MeVC: An Internet Value Stock?
By Whitney Tilson
July 17, 2000
I used to buy tech stocks -- in fact, a lot of tech stocks. For a number
of years, approximately half of my purchases were in this sector, as I
added some of the world's finest companies to my portfolio at, if not
cheap, at least reasonable prices. But as valuations soared -- the
Nasdaq rose more than 50% in the second half of last year, and
another 4% so far this year -- I stopped buying tech stocks because I
was increasingly uncomfortable with the risk/reward tradeoff at such
high prices. In fact, for more than a year, since mid-June,
1999, I have only purchased one stock in this sector: I recently bought the meVC Draper
Fisher Jurvetson Fund I (NYSE: MVC) , which I believe remains
attractively priced.
The meVC Draper Fisher Jurvetson Fund I
The meVC DFJ Fund is a venture capital fund that invests in (from the
prospectus) "information technology companies, primarily in the
Internet, e-commerce, telecommunications, networking, software and
information services industries." The fund focuses on mezzanine
round investments, which are generally the last financing events prior
to an anticipated liquidity event (e.g., a sale/merger or IPO).
The fund's manager is John Grillos, who has over 20 years of
experience in the information technology industry, including 10 years
as a venture capitalist. I spent an hour with Grillos in April and was
very impressed. He's a no-nonsense guy with very little patience for
the hype that still characterizes much of the dot-com sector in Silicon
Valley.
Unlike most venture capital funds, which can tie up an investor's
capital for 10 years or more, the meVC DFJ Fund is structured as a
closed-end fund and its shares trade on the New York Stock Exchange,
so investors have full liquidity. Because it's publicly traded, the price of
the fund can fluctuate widely, which can create excellent buying
opportunities for patient investors.
Like most venture capital funds, the meVC DFJ Fund charges investors
a hefty 2.5% annual management fee and takes 20% of the net
profits.
Why Venture Capital?
In my last column, "Twelve Internet Myths," I concluded -- despite my
skepticism about many of the businesses in this sector -- that there
are some excellent investments. Sometimes I buy the stock of a
public company, but I've found that many of the best opportunities lie
in private companies because they are generally priced much more
attractively.
Getting in not just at the IPO price, but at the price one or more
rounds of financing prior to an IPO can make an enormous difference
in returns, as evidenced by the fact that average returns to venture
capital investors were 146% in 1999. Over the past 10 years,
later-stage VC returns have averaged 26.5% annually versus 18.2%
for the S&P 500. That's more than a tenfold increase vs. a fivefold
increase in the S&P 500. Pretty amazing, eh?
But very few people see enough deals or have the skills to invest
directly in private companies, and you have to be an accredited
investor ($1 million of net worth or $200,000 of annual income) and be
well connected to invest in pretty much any venture capital fund.
Venture Capital for the Masses
So what's the average investor to do? One option is to invest in the
stocks of the few corporations that are effectively VC funds, such as
Safeguard Scientifics (NYSE: SFE) , CMGI (Nasdaq: CMGI) , and
Internet Capital Group (Nasdaq: ICGE) . In a spectacular mania,
these stocks skyrocketed late last year and early this year -- and have
since crashed by 63%, 71%, and 81%, respectively, from their
52-week highs. But even at today's lower valuations, they still appear
to trade at significant premiums to their asset value (it's hard to
calculate this number accurately). Also, as corporations, any
distributions are double-taxed, just as dividends are.
Andy Singer, the CEO and co-founder of meVC, has a different vision.
By creating a family of high-quality funds open to all investors on the
same terms as traditional venture capital funds, he seeks to
democratize this clubby world. The meVC DFJ Fund is the first of many
funds he plans to create under the meVC name.
The Fund's Valuation
In March, 20,000 investors bought 16.5 million shares of the meVC
DFJ Fund at $20 each, raising a total of $330 million. After the
underwriting and other fees, adding back interest, the net asset value
of the fund today is $19.07 per share. This is composed of
$5.79/share of investments (Grillos has made 11 investments so far,
including one today, totaling $95.5 million) and $13.28/share in cash
that has yet to be invested. Yet the fund closed Friday at $16. That
means that an investor is buying $5.79 worth of investments for $2.72
($16.00 - $13.28) -- a 53% discount.
It's not quite this simple, of course. The cash isn't going to be paid
out -- it will be invested over the next two years -- so an investor must
have confidence that a significant number of the fund's current and
future deals will be successful. But how? The future deals are
unknown, as is key information about the 10 deals to date, such as
the valuation at which Grillos invested or the financials of the
companies.
A number of factors give me comfort, beyond Grillos' track record and
my personal impression of him. First, the fund has co-invested so far
with some of the top names in the venture capital business: Bain
Capital, BancBoston, Battery, Bessemer, Bowman, GeoCapital,
Hummer Winblad, Maveron, Mayfield, Morgan Stanley, Oracle,
Sequoia, Technology Crossover Ventures, Trident, Venrock, Yahoo!,
and Zero Stage Capital (you can read the press releases for a full
list). Also, the first investment wasn't made until May 22, long after
valuations had dropped markedly.
A final point worth noting is that the value of the fund's investments
are likely to increase over time as the companies grow, yet this will
often not be reflected in the net asset value calculation, which is
based on the price paid for the investment or the valuation of the
most recent round of financing, both of which can dramatically
understate the true value of a holding. Thus, there's an argument to
be made that the fund should trade at a premium to net asset value,
rather than the discount that is typical of most closed-end funds.
Why Is the Market Mispricing the Fund?
To make an investment, I have to believe that the market is
significantly undervaluing a stock. So why do I think that the market is
undervaluing the meVC DFJ Fund? Two reasons. First, the fund is in a
very unpopular sector. Since the end of March, the Nasdaq has fallen
more than 10%, and the stocks of publicly traded VC funds have
fallen far more. Once high-flying incubators (now scornfully called
"incinerators" by many) have been unable to go public or, in the case
of divine interVentures (Nasdaq: DVIN) , gone public with uninspiring
debuts. But the meVC DFJ Fund is not an incubator, nor is it doing the
riskiest early stage deals. In general, it is investing in companies with
established economic models, complete management teams,
numerous customers, and meaningful revenues.
Second, the meVC DFJ Fund is new and has only been trading since
June 26 (after the fund closed, the shares didn't trade for 90 days to
give Grillos the opportunity to make the first investments). Thus, it is
not yet well known and there is no Wall Street coverage. This will
undoubtedly change.
Conclusion
Venture capital is not for the faint of heart. Even in a well-managed,
diversified fund, investors run the risk of substantial losses, especially
given the still-high (though much reduced) valuations. But if you're
looking for exposure to the Internet sector -- something I'd only
recommend for a small percentage of your portfolio -- I believe that
buying the meVC DFJ Fund is one of the best ways to do it.
-- Whitney Tilson
Whitney Tilson is Managing Partner of Tilson Capital Partners, LLC, a
New York City-based money management firm. Mr. Tilson appreciates
your feedback at Tilson@Tilsonfunds.com. To read his previous guest
columns in the Boring Port and other writings, click here. |
