Crossroads Capital: Busted BDC, Bulldog Pushes Toward Liquidation

The tide has just about fully washed out of the business development company sector (more on the manager/fund raiser side), most BDCs are really just leveraged loan vehicles and not "private equity for main street" as they were originally intended.  One of the few private equity like BDCs is tiny Crossroads Capital (XRDC), which has changed its name twice in the past two years (f/k/a BDCA Venture and before that Keating Capital) as it's original asset manager was purchased by an affiliate of the toxic Nick Schorsch and then recently famed closed end fund activist Bulldog Investors won board seats and took control of the company in the second half of 2015.

The grand plan was to invest in companies approaching an IPO, from the 2013 10-K:

"Our strategy is to evaluate and invest in companies prior to the valuation accretion that we believe occurs once private companies complete an initial public offering.  We seek to capture this value accretion, or what we refer to as a private-public valuation arbitrage, by investing primarily in private, micro-cap and small-cap companies that meet our core investment criteria.  Our investment strategy can be summarized as buy privately, sell publicly, capture the difference."

With the benefit of hindsight this strategy looks a bit silly, especially in the "unicorn" Silicon Valley valuation environment that's been going on for a while and is arguably the opposite of what's described above, private companies are being valued at a premium over public ones.  But in the middle of a bull market this is an easy high fee product to sell to main street retail investors looking for a way to profit from hot technology IPOs.  The slowing IPO market and high fees began to take their toll and this BDC started trading at a significant discount to net asset value before long.

Bulldog Investors, led by Phil Goldstein, is famous in the value investing community for their activism in closed end funds and other investment companies.  These vehicles often trade for a discount to NAV due to their high fees and closed end nature, there's no mechanism for investors to redeem their shares at NAV like opened end funds.  Bulldog often accumulates a large stake and then pushes for the manager to take steps to force the price back to NAV, typically first through share buybacks, if that's unsuccessful, a liquidation of the fund.

Bulldog went active on Crossroads Capital (then BDCA Venture) in March of 2015, here's the letter, calling for a sale or an orderly liquidation.  They've since bought more in the mid-$4s, now owning 11.65% of the shares.  Events didn't move quickly enough, Bulldog launched a proxy fight and gained board representation, Andrew Dakos of Bulldog was named Chairman of the Board, and the company parted ways with its external manager in October 2015.  They've since slashed operating expenses and outsourced most of the day to day administrative tasks to a third party provider.

On 1/25/16, the company announced their new strategy:

“The Company's new investment objective is to preserve capital and maximize shareholder value. The Company seeks to achieve its investment objective by pursuing the sale of its portfolio investments, limiting expenses and deploying surplus cash as appropriate, including into yielding investments to offset operating expenses.”

In the same press release they stated the current cash is approximately $1.46 per share.  So at today's $2.46 stock price, what is an investor getting for the additional $1.00 per share?  Below are their portfolio investments as of 9/30/15, its worth noting that they took the overall value down 12% from the 6/30/15 marks and will likely take something similar off for the 12/31 net asset value.

Using the 9/30 marks (additional writedowns likely), after cash you're only paying 25 cents on the dollar for the remaining portfolio ($4.02/share).  Most of their investments are in green energy and social media type private companies, not something I'm able to value but I did some light Googling and most of them seem reasonable and potentially worth something.  January was the first month in a long time where no IPO was completed in the United States, a quick liquidation of the assets might be difficult.  In the latest 10-Q:

"We further believe there may limited opportunities to sell our interests in existing private portfolio companies to third parties in privately negotiated transactions.  Accordingly, it is possible that an orderly monetization of our current holdings may take three to five years or more."

So that's base case, but I don't think it's as simple as a big discount to NAV being closed over three to five years (don't forget - outside chance their portfolio appreciates), that wouldn't be quite as interesting.  Now that Bulldog Investors is in control of the company, and armed with a $2MM buyback authorization (if fully utilized at current prices it would increase NAV by ~5%), additional buybacks could be in the cards, liquidation distributions, and other levers pulled here to generate returns for those that stick around.  I also wouldn't write off the possibility of a quick portfolio sale of the investments at a discount to another entity.  Crossroads Capital is a jockey play on Bulldog Investors being able to unlock the value backstopped by paying a cheap price for the asset base.

Why is it cheap?

• IPO window is potentially shut for these small cap speculative technology companies, uncertain time frame for value realization.
• The company is stopping regular distributions, the last of the retail BDC dumb money has probably sold out in the last two months.
• Liquidations in general tend to scare off investors: there's a lot of red tape holding up dissolution, they take longer than people would think, and can have principal/agent problems (even the bare bones administrative staff at a company liquidating isn't running to lose their job).  But with the largest shareholder in control, there's some confidence that the process will be expedited as much as possible.

I'm finding quite a few of these busted small/micro cap financials with a lot of cash recently and started to develop a small tracking position bucket, I added this one to it.

Disclosure: I own shares of XRDC