June 12, 2018 - 4:34pm EST by
2018 2019
Price: 95.25 EPS 0 0
Shares Out. (in M): 40 P/E 0 0
Market Cap (in $M): 38 P/FCF 0 0
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT 0 0

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I’m writing to recommend the convertible bonds of GSV Capital (“Global Silicon Valley”; ticker: GSVC) at the current price of approximately 95.25.  GSVC is a publicly traded investment company organized as a Business Development Company (“BDC”).  Hence the name, GSVC makes investments in private companies, generally in the technology/internet space with very large TAMs.  While some might call this “venture capital”, the initial concept behind the company was to invest in pre-IPO equity offerings or to purchase private stock on the secondary market pre-IPO from founders, employees, or early-stage investors looking for liquidity.

I think the convertible notes are compelling for 2 reasons:

1)                   1)   The 5.9% yield for just under 5yr paper is decently attractive for notes which I think carry minimal (if not negligible) risk.  The only possibility of impairment I can imagine would involve either outright fraud or extremely gross negligence by the managers.  Adjusting for certain balance sheet items, there are $264mm of assets supporting the $40mm of debt (6.5x coverage) which I expect to increase to $281mm by 2Q (7x coverage).  $51mm of these assets are cash and $122mm (as of 1Q18) comprise of Palantir, Spotify, Coursera, Dropbox, and Lyft, highly liquid public and private companies sporting multi-billion dollar valuations. 

2)                   2)    I don’t think the current bond price incorporates much value to the convertibility feature of the notes.  The strike price for the converts is $10.72/share, very far out of the money relative to the current stock price of $6.75.  I will describe my view in more detail below but I think the stock is very undervalued.  NAV as of 1Q18 was $9.99 per share and I expect it to increase to $10.60 at the current prices of SPOT and DBX.

In summary, with the convertible notes, I think you get to get a free option on a high return investment company with a strike price approximately at the current NAV (my calculation) while earning a low to no-risk yield of ~6% while you wait for either the NAV to continue to increase or the discount to the NAV to compress.


Background – Coming Full Circle

GSVC IPO’ed in 2011 with the pitch of offering public markets investors access to large and growing private companies.  I think the concept made sense – the argument was that access to capital was just as easy (or easier) in the private markets as it was in the public markets so the fastest growing companies were waiting longer and longer to go public.  I personally think this was a great idea and it would have been a phenomenal success if they stuck to that business model.     

Despite home-run investments in Facebook, Twitter, Spotify, Lyft, Palantir and probably others (these investments returned 2-5x back to GSVC), GSVC has not created any value for shareholders since its IPO.  This was also over one of the frothier 7 year time periods in public and private market history.  The major cause for this underperformance was what I would consider “strategy shift”.  With the success of Facebook and Twitter, I think management got arrogant and began making many very early stage investments in seed and series A equity offerings.  This is obviously a very different risk profile from a final capital raise before an IPO or a secondary purchase before a slated IPO.  Management proved atrocious at the true “venture capital” game and squandered the substantial profits they were able to make on their later stage and lower risk investments.

I say they have come full circle because they have acknowledged their mistakes and will not make seed or series A investments going forward.  They are concentrating their portfolio back to the larger and more established private companies.  The portfolio has gone from 45 investments as of the end of 2016 to 29 investments as 1Q18 (28 or less now).  The top 5 investments make up 59% of the portfolio and the top 10 are 83%.  Rather than a smorgasbord of small VC investments, GSVC shareholders have a very good sense of what is in the portfolio and thus should be able to feel far more comfortable with the marks and NAV, something which I think is very important to investors in closed-end investment companies.  Going back to the basics is working too – NAV/share has increased from $8.66 as of the end of the 2016 to $9.99 as of the end of 1Q18.


Fee Reductions, Share buybacks

In December of 2017, a larger investment firm, HMF Partners, made a strategic (undisclosed) investment in the manager of GSVC, GSV Asset Management.  Maybe it is a coincidence, but ever since the HMF investments, GSVC has been significantly more commercial and shareholder friendly.  They have reduced the management fee from 2% to 1.75%, forfeited $5mm of accrued but unpaid incentive fees (the incentive fees are not paid until investments are realized and must beat an 8% hurdle), agreed that incentive fees would not be paid until both the NAV and share price exceeded $12.55 per share, and initiated a share buyback.  They bought $5mm of stock in 2017 at an average price of $5.28/share and further bought $1.2mm of stock in 1Q18 at an average price of $6.90.  There remains $8.8mm authorized under the share repurchase program (three separate authorizations of $5mm).  BTIG is taking the management team on an NDR in New York this Tuesday so they are become more investor-facing as well.

Share-repurchases obviously reduce the amount of assets for which the managers earn fees so I think it’s a powerful sign for how cheap management believes its stock is.  I also think management is now playing the long game in terms of fees collected.  I think they feel strongly about the stock price increasing beyond the $10.72/share strike price on the converts.  While they will lose $15mm of assets to earn fees on now from the share repurchases (far away from their HWM to earn incentive fees), the increase in the NAV could easily offset this.  Also, $40mm of convertible notes will become shares above $10.72 at which time they will likely be able to re-lever with a new, larger convert offering, further increasing their asset base.


Balance Sheet and NAV per share

I believe it is BDC regulations that cause the “investments in US T-bills” on the balance sheet at the end of each quarter.  I adjust the balance sheet to remove those Tbills (and the payables associated with them) and I ignore the $50mm of convertible notes that will be retired with cash in September.  With these adjustments, I view the balance sheet as of 3/31 as $212mm of investments, $51mm of cash, and $40mm of debt related to the converts I am suggesting here. 

SPOT and DBX are both public now, so assuming they have not sold any shares of SPOT (they are still subject to their 180 day lockup for DBX), those should add $11.8mm to the NAV at current prices.  They fully exited General Assembly Space in the quarter which I assume was at NAV which will add $9.6mm of cash to the balance sheet.  Lastly, GSV Labs (fka NestGSV) raised $7mm at a $25mm pre-money valuation.  I calculate that this added $5.7mm to the NAV.  I deduct $3mm from the NAV during the quarter for interest, fees, and expenses.  Thus, given the information we have today (assuming other valuations remains static), I think the company has $220mm of investments, $61mm of cash (7x coverage on the notes), and a NAV of $10.59/share.

If I like the convertibility feature of the debt at $10.72, why not suggest the stock at $6.75?  If the company were more aggressively buying back stock, I probably would be.  Given just the $6.2mm thus far, the jury is still out for me.  At this point, I like the risk-reward profile of the bonds more.  I personally believe the bonds are cheap outright (I know it is a very small issue, but 6% for 7x covered 4.75yr paper just seems far too wide).  I still believe there’s a better than 50/50 probability that there is a strong rally in the stock which will drive the price of the bonds higher, but small-cap closed-end fund stocks are difficult to predict, thus I would prefer to collect my yield and hope for big pop in the stock in the coming years.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


1Q18 Earnings

Further share buybacks


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