Description

Investment Thesis: Harris & Harris Group (“TINY” or the “Company”) is a public venture capital company that focuses its investments on tiny technology. The confluence of the following makes TINY an attractive short: (1) mediocre track record, (2) inability to invest significant sums, and (3) a silly valuation.

The Company

TINY describes itself as venture capital company, specializing in tiny technology, that operates as a non-diversified business development company. TINY defines “tiny technology” as employing technology at the microscale or smaller. Microscale involves measurements in millionths of a meter. Nanotechnology involves measurements in billionths of a meter. I won’t pretend to understand the physics that underlies tiny technology. I submit such an understanding isn’t necessary. At the current valuation of TINY, I doubt that a typical VIC member will believe that such an understanding is necessary either.

Valuation

With 17.4 million shares and a stock value of $14.84, TINY is valued at $258 million. Since TINY is a venture capital fund, its compensation scheme resembles other vc funds, namely, its managers earn 20% of any net realized income. For our purposes, let’s assume that such a compensation scheme represents 15% dilution. Thus, TINY’s fully diluted value is $304 million.

Now what does an investor get for his $304 million? At September 30, 2004, TINY had fair value of investments of $78.6 million with a cost of $78.9 million. Right away, one can see that TINY’s track record has not exactly been spectacular. Let’s go a little deeper. Of the $78.6 million, $51.5 million is invested in Treasuries. That leaves only $27.1 million of venture capital investments. And all of that is not in tiny technology. TINY has investments of $16.8 million in tiny technology companies. The remaining $10 million is largely comprised of an investment in a non-tiny technology, public medical devices company (NeuroMetrix-(NURO)).

So what is an investor paying for TINY as a multiple of its tiny technology investments?

Market Value of TINY: $304 million
Less: Treasuries ($52) million
Less: Other VC investments ($10) million
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Market value of tiny tech investments $242 million

Multiple of fair value of tiny tech investments: 14x

Admittedly, the analysis is a little unfair. After all, TINY has $51 million of liquid investments that it can use to make investments in tiny technology companies. If TINY can invest the $51 million well, maybe the stock will be worth more than its current NAV. The best way to assess this possibility is to examine the Company’s track record. As of 12/31/03, TINY had invested in eleven tiny technology companies. As of 9/30/04, TINY had exited one of those investments at a significant gain (267%). One other investment was written up by 56%, three of the investments were marked at original cost and the remaining five had been written down an average of 56%. Thus, the average return has been 4%.

It is safe to say that if there are any hidden homeruns, they are unlikely to be hidden among the $5 million of investments that stood still. As anyone familiar with VC investing knows, successful start-up technology companies have an unlimited appetite for capital. If these companies could have raised capital at higher valuations, they almost certainly would have. The fact that they did not is strong evidence that TINY does not have significant unrealized gains in these investments.

Not only has TINY had mediocre returns, it is difficult for them to put their money to work. So far in 2004, TINY has managed to invest $11 million. To be sure, that is a lot more than the $3.7 million TINY invested in 2003. Still, it implies that TINY will not be fully invested for three to four years. In the meantime, shareholders get to earn a Treasury return on a significant percentage of the assets under management.

So what is left to discuss? Let’s compare TINY to a typical VC fund. A VC fund usually has a 20% override. TINY also has a 20% override. A typical VC fund charges no more than 2% for expenses. TINY’s run rate of operating expenses is $3.6 million per annum or 4.5% of assets under management. That is about three times what a VC fund charges. A typical VC fund permits investors to buy in at NAV. TINY is currently valued at 3.3x NAV.

There is no obvious catalyst here, just a truly ridiculous valuation. The borrow is a little tight, but I’ve been able to find shares consistently.

Catalyst

No real catalyst, just a silly valuation