Liquidation – 38%+ Upside
This is a liquidation of a former VC fund Safeguard Scientific. Liquidity is limited, daily trading volume is around $30k. As part of the ongoing wind-down process, SFE will distribute its excess cash to shareholders in the next quarter, which should be equal to c. $0.43/share or c. 40% of the market cap. The full liquidation process is expected to last 2 years. The amount of eventual shareholder distributions largely depends on the sale/exit proceeds of the company’s remaining private equity holdings. Using estimates provided by management, I arrive at SFE liquidation value of $1.52-$2.73/share. This implies a 38%-148% potential upside in two years with c. 40% of the invested capital to be returned in Q4’23. The main issue here is that SFE will be delisted after the dividend in Q4. This adds substantial uncertainty of holding the remaining 60% of your investment in a non-tradeable company for a few years until full liquidation.
SFE currently trades at a market capitalization of around $17m. The company has $15m of cash, no debt, and $13m in carrying value of equity investments in private holdings, out of which 7 are material enough to influence the outcome. These equity investments are mostly focused on healthcare and tech. The carrying value of these private holdings is significantly depressed and does not reflect the real market value due to equity method accounting. Equity accounting requires SFE to constantly adjust the carrying value of its investments downwards based on SFE’s portion of losses incurred by the investees (and losses are natural for these early-stage companies). Historically, SFE has exited most of its holdings at a very material premium to carrying value (see table below).
Management expects the remaining equity holdings to be monetized for $25m-$45m. This implies a 2x-3.5x premium above the current carrying value and is somewhat in line with the historical premiums achieved. Using these estimates, my liquidation value calculations are provided below:
- $15.1m – cash as of Q2.
- Plus $25m to $45m – estimated proceeds from the monetization of equity investments. There should be no tax overhang from these exits given that SFE has $300m of NOLs.
- Less $2m – cash burn for H2 2023. This estimate is in line with the current $3m corporate expense run-rate noted by management (plus around $0.5m per half-year in stock compensation expense).
- Less $3m – cash burn for the remaining 2 years until full liquidation. In the recent call, management noted that delisting will allow them to reduce annual corporate costs by 50% or $1.5m.
- Less $10m – for further winddown expenses and any other contingencies.
This results in a liquidation value of $25.1m-$45.1m. The company has 16.5m of shares outstanding.
The whole investment case for SFE heavily relies on the management’s sale proceeds estimates for the equity investments. So far, their track record of exits has been pretty decent. They’ve also returned a substantial amount of capital to shareholders since 2018 ($65m through dividends/share repurchases and $58m by covering debt) and will now return almost half of the remaining cash in Q4. However, it is worth noting that these guys are not great capital allocators (the VC fund generated 2% IRR from 2006 to 2015) and receive pretty large compensation compared to their 8.6% ownership stake in SFE. CEO made almost $1m and CFO – $0.5m last year.
Historical equity investment exits of SFE:
SFE has adopted this gradual liquidation strategy in 2018. The wind down was initially expected to last 3-4 years, however, got significantly delayed due to COVID and the market turbulence in the biopharma sector since last year. Last year in March, SFE suddenly announced a strategic review to consider other alternatives besides the ongoing liquidation. Management said they wanted to see if any value could be extracted from the $300m of NOLs that SFE holds. Earlier this year, the company entered into exclusive negotiations with one interested party, however, the talks collapsed last month due to “valuation, tax, and structural elements”. As a result, SFE has now said it would fully focus on the liquidation. The fact that the strategic review ended without a deal is not very reassuring. However, it could also be a sign that management was not willing to destroy shareholder value via some bad reverse merger or other transaction. In fact, management previously commented on one of their main strategic review guidelines being “don’t sell assets below their fair value or natural exit values”.
The market for biopharma-related asset sales is currently not very favorable, so there is definitely some risk to the timeline of the liquidation. Last year, management reported multiple M&A discussions for a number of their current holdings, but none of them materialized. However, last year was a bit of a bottom for the industry, and there apparently has been some improvement in the M&A market this year.
Available information on the remaining equity holdings is quite limited. Management segments them into 2 categories: Bucket 1 and Bucket 2. The first category includes the best remaining companies, which are well-capitalized and are doing well with their business plans. Management expects to receive the majority of exit proceeds from the Bucket 1 companies. Bucket 2 is comprised of companies for which management expects to receive minimal or no proceeds from the exit. More details on the remaining holdings are provided below.
Bucket 1 companies:
- Moxe – 19.3% stake. Carrying value – $5.8m. Cost basis – $7.5m. Provides clinical data clearinghouse services. The key product, Substrate, serves as an electronic medical record integration platform, facilitating the real-time exchange of data between payers and their provider networks for risk adjustment and other use cases. Annual revenue range: $5m to $10m. In the Q2 call SFE management commented that Moxe’s H1 2023 revenue grew 20% YoY and that Moxe has just signed another contract with a top 5 electronic medical health record vendor.
- meQuilibrium – 31.3% stake. Carrying value – zero. Cost basis – $14.5m. Offers an engagement and performance platform that leverages behavioral psychology and data science to improve workforce resilience, agility, and adaptive capacity. Revenue range: $20m-$30m. meQuilibrium posted the first half of 2023 revenue growth of over 20% year-on-year and was operating cash flow positive in Q2.
- Clutch – 41.7% stake. Carrying value – $1.5m. Cost basis – $18.3m. Offers customer data and marketing platform services for loyalty and gift card management. The majority of Clutch’s revenue is transaction-based, while a small portion is via onboarding fees. Customers include any consumer business that uses gift and loyalty programs. Customers pay a transaction fee for users who use the loyalty and gifting features platform. Revenue range – between $10m and $20m. H1 2023 revenue grew 35% YoY.
- Prognos Health – 19.4% stake. Carrying value – $4.5. Cost basis – $17.6m. Prognos aggregates and analyzes clinical diagnostic data for life sciences, diagnostic companies, and payers, aiming to improve health by disease prediction. Revenue range – between $10m and $20m.
Bucket 2:
- Trice Medical. Carrying value – zero. Cost basis – $12.2m. Trice manufactures and sells disposable cameras and instruments that enable faster diagnostics and shift of low-risk procedures to the office and surgery center settings. Revenue ranges from $20m-$30m. SFE exited its position in July as part of a similar senior lender-led restructuring and recapitalization. Trice is currently in the process of recapitalizing and raising third-party capital. If the transaction goes through, SFE expects to move the asset to bucket 1.
- InfoBionic – 25.2% stake. Carrying value – zero. Cost basis – $22m. Creates patient monitoring solutions for chronic diseases. Revenue range – between $10m and $20m.
- Syapse – 11% stake. Carrying value – zero. Cost basis – $26.6m. Syapse integrates, standardizes, and normalizes clinical and genomic data in a centralized platform that can be utilized by healthcare providers and researchers. Revenue range – $10m to $20m.
- Others. Carrying value – $1.2m. Cost basis – $19.7m.
What gives you confidence in the managements projections of value? I remember this name being mentioned on SSI in 2021, and back then it was almost a $9 stock with a 35%+ upside in a liquidation scenario. Since then no dividends have been paid, and the stock is at $1.00 now. It seems that back then they were wildly optimistic and why would it now be different?
I also have my doubts about using carrying value vs gain as a measure to estimate if managements estimates are accurate. Due to the money losing nature of their VC investments these carrying values are going down every month, and if they eventually manage to sell something it should not be a surprise that it is above these carrying values. But what are those carrying values going to be when they finally get a deal? For example, back in 2021 Clutch still had a carrying value of 4.7 million and now it is down to 1.5 million. Wouldn’t help a 2021 investor much if they sell it now for 2 million “above carrying value”. And that could easily be also the problem if they finally sell it in 2023. Perhaps the carrying value will be zero by then, and they sell it for more than that…
In the conference call management notes that 5 out of 8 of their portfolio companies have been running an active sale process with a big investment bank, and there hasn’t been any deal and it didn’t sound like we should expect anything soon. If you can’t sell these things they are obviously not worth what they think they are.
AV, thank you for the comment. These are all valid points, some of which I’ve addressed in the write-up. I agree it’s a risky setup with the thesis largely based on trusting the management and their estimates. However, I also think it’s an interesting situation to track and it does have several interesting angles, including large potential upside, major upcoming dividend and the track record of the previous exits. The fact that management has now segmented the remaining companies and for the first time ever has given a more tangible range for the exits projections is also interesting.
I agree that carrying value is not a perfect reference point, but it is one of the only few available metrics that public investors have. Cost-basis of the investments could be another one, however looking as historical exits is gives an even murkier pictures (some exited above cost basis, and some significantly below). From the 15 companies that management has sold so far, the total sale proceeds were $265m vs $189m cost basis. That’s 1.4x sale proceeds/cost basis multiple on average (however several successful exists – Flashtalking, Propeller Health, MediaMath – are strongly lifting up the average). However, management’s current estimates of $25m-$45m would be just 0.43x-0.77x of the cost basis for the 4 remaining Bucket 1 companies.
Lack of recent progress in the sale process is concerning. However, given the market environment last year, maybe that’s not really that surprising. Regarding the share price downfall since 2021, that has been mostly correlated to the major sell-off/deteriorating valuations in the biopharma sector, especially among the early stage companies. According to management focus of the buyers has noticeably shifted from the growth stories towards timeline to cashflow breakeven. M&A environment has apparently started improving recently. The Bucket 1 companies seem to be doing well and growing fast.
Altogether, I would love to have a stronger valuation support rather than management’s estimates or carrying value indications, but we do not have that luxury. Is there enough to trust management and their liquidation timeline, also do not know. There is a real risk that public shareholders will get just the planned Q4 distribution with no further proceeds after the company goes dark. However, in my eyes that kind of scenario looks unlikely.
Good questions from AV – given that response still leaves SFE attractive, after they delist will it be trading on expert market or just sitting there?
If trading on expert and you’re able to buy there, would be advisable to wait, no?
I do not know if SFE will continue to trade on expert market or not after delisting. And I think you are right that the volatility around delisting could provide a more favorable entry point.
1.53 lower bound still looks good with latest update from earnings transcript (16.285mm shares outstanding might have improved it, vs 16.5 prev)
https://seekingalpha.com/article/4647540-safeguard-scientifics-inc-sfe-q3-2023-earnings-call-transcript
Mark Herndon
We have a question on the web that is can you go into more detail as to the $25 million lower bound of proceeds? Is the $25 million split fairly equally between the five companies. So just comment a bit on the methodology of how we came up with that number. So basically, we took the low end revenue estimates, right? So projected revenues for each of those five companies between now and [indiscernible], the low end of that, we applied kind of low end revenue multiples, low meaning if you look at the market, either public markets across cycle, and then we — that would get your enterprise value is tracked out your net debt, and you would run that remaining value through the waterfall, each company has its own preferred stock and auction pool, et cetera, to come up with Safeguard’s proceeds. That would be the future value of Safeguard’s proceeds, which is the $25 million at the lower bound.
Last week SFE announced a special dividend of $0.35/share (vs the current $1/share stock price), with ex-dividend date on the 29th of Dec. The stock would deregister from SEC and delist from Nasdaq shortly afterwards.
The amount of dividend is below my initial expectations of $0.43/share (which I calculated just as half of the cash balance) and it seems that management is retaining $10m out of $15.5m in cash. Not clear why so much cash needs to be kept on the balance sheet, as cashburn during Q3 amounted only to $0.4m and is likely to be even lower after delisting/deregistration. I was hoping a larger portion of liquid resources will be deemed as ‘excess cash’ and get distributed to shareholders. So the lower dividend is clearly not a good sign and does not bode well for the prospects of a holding a delisted company for roughly 2 years of liquidation with even less/zero disclosures from management. No position.
https://www.bamsec.com/filing/110465923124747?cik=86115
This is an educational question if anything – how do shareholders of record as of Dec 19 receive a dividend but stock doesn’t go ex-div until the day after payment? If you buy now, you won’t receive the dividend, yet the price is unaffected. If you held on Dec 18, then does it make any sense to continue holding when it seems rather certain the price will go down by 35c on payment date (28th) or ex-div (29th)?
The Company has previously announced that the Board declared a special cash dividend of $0.35 per share, contingent on the adoption of the Amendments to the Articles of Incorporation at the Special Meeting and the Board thereafter giving effect to the Transaction. On December 15, 2023, the Board approved such special cash dividend without any contingencies, and it is payable on December 28, 2023 to shareholders of record as of the close of business on December 19, 2023. The ex-dividend date will be December 29, 2023.
It is weird to me too but…
If the dividend is 25% or more of the stock value, special rules apply to the determination of the ex-dividend date. In these cases, the ex-dividend date will be deferred until one business day after the dividend is paid. (investor.gov/introduction-investing/investing-basics/glossary/ex-dividend-dates-when-are-you-entitled-stock-and).
Ah ok I see, so the date of record is just irrelevant because anyone who buys now will obv get a dividend….I assume?
Also is there an odd-lot play per account (similar to single share reverse splits), or per SSN per broker (similar to tender offers), or is there no play because you have to be a registered shareholder?
“Based on the stock split ratio chosen by the Board, a shareholder of record owning immediately prior to the effective time of the reverse stock split fewer than 100 shares (the “Minimum Number”), would be entitled to a fraction of a share of common stock upon the reverse stock split and will be paid cash in lieu of such fraction of a share of common stock, on the basis of $1.65, without interest (the “Cash Payment”), for each share of common stock held by such holder (the “Cashed Out Shareholders”) immediately prior to effective time and the Cashed Out Shareholders would no longer be shareholders of the Company.”
https://ir.safeguard.com/financial-information/sec-filings//?shortDesc=Current%20report%20filing&format=html&secFilingId=7b24ecd9-c09a-408c-8720-e9e2ffdb1f98
This applies to registered shareholders only. Beneficial owners will not be counted as odd lots and will be aggregated at the broker level.
So this is only for $60 or so, but transferring to agent/registering your shares is very easy in Interactive Brokers. Just go to Transfer Position under Acct Mgmt and once you choose US, you’ll see a DRS option.
SFE released a press release saying that it intends to file Form 25 with the SEC on February 2, 2024 to voluntarily delist its shares.
https://www.bamsec.com/filing/143774924001865?cik=86115