Description

Safeguard is a publicly traded venture capital firm in the midst of a liquidation. The company was last written up at $11 in March 2019. Since then, the stock is down over 35% despite material progress on the wind-down. In addition, the company may face non-fundamental selling in the next month as they are kicked out of the Russell 2000. Blackrock, Vanguard, and State Street alone own 3.4m shares, representing ~29 days of volume.

While the company is liquidating, both the opportunity and risk reside in the fact that the timeline and proceeds are largely out of management’s control. The company cannot put out a proxy with a definitive range or timeline, as they are dependent on the liquidity at their portfolio companies. After ~3 years of winding down, today the portfolio is arguably comprised of the best remaining investments with the highest probability of positive returns from cost. Today the company trades at a 30% discount to the cost of their portfolio, and is actively buying back stock at a discount to fair value.

Brief History

Prior to 2018, Safeguard operated as a VC firm investing primarily in healthcare and digital media. The company has a mediocre but positive track record. Over the past 15 years, they have realized 36 investments, netting a 1.3x MOIC and a 9% IRR over the period. Despite having a track record of making money, the company still trades at a discount to the cost of their investments.

Historically, Safeguard has mostly recycled proceeds from successful investments back into new ones. From 2010-2020, the company spent over $400m on new investments, $175m on paying down debt (fully repaid as of 2019), and only $56m on returning capital.

The strategy changed in 2018 when an activist, Joe Manko of Horton Capital, became involved. Horton eventually gained control of 2 of the 4 outstanding board seats, and motivated the transition away from Safeguard’s long-time CEO Steve Zarilli to Brian Sisko to wind down the business. The process was slow during Brian’s tenure, and he was replaced at the beginning of 2020 with Eric Salzman. Eric was originally hired as Chief Restructuring Officer, and was later promoted to be CEO in the fall of 2020. Eric has succeeded in monetizing a number of investments, as well as trimming the portfolio of those with a lower probability of success.

Liquidation Process

In January 2018, motivated by Horton, the company announced they would cease deploying capital into new investments, and would only deploy capital in select follow-on opportunities in order to maintain their ownership interest where it would be important.

As a part of the new strategy, the company has also worked to reduce their cost structure. The run-rate G&A for the business has been cut by 75% from more than $18m/yr to ~$4.6m/yr for 2021. Major sources of savings have included the exit of their office lease, reducing headcount to a few key remaining employees (CEO, CFO, GC), switching auditors from KPMG to Grant Thorton, as well as number of other changes. As the portfolio continues to shrink, the cost structure should as well (for example, as the company shrinks, they will no longer need an in-house GC, etc).

In terms of the actual liquidation, the company has made substantial progress, reducing the number of investments to 12 as of Q1 2021. These are again arguably the best positioned for success, given the company has made a concerted effort to trim or eliminate the less promising portfolio companies.

These investments are mostly in the mid/later part of their lives, with the most recent being five years ago in 2016. However, these companies are in varying stages of growth or monetization. A number are looking to capitalize on favorable market conditions to either raise capital or generate liquidity for their investors. Out of the remaining 12, one is slated to go public this summer (S-1 already filed), another is in the middle of a strategic process, Mediamath was just reported by the WSJ to have hired Centerview to run a process, and a handful of others are entering into discussions with bankers.

The majority of the remaining portfolio is comprised of healthcare companies, a number of which including Prognos, meQuilibrium, and Zipnosis (recently bought by Bright Health for equity) are covid beneficiaries. Some of the digital media companies faced headwinds through covid due to exposure to retail and travel, but have returned to or exceeded pre-covid levels.

Potential Sources of Outsized Returns

Despite the fact that Safeguard trades below the cost of its portfolio, SFE has a number of investments that have the potential for substantial upside. (Some of these have been highlighted by SFE in “fireside chat” discussions - all replays are available on their website includes interviews with CEOs of Flashtalking, Prognos, meQuilibrium, and Aktana).To highlight a sample of some of the most promising below.

Flashtalking: This is a fast-growing, profitable and independent ad-tech company. It is the first and leading cookie-less ad management platform, thought of as the “anti-cookie / anti-Google” solution for advertisers who are preparing for Google’s elimination of the cookie in 2022. The company has been profitable since day one is growing despite exposure to retail/travel verticals that were negatively impacted by covid. We have spoken with customers and other industry participants who have indicated that Flashtalking is by far the first mover and leading player in terms of optimizing ad campaigns without cookies.

A number of Flashtalking’s ad-tech peers with similar growth rates and margins trade at very rich valuations of >5x sales and >20x EBITDA. SFE’s cost basis ($19.2m / $0.91/share) implies a valuation of $145m for the company, or 1.3x 2022 Sales / 5.9x EBITDA. A valuation of 10-15x EBITDA, while still a large discount to peers, would be a meaningful improvement relative to the current share price. If Flashtalking were valued in-line with the peer median, it would be worth $4.27/share to SFE, or 60% of the market cap and 73% of the enterprise value.     

MediaMath: Another ad-tech company, this has similar potential in terms of magnitude of upside, though a greater degree of risk. MediaMath has long been the #2 independent DSP (Demand Side Platform), facilitating programmatic buying of advertising. The closest peer is Trade Desk (TTD), which trades at 18x 2022 sales and 50x EBITDA. Peers Appnexus, Marketo, and Dataxu have all been bought by strategics for between 5-17x sales. It was reported last week that MediaMath recently hired Centerview to run a strategic process. They last hired bankers in June 2020 to explore restructuring their debt. This time around should be more from a position of strength given the recovery in the ad market, and various improvements the company has made over the past year.

MediaMath has had a rocky road since their last round of funding in June 2018. That round of funding launched the company into unicorn status after raising $225m from a number of firms including Searchlight. Since then, MediaMath has undergone multiple restructurings (some due to covid pressures on the ad business) a lawsuit with Searchlight, a management reshuffle, and a new product rollout.

We have spoken with multiple former employees of MediaMath who consider the company to be at an inflection point. New leadership (excl. the Founder & CEO) has been installed over the past year, professionalizing the management team which has mostly been the same since the founding of the company in 2007. This new team is leading an improved user interface rollout, as well as a new initiative called SOURCE, which is oriented around the advertising “supply chain” and meant to improve transparency and accountability through the system. The SOURCE initiative is thought to be highly unique, but unproven. These former employees believe that if MediaMath can successfully make this transition, they could be worth an equivalent or greater amount than their last funding round in 2018. For reference, Viant (DSP), is a similarly sized DSP, and is currently worth ~$2bn, or ~8x 2022 Sales.

While the corporate restructurings, management reshuffle, and investor lawsuit are behind them, the company does have some debt, and is perhaps breakeven, maybe slightly cash flow negative, so the potential for a $0 here is real.

• In terms of the lawsuit, the details are available here (https://law.justia.com/cases/delaware/court-of-chancery/2020/ca-no-2020-0652-sg-0.html). Searchlight attempted to sue MediaMath over a matter of wording, and the suit was thrown out in December 2020. A former employee familiar with the matter described it as “ridiculous”.

Prognos: Prognos is a healthcare analytics platform. The company aggregates and structures patient-level clinical data from more than 325m patients, and provides a marketplace for life science companies and payers to purchase and access that data to improve patient journeys, provide care & risk alerts, etc.

Since last raising capital in 2017 at a $103m valuation (~10x fwd sales), the company has doubled in size from 2018 to 2020 to ~$22m in revenue. There are a number of incumbents in the space (Iqvia, Healthverity, others) which would be natural acquirers, and per conversations with a former senior employee, the management team is predisposed to sell rather than go after it for the next 5-10 years and really try to own the category. The company has apparently turned away money from investors in order to be as efficient with their capital as possible.

At SFE’s cost Prognos is valued at $44m, or ~2x 2020 sales. Even at a 25% discount to the last round (and the company has doubled in size since then), that would equal an incremental $0.45/share to SFE. If the valuation stayed flat (~10x sales), based on 2020 revenue, Prognos could be worth $217m, or almost $3/share in value to SFE.

Bright Health: SFE acquired an interest in Bright Health in March 2021 through the sale of Zipnosis, a telehealth company. As part of the deal, SFE received $3.3m of cash, and an equity interest which SFE valued at $15.3m. In mid-May, Bright Health filed their initial S-1 to go public, and earlier in April, Bloomberg reported they could be seeking a valuation of up to $20bn.

In Bright Health’s S-1, the company disclosed they issued 1.4m shares as part of the Zipnosis acquisition, and assuming SFE was entitled to their pro-rata share of 37%, that would equal 530k shares.

Based on SFE’s mark, and the 160m shares outstanding (pre-offering), it seems SFE’s stake in Bright Health ($29/share) implies a valuation of $4.6bn. Should Bright Health be able to achieve their reported goal of up to a $20bn valuation, that could lead to a meaningful lift in SFE’s equity interest.

Governance

Governance isn’t a huge issue given the presence of the activist Joe Manko, and another affiliated director, Russell Glass. Eric Salzman the CEO seems committed to the wind-down, though his incentives are not fully aligned with shareholders (as displayed in the recent advisory vote on compensation, which narrowly passed with 52% of votes for, and 48% of votes against).

The main issue is Salzman is paid very well (arguably too well) and his compensation will likely need to be adjusted, especially as the portfolio becomes smaller. While he is motivated by the stock price, there is no real incentive for him to wind down SFE as fast as he can. Salzman makes a $500k base salary with a bonus opportunity, while also having a full-time CFO and GC to help him out. He does have a 100k share PSU grant (drivers undisclosed), and has been paying taxes in cash rather than paying via delivery of shares, leading to him effectively ‘buying’ stock.

The company is fairly unique in its use of cumulative voting. Under the structure, each shareholder can pool their votes for a single candidate (# Votes = Shares Owned x # Directors… all votes can be directed towards one director). In the case of SFE, owning 1 share entitles you to 4 votes (4 directors), which can all be directed to a single nominee. This provides added influence for active managers. In addition, as the passive ownership cycles out following the Russell 2000 deletion, shareholders should be even more capable of positively effecting change if need be. 

Valuation

SFE currently trades at a >30% discount to the cost of its investments, and a more than 50% discount to where these companies were valued on a last-round basis.

In a scenario where Safeguard achieves slightly better than its cost base, cash is written down fully, and no credit is given to the $6m buyback program (a 10b5 program is currently in place being run by Stifel), you can get to a share price of ~$11, or >50% above current levels.

As discussed, there is potential for material upside from one or more of a number of investments. If any of these do work in a big way, it not only augments the return profile, but also substantially de-risks the investment from the current price of $7.00.

Taxes are a non-factor in all but the upside case, as SFE has more than $360m of NOLs.

Risks: The obvious risk is this a portfolio of venture capital investments, many of which are unprofitable. Profitable exits and liquidity depend on open and favorable capital markets. 

Catalyst

Further portfolio monetizations