Oh boy, here's a whole new bunch to start researching!
Internet backdoor IPOs sure took it on the chin today. The followinf article from Business Week Online has a bunch of new (and old) backdoor ideas:
BW ONLINE DAILY BRIEFING
Street Wise by Amey Stone February 16, 1999
You, Too, Can Be a Venture Capitalist
How? By buying stock in a publicly traded company that invests in a portfolio of startups
Want to get in on those 30% to 40% -- and sometimes, far better -- venture capital returns? Unless you're part of that clubby elite with at least $100,000 to invest (and for top funds you would need millions), traditional venture firms won't give you the time of day.
There's a way, however, for all investors to play the venture capital game. At least a dozen publicly traded companies are, if not exactly venture capital firms, close to it. They seek out fast-growing young businesses in need of capital and invest a few million in them, usually forming a portfolio of 20 to 30 such investments.
Take note of this disclaimer: Most pros warn that these risky stocks should probably make up no more than 5% of your portfolio. Many of these companies -- excluding ones that focus on Internet and technology companies -- have performed poorly in the past year as small-cap stocks have lagged behind the overall market. Still, some value-oriented analysts believe that makes them good buys now.
"This is the only way that retail investors can invest in venture capital without committing a huge sum of money," says John Roberts, a senior analyst at Hilliard Lyons, a regional brokerage firm that specializes in finding good values in small companies. "The risks are very high, but you want to have a portion of your money invested there because, if these things work, they are clearly investments that have enormous return potential," says Al Shams, director of research at Southwick Investments, an Atlanta firm that specializes in uncovering small, under-researched stocks.
WHAT REALLY COUNTS. These companies exist within a variety of structures. Several are set up as closed-end funds. Others are structured as business development companies or regulated investment companies. But what really counts to investors is the expertise and track record of the manager who is calling the shots. With these kinds of firms, managers usually take an active role, recruiting top management at the companies they invest in, negotiating strategic partnerships and acquisitions, and helping take the company public when the time is right.
For instance, Nolan Lehmann, president of Equus II (EQS), has been a director at Equus II's management company since 1983 and sits on the board at 10 of the fund's holdings. "Each business is relatively small, and the managers generally don't have as much experience as we're able to bring to the party and don't have the ties with the financial community," he says.
As a group, publicly traded venture stocks have hardly been world-beaters, having lagged behind the S&P 500 during the past one, two, and five-year periods, and in many cases they've been net losers. Among those that have beaten the market over the short and long term are CMG Information Services Inc. (CMGI) and Safeguard Scientifics (SFE).
Indeed, for investors looking for a venture capital play, CMG is one of the most exciting stories. This Andover (Mass.) firm is part holding company and part venture capital fund for about 30 Net-related startups. Not only does CMG provide capital and guidance to its firms but it also gets its holdings to work together to share customers and technologies. Its marquee investments include several million invested early in Lycos (LCOS) and GeoCities (GCTY), investments that quickly appreciated 100-fold. CMG's stock has climbed from $10 to $104 in the past 12 months. Despite the high price, "I continue to love it," says First Albany analyst Ullas Naik. "It is probably the only long-term buy in my universe." He recommends that investors add to their holding on weakness in this volatile sector.
While Naik doesn't officially cover Safeguard Scientifics, he says he's impressed with it. Safeguard invests in a broader range of high-technology companies than CMG and has already risen 55% this year. It's expected to spin off its Internet Capital Group (ICG) division in a public offering within the next year.
BETTER VALUES? CMG and Safeguard Scientifics are two of the group's success stories. But other stocks may represent better values, partly because they don't focus as much on the high-flying technology sector. Shams recommends three stocks, all structured as closed-end funds (which means that, unlike traditional open-end mutual funds, the stock trades on an exchange, independently of the value of all the fund's holdings). All three are trading at about a 30% discount to net asset value (NAV), which is basically the market value of all the companies in the portfolio expressed in per-share terms. This means investors stand to benefit not only from the gains in the fund's underlying holdings but also when the discount narrows, which it will when small-cap stocks return to favor, Shams believes.
Houston-based Equus II invests in companies that already have a product and revenues but need capital to take advantage of new opportunities. Lehmann says Equus' specialty is investing in companies in consolidating industries and bolstering them with acquisitions. NCI Building Systems (NCS), a maker of metal buildings, is a signature deal. Equus invested about 10 years ago, when NCI had one plant in Houston and less than $20 million in revenues. NCI made about a dozen acquisitions, went public six years ago, and now has nearly $1 billion in annual sales. But NCI has a current p-e of only 11 when its earnings growth rate is 34%. "I'd say that's undervalued," says Lehmann.
So is Equus II, says Southwick's Shams. The stock has lost 50% of its market value in the past year, partly because of general weakness in the micro-cap market but also because the company had to write down some investments in oil-services companies last December. Shams reiterated his buy rating on Feb. 8, expressing faith in Equus II's experienced management and a conviction that its problems are temporary.
Another stock Shams recommends: Dallas-based Rennaisance Capital Growth & Income Fund III (RENN). It's similar to Equus II, but it makes loans in the form of convertible debentures, which can be converted to stock if the company is doing well. "If it's not successful, we're a debtor," explains President Russell Cleveland, in which case the company recovers its investment as loan payments. Its biggest position is in toy manufacturer Jakks Pacific (JAKK). Two other holdings: Display Tech (DTEK), which makes high-tech electronic signs; and Lifequest Medical (LQMD), which makes tools for microsurgery. Shams also likes Harris & Harris Group (HHGP), which is involved with earlier-stage companies, including several in medical technology.
Roberts mentions three venture capital plays he thinks are undervalued. Equus II, which is trading at about $15, is worth $22 or $23, he believes. Thermo Electron Corp. (TMO), which invests mainly in technology companies, is also trading at $15 and should, Roberts says, fetch $25 a share. Capital Southwest (CSWC), which he says is comparable to Equus, is trading at around $85 and is worth $140 to $150, he figures.
LENDERS, TOO. Roberts also favors some less risky companies that function more as small-business lenders rather than venture capital firms. Allied Capital (ALLC) and American Capital Strategies (ACAS) have yields of 8.2% and 9.5%, respectively. Least risky of all is factoring company KBK Capital Corp. (KBK), which purchases accounts receivable, he says.
Remember, though, that while these companies gain some diversification by investing in a range of properties, they're only as good as their management team. Consider Zapata Corp. (ZAP), a fish-meal processor that tried to remake itself as an Internet portal almost overnight by buying small Web sites. Despite management's sudden shift into a vastly different business, Zapata's shares climbed to nearly $25 on the news. But they plummeted to $7.50 when the company dropped its plans to acquire 31 Web sites. (It has since revived those plans.) Investors who weighed management experience could have avoided this fiasco.
Another cautionary tale for investors can be found in Sirrom Capital (SIR), which handed out small loans to dozens of companies but without as much due diligence as other lenders exercise, analysts say. Its share price crashed last summer after it disclosed that a few of its deals went sour. In January, Sirrom said it will be purchased by Finova Group (FNV), a large, conservative lender to small and midsize businesses that promises to add more due diligence.
What investors probably don't need to do is study the underlying holdings of these venture companies. As with mutual funds, investors shouldn't "second guess" the management team, says Roberts. "You have to believe that they know these companies much better than you do." So, if you put your money behind a smart, experienced manager who can shepherd a promising flock of young companies to success, you, too, can have a shot at scoring in the venture capital game.
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