Safeguard Scientific (SFE) – Tender Offer and Liquidation – 35% Upside

Current Price: $8.54

Offer Price: $7.90 - $9.00 and $11+ in liquidation case

Upside: $45 in tender for odd-lots or 35%+ in liquidation case

Expiration Date: October 1st, 2021

Proxy

 

Liquidating VC fund Safeguard Scientifics announced tender offer for 20% of its outstanding shares. Aside from the current offer, there is also a rather risky liquidation case with 35%+ upside but highly uncertain outcome and timeline.

The tender range is set at $7.9 - $9.0/share resulting in $45 upside and $63 downside opportunity for odd lots. Directors own 3.8% and will not tender. Participating with a larger position seems risky - despite a fairly large tender size and company trading materially below liquidation value, SFE trading volume is quite limited on most days, so if larger holders decide to exit, the tender may get filled up rather quickly.

Major shareholders - First Manhattan (5.3%), Thomas A. Satterfield (6.6%), Yakira Partners (5%).

 

Liquidation Scenario

SFE is a VC fund, which used to invest in healthcare and media/tech sectors. Historical investment returns were poor, generating 2% IRR from 2006 to 2015. After the activist pressure the fund initiated the liquidation process in early 2018. There seems to be a 35% spread to the post-tender liquidation value if portfolio investments are accounted at cost basis. However, due the nature of the portfolio and questionable managment's incentives, the range of potential liquidation outcomes is wide and the risk of thinks going south is significant. The timeline of investment monetisation currently unclear.

More details on the liquidation thesis can be found here. Brief summary is provided below.

At the moment, the portfolio consists 11 holdings, mostly equity investments in private firms. Portfolio composition as of June’21 presented in the table below. Also at the end of Jun'21 the company had $21m in cash, or $18m in net cash after deducting current liabilities (no long term liabilities except for headquarters lease).

Note: management argues that carrying value is not reflective of the true value and should be ignored as a simple accounting entry (presentation).

Since Jun'21, the company has exited exited Flashtalking generating $44.8m cash proceeds (vs $19.2m cost basis) and announced the current tender offer for $35m of outstanding shares. On top of that, SFE owns 1.3m Bright Health Group (BHG) shares, which at the market value are worth around $13m, but will be locked until Dec'21.

Excluding Flashtalking and attributing full market value of BHG shares the total cost basis of the company's portfolio stands at$166m. Assuming the company closes the tender at current price by repurchasing 4.1m shares, it will have around $28m of net cash left (excluding current liabilities). That sums up to the liquidation value of $194m vs the post-tender market cap of $143m (assuming the share price stays the same). SFE has $362m of NOLs so taxes are not the issue here.

Compared to post-tender market cap, there situation seems to offer 35% potential upside, however, it is important to note that the company is burning $5m in annual G&A (ex. stock based comp., based on management communication during the latest conference call), while the remaining portfolio also requires $5m-$7m of follow-up investments annually (should decrease in time as the portfolio shrinks). This way, the whole thesis ends up depending on the assumption that management will be able to exit investments significantly above the cost basis so that the difference will be enough to cover both the cash burn and potential losses from any failed investments. The few recent exits (Zinopsis was exited at over 80% of cost basis in April) provide some confidence for this case, but given the nature of the portfolio (VC style investments in tiny healthcare/digital media companies) and terrible historical track record of the investments (only 2% IRR), the uncertainty is high.

On a positive note, the company seems to be moving in the right direction and has significantly reduced corporate overheads from the $16m in 2018. The activist Joseph Manko is still on the board, which should keep the management in check. On the other hand, Manko and the board itself own negligible/small amount of stock, while the combined compensation of the CEO & CFO alone was over $1.1m in 2020, which seems excessive and not that shareholder friendly.

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