Monday, March 7, 2011

Capital Southwest

Late last year, we looked at a situation that very much resembled a leveraged buyout opportunity in which ordinary investors could partake. Today, we look at an opportunity in another area that retail investors are usually blocked from: venture capital. But in keeping with the value mantra, there is one special characteristic of this investment that makes it appropriate for this site: the company trades at a large discount to its investments.

Capital Southwest (CSWC) is a "venture capital investment company whose objective is to achieve capital appreciation through long-term investments in businesses believed to have favorable growth potential." But while the company trades for just $370 million, it has net assets of $514 million, giving investors the opportunity to participate in the equity of the underlying companies at a rather large discount.

Of course, as with any investment, there are specific risks of which investors should be aware. Valuing companies with steady cash flows is hard enough (as proof, consider the wild stock market fluctuations from year to year of even the most stable of corporations), but valuing young, development stage companies is even harder. There is no public market for most of Capital Southwest's investments, and therefore it's hard to know the margin of error surrounding that $514 million number quoted above; it's entirely possible that there is no margin of safety, or conversely, that the margin of safety is much larger than we think!

This company's investing policy also appears a bit mixed, as it doesn't really stick to its "venture" mantra. It also looks for companies with positive cash flow, which is rare in the venture capital space (hence the need for direct investment). As a result, Capital Southwest also owns a number of public companies, including Heely's, which has been discussed on this site as a potential value play.

It's also possible that the company will trade for a discount to its investments eternally, or at least for a very long period of time. But shareholders should still benefit from the discount as long as net assets grow (which, of course, is far from guaranteed); if net assets grow 10% for example, then an investor who buys at a 50% discount sees a return of 20%. It should also be noted that Capital Southwest was trading without any discount as recently as mid-2008, which may help reassure those who fear the dreaded "eternal" discount.

To protect ordinary investors from themselves, securities regulations make it very difficult for regular investors to invest in venture capital funds. But through public company Capital Southwest, ordinary investors can indeed participate in venture capital, and at a large discount to the approximated fair value of Capital Southwest's net assets.

Disclosure: None


Paul said...

Hmmm...this one seems interesting. It's very nice to see that the CEO has about 8x his salary invested in the stock too.

If someone knows how much the investments are worth, I think he may be one of them.

Philbert said...

I own this one. Bought it a couple of years ago at around $70. Well run company, very low profile, long term investors, management owns about 24 percent of the outstanding shares.