Description

Today I am posting two ideas, one long and one short, each for a publicly traded investment vehicle. While not exactly a pair trade – I think each is interesting on its own, and the underlying assets are different – the basic set of facts relative to each other highlights the opportunity:

• One has an excellent long-term track record; the other does not

• One trades near its all-time widest discount to NAV; the other does not

• One is buying back shares aggressively; the other is not

• One owns a high-quality set of assets with public marks; the other does not

The Short: Sofina

Sofina (SOF) is a Belgian publicly listed investment vehicle that invests in private tech and growth investments directly and through third-party managers. Despite investing heavily in tech and growth, SSOF has significantly underperformed tech indices over the last two decades while extracting meaningful fees from shareholders. Sofina’s stated NAV was only marked down 18% in 2022 and is flat through its most recent update on 6/30/2023. As of 8/25/2023, SOF trades at a discount to the stated NAV of 27%, which is near its long-term average. We believe a short of Sofina provides meaningful potential downside via headwinds to NAV, the continued drag from multiple layers of fees, and the possibility of a larger discount over time. The stock is also an attractive hedge vs. longs focused on tech and growth, in our opinion. 

Performance:

Despite investing heavily in tech and growth over the past two decades, Sofina has generated mediocre returns, with NAV/share compounding at 5.5% since 2006 (in local currency). Stock performance has been in the same ballpark, while the QQQ has compounded at just under 15% over the same time frame: 

Today, Sofina stock is trading at a slight discount (27% Discount) to its historical average of 25%. 

Portfolio

Sofina splits its portfolio into two segments: Sofina Direct (54%) and Sofina Private Funds (46%). Sofina Direct invests directly and through co-investments, while the Private Funds business is allocated primarily to large venture capital funds. The overall portfolio is highly diversified, with the largest holding, ByteDance, representing 5% of NAV. The top 10 fund investments collectively represent 25% of the total portfolio value. 

In terms of portfolio quality, our base case is that this extremely diversified portfolio will likely get mediocre returns over time, consistent with Sofina’s history. Bytedance is likely the riskiest from a short perspective – it’s been reported that profits hit $25 billion in 2022 – but it’s just 5% of assets and likely has a wide range of potential outcomes for obvious reasons. Outside of Bytedance, nothing seems scary from a short perspective – Petit Forestier is a European company focused on refrigerated vehicle rentals. Cognita owns private schools around the world. Cambridge Associates is a large investment consultant. Between the small position sizes and profiles of the businesses, there doesn’t appear to be anything particularly asymmetric that could hurt the short. 

Sofina’s portfolio of VC funds has large, blue-chip managers in it. We believe the aggregate portfolio is likely overstated now due to the common valuation lag amongst startups and venture capital after periods like 2022. The managers also charge significant fees – sometimes as high as a 3% management fee and 30% carry – which will continue to dampen any upside over time. 

Fees:

Per management, SOF does not charge an explicit management fee and carry like many other investment managers, but instead incurs "management expenses." These expenses are what the company believes it needs to run the business, like salaries, research expenses, office space, travel and housing allowances, stock options, and cash bonuses. Additionally, SOF has a Long-Term Incentive Plan (LTIP), which pays variable compensation tied to NAV growth over its primary benchmark, the MSCI All Country World Index (ACWI). While the company states they don't charge "carry," the structure of the LTIP is effectively carry (below), and it is measured vs. a benchmark that does not reflect the company’s focus on tech and growth investments. 

SOF also incurs underlying fees from its Private Funds investments. Taken together, the direct expenses charged by SOF and the underlying fees from its Private managers create a sizeable overall fee drag. 

Sofina repurchases a small number of shares, but it mostly offsets dilution from stock-based compensation. SOF also pays a small annual dividend of €3.24 per share or a 1.5% dividend yield as of 7/31/2023. With little capital returned to shareholders, most of the cash from realizations is funneled back into new direct or private fund investments. 

Disclosed Short from Gladstone Capital:

Sofina hit our radar when Gladstone Capital, a London-based hedge fund, publicly disclosed a short position in the stock. We have tracked and analyzed the disclosed short positions of hundreds of hedge funds, and based on public disclosures, Gladstone has one of the best track records, with notable bets against Atos, Adler Group, Orpea, Samhall, TeamViewer, and Embracer Group. While Gladstone's involvement is not necessary to be short Sofina, we believe it is an interesting additional data point. 

Based on our calculations, here is the performance of the stocks that Gladstone has publicly disclosed short positions in (this does not consider the cost of borrow):

Risks:

• ByteDance is the single largest investment for SOF and has a wide range of outcomes. 

• Sofina could materially step up its level of buybacks to actively work on reducing the discount to NAV

Catalyst

• Headwinds to NAV from tech/VC hangover
• Continued drag from multiple layers of fees