I just read in the WSJ about the plunge in value of a couple business development companies (BDCs) following the IPO disaster that is Facebook (FB). BDCs are interesting creatures — essentially, they are publicly-traded private-equity funds that typically invest in small to medium-sized companies’ debt and equity. Two BDCs were discussed, SVVC and GSVC. The more interesting company was SVVC (Firsthand Technology Value Fund, Inc). The article indicated it was trading at a discount to its cash value. I have in the past made investments / longer-term trades based on special situations and valuation so I decided to exercise my value-investing skills and take a look.
The first thing to do when investigating something like this is to calculate its pro-forma numbers. BDCs have a net asset value (NAV) that is updated quarterly. Because of its large share issuance in April and its large holdings of FB, I had to adjust all the numbers from its most recent quarterly report. Take a look at the Google Doc with my numbers. I came up with net cash value per share of $20.39 and an adjusted book value per share (accounting for the decrease in value of publicly traded stock in Facebook and Intevac since the end of the first quarter) of $24.10. With a closing price yesterday of $18.24, SVVC would seem to be a screaming buy, because it is trading at a 10.5% discount to its cash alone (ignoring the value of its investments).
The problem with looking at the valuation that way is that BDCs exist to invest, and depending on the market’s mood, BDCs can trade at a premium or a substantial discount to their NAV. In fact, it is much more common for them to trade at a subtantial discount to their NAV. One BDC I am quite familiar with, having previously invested in it and analyzed it in detail a few years ago, even talking to their CFO, is MVC Capital (I am no longer invested in it). Of the BDCs that existed a few years ago, MVC Capital was my favorite. As of the market close yesterday ($12.48) and using the NAV from the end of April (the most recent NAV given by the company), the stock is trading at a 27% discount to NAV.
SVVC will not liquidate and give cash back to shareholders. The cash it has will be invested and as a result it should trade in line with other BDCs, at a discount to the total value of its assets. It is currently trading at a 24% discount to its NAV (adjusting for the decrease in value of publicly traded stock since its last NAV report at the end of March, but not accounting for the likely decrease in the value of its private equity investments). This discount is similar to the discount of MVC Capital (which invests in significant debt as well as equity, meaning it has less market / business risk), meaning that SVVC is fairly valued, despite trading at a discount to net cash (liquidation) value.
Disclaimer: I have no positions in any stocks mentioned and no relationship with any people mentioned. This blog has a terms of use that is incorporated by reference into this post; you can find all my disclaimers and disclosures there as well.
Couldnt this argument be applied to all companies? For example, lets say a manufacturing company has only these items on its balance sheet: $30 cash, $10 PP&E, and $40 equity. Lets say its fully diluted market cap is $25. You may argue that it is not undervalued because management may invest the $30 cash in unprofitable ventures rather than dividending it out. However, many people would call this a raging buy! It is what Benjamin Graham would call a net-net. http://greenbackd.com/2009/04/03/tweedy-browne-updates-what-has-worked-in-investing/
Operating companies only rarely trade at discounts to net cash value. But I think the important thing is that because BDCs hold primarily illiquid investments and they mark them to model (as there is no market for them), in times of market stress investors mark down the value of those illiquid investments to reflect the decreases in value that are not captured by the price the BDC values those investments at. So then the stock of BDCs trade at a discount to the market.
Your argument is of course correct in that if management invests well, then the company certainly should not trade at a discount to book value, let alone cash value. But the record of SVVC management is fairly poor so far, with a $3 decrease in NAV from inception in spring 2011 to the end of 2011.