, which is roughly equivalent to their book value. In their early days as a public BDC, the shares usually traded right around book value, spiking up before the Facebook IPO to more than 3X book value, but since then it has generally traded at a substantial discount (for the Twitter IPO the reaction was much more muted, GSVC’s shares then topped out at about 1.25X book value).

So the discount to book value basically means that the market either thinks they overpaid for some of their companies, or are overvaluing them now, or that it’s simply wise to discount the valuations of private companies and not pay full price. Much of the value that individual investors see in pre-IPO companies like Dropbox or Lyft (two other companies they own pieces of, Dropbox is a fairly large holding) comes from the scarcity — once you could buy Twitter on the public markets, not so many individual investors were excited to buy GSVC as a way of getting exposure to TWTR… even at a discount.

And, of course, part of that discount is probably due to the fact that you’re essentially buying shares in a levered hedge fund — GSV Capital pays a management fee and an incentive fee to its portfolio managers that, if combined with their overhead, means they’re spending something close to 10% of their asset value each year (that’s going by just the last quarter, when expenses were about $8 million), and they do borrow money (only about $68 million in debt last quarter, versus the $475 million valuation for their portfolio, so it’s not egregious). Venture capital always comes with high fees, so that’s no surprise — and I have no problem with incentive fees for managers who generate consistently strong long-term returns, though I’m not so sure GSVC has proven themselves on that front yet.

They have grown the book value of the company by about 7% since the Summer of 2012 — the only real growth in GSV’s book value came in their first year as a public company, back in 2011… so it’s too early to judge their long-term performance, perhaps, but not too early to remind you that so far their only success has come from the popular excitement over the Facebook and Twitter IPOs, and that the Twitter IPO and their gradual sell-down of that TWTR position, though it did boost their stock market valuation for a while, failed to be successful enough to cover their losses in other venture investments over the past 18 months. There’s a reason why venture capital investors are diversified, and why venture funds tend to tie up their investors capital for long periods of time, often with funds that have a fixed life of ten years… long term investors in GSVC would have to be patient, I expect, and short-term traders should be looking for those spikes in value if any excitement develops over one of their companies possibly filing for a high-demand IPO.

You can see the portfolio makeup for GSVC here[22] or their “Investment Backgrounder” here[23]. The shares of GSVC have been moving up recently, though I’d argue that’s at least as much about Twitter’s recent improvement as it is about Palantir and any potential IPO they might have (Dropbox will very likely go public before Palantir, though their competitor Box’s early days as a public company may not be encouraging them to hurry). GSVC is indeed a levered investment in private, venture-stage companies, and if the past is prologue they’ll depend on fairly high-profile “exits” to get a big premium to net asset value — I haven’t parsed their universe of smaller investments in education or social tech to hazard a guess at whether there are other big “hits” in that portfolio.

There are other BDCs[24] that invest in venture companies, from Prospect Capital (PSEC)[25], which puts a smaller amount into those riskier holdings, to Hercules Technology Growth (HTGC), among others — Prospect was teased by the Oxford Income folks as a play on the “President’s Private Stock Market” last year[26], Hercules by Ian Wyatt[27]’s High Yield Wealth[28] as a “silicon valley bank” last year — both of those pay substantial dividends[29] and focus more on lending to venture or technology companies and get a (smaller) kicker from rising equity values at their client companies, which is more typical of a BDC. Neither of those is guaranteed to be safe either, of course… PSEC has had a rough few months and trades at about 90% of book value these days, HTGC is flying a big higher and trades for 1.5X book, I haven’t looked at them in any detail recently. As income investments, they will likely be much more sensitive to changing interest rates than is GSVC.

It makes sense to me that GSVC trades at a discount to their portfolio’s current valuation, but if there’s a mania of excitement over Coursera[30] or Dropbox or Palantir then sure, it’s possible that investors will trade it up rapidly and give you a nice windfall — but I suspect, after the Facebook and Twitter investments failed to work out for “buy and hold” GSVC shareholders, that there will be other folks eager to “sell on the news” if that happens as well, which would mean a pretty bumpy chart for the stock. Sound like the kind of thing you want to own or speculate on? Let us know with a comment below.

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