Tuesday, February 2, 2016

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


  1. This looks interesting. Do you know how the dividends would be taxed? Best would be as a return of capital.

    1. If they go down the liquidation route, yes, I would imagine the distributions would be a return of capital. The portfolio investments as a whole are below cost, a couple are marked above, but my guess would be a return of capital. Bulldog's cost basis is a lot higher than current market price, so if they did sell the company outright maybe they'd be less tax sensitive than those buying after the wash out. Thanks for the reading.

  2. 10-K came out today, they've slightly adjusted the investment strategy to:

    "On January 20, 2016, our Board of Directors changed our investment objective to preserve capital and maximize stockholder value by pursuing the sale of our portfolio investments, limiting expenses and deploying surplus cash as appropriate, including into yielding investments to offset, in part, operating expenses. Subsequent to this change in our investment objective and in recognition that the monetization of our current holdings under our prior policies and investment objective could take three to five years or more and the amounts realized may be less than current fair values, our Board of Directors on March 25, 2016 resolved to monetize our portfolio holdings at the earliest practicable date.

    This resolution, together with adverse developments in financial markets to date in 2016, makes our investment portfolio susceptible to the risk that near-term sales could result in amounts realized being less than the fair values determined as of December 31, 2015, as we actively seek to sell our investments, either individually or in groups, it is possible that we will experience substantial differences in the exit prices ultimately achieved on our portfolio holdings as compared to the respective fair values as of December 31, 2015."

    NAV is down to $5.06, but the timeline to liquidate is moved up, net net a positive development.

  3. Silkroad and Centrify appear to be strong/growing companies with real value and have reputable investor bases. The valuation model assumptions laid out in the 10K appear extremely conservative with 25%-30% discounts, plus liquidity discounts of 9%+. I would venture to guess any sale below these book values would turn out to be a hell of a deal for someone. trading volume may limit the impact of the repurchase program, but it would be a great use of cash. I conservatively view the cash in excess of the allotment to potential buybacks as 50% "floor" and 50% future burn rate prior to sale. Looks like ~$1mm/yr burn with some interest revenue offset. Hopefully they can monitize quickly...nice find! -JA

    1. Good comment and color on the marks. What I found most interesting from the 10-K was the table in the footnotes (F-37) showing the NAV per share at various discounts applied to where they might sell the investment portfolio. To me that signals a willingness to move this fairly quickly to a financial buyer and not wait for each investment to have a liquidity event under the previously discussed 3 to 5 year timeline. Thanks for the comment.

  4. When they say their exit prices could differ substantially from book value, they mean to the upside. most of their companies are really legit.

    1. That would be a nice surprise. I took it the opposite, willing to move them quickly for a reasonable discount, do whatever to increase the overall IRR. Which companies are you ascribing the most value to above their mark? Or which are the most legit?

    2. Q2 NAV out today, down $1 from 3/31 to $3.23/share. Ugly.

    3. yeah i didnt realize earnings were today. thats frusturating. haha.

      i wish theyd do a call or something. idk. i guess they couldve messed up entering at $4.50 - just difficult to think that they didnt have a better grasp on the assets they were buying before they came in.

      also, the writedowns are very much mechanical - revenue multiples for comps, p/e multiples for comps, etc. but what's their comp universe? If it's just some public index that's getting swatted currently, but their businesses are good, then they might have to write them down? just based on the methodology thye use? i really dont know. like i said, wish i could find more info

  5. SPE is quite overrated and this deal was fortunately a tiny one for them.

    The author got a good price. If you buy today you are likely to get back $2.60-$2.90, IRR of maybe 5-10%, nothing to see here.