Venture On The Cheap Publicly Traded Companies

 

Nearly two years ago, Merrill Lynch Venture Capital Inc. put together an unusual partnership. While most venture capital funds raise money in chunks of $150,000 and up, this one sold partnership interests in units of $5,000 apiece. The 12,000 units sold by the company gave Merrill Lynch $60 million to invest in new enterprises. And they provided several thousand investors with a cheap avenue into the alluring world of venture capital.

Sound appealing? Tough luck. Although both Shearson/American Express and Prudential-Bache Securities are contemplating similar funds, no one had introduced one as of early this year. And Merrill Lynch has no immediate plans for a successor.

That leaves a tempting but tricky batch of investments for would-be venture players seeking a diversified portfolio for less than $150,000. In this category are eight or nine publicly traded venture capital companies and an equal number of venture-minded small-business investment companies (SBICs). Most such concerns maintain relatively small portfolios that include new enterprises, potential turnarounds, and leveraged buyouts. Some also invest in the secured loans that are the traditional province of the SBIC.

There is, without a doubt, money to be made. Narragansett Capital Corp., traded over the counter, sold for less than $10 a share as late as 1977. Early this years its managers offered to buy it out at $50 a share. Capital Southwest Corp., another OTC stock, went from a low of 2 1/8 in 1977 to 14 six years later. The share prices of the two funds appreciated 34% and 27%, respectively in 1983 alone and Narragansett paid a dividend of $3.20 per share along the way.

Estimating what these stocks are likely to do, however, is not easy. Like shares in ordinary closed-end mutual funds, which they resemble, most venture-company stocks sell at a discount from the underlying net asset value of their portfolios. That is because the true value of the young companies in which they own shares is hard to gauge, and because it may take years for the investments to bear fruit. But the discounts -- let alone the net asset values -- are by no means easily predictable. At times the stock price may shoot up well beyond the net asset value, only to fall equally quickly.

The reason for this lies in the mercurial nature of venture investments. "What tends to happen is that one of a company's investments will work out very well and a number of them won't," explains Thomas J. Herzfeld, a South Miami, Fla., broker whose firm specializes in closed-end funds. "What you'll see is very erratic behavior." Herzfeld points to the dramatic example of Boston's Nautilus Fund, which held a substantial position in Apple Computer Corp. just before the company went public in December 1980. Nautilus stock shot from about $15 a share to nearly $53 in a few months "just because people wanted Apple." A few months later it had fallen to $24.

Ordinarily, the gap between stock price and net asset value tends to widen and narrow in response to less-publicized portfolio events. Investors who plan to trade the funds -- or who simply value liquidity -- thus have to follow their investments closely and plan carefully when to buy and when to sell. Otherwise they are apt to be locked into a company that is selling at a discount and that won't realize gains on its investments for four or five years.

Trading can also be tricky. "You can't buy [these stocks] in any quantity," says Morton Collins, general partner of DSV Partners III in Princeton, N.J., and a former president of the National Venture Capital Association. "If you went in with $100,000 to buy some, you'd probably double the price of the stock." Herzfeld, however, believes that a broker experienced in trading thin stocks can buy and sell the venture companies without much difficulty. "There's a pretty active block market that may never see the floor of the stock exchanges," he says.

Even this indirect kind of venture capital investing, in any event, is not for the nervous. In the 1960s, observes Pratt of Venture Capital Journal, there were 50 or so publicly traded SBICs and venture companies. In the early '70s they were selling for average discounts of 70%, and many have since gone out of business. This dismal history, says Pratt, bodes ill for the future -- and reflects the inherent contradiction between the long-range perspective required by venture capital investing and the short-term outlook of most stock-market investors. "How do you maintain a long-term view," he asks, "when you've got people who expect your stock to go up monthly?"

The great virtue of Merrill Lynch's scheme, according to Pratt, was that the company made it virtually impossible for investors to get out before the 10-year partnership had run its course. Until Merrill Lynch or someone else decides to do a repeat performance, though, the modestly heeled venture investor is left with the public companies. Unlike Merrill Lynch's partnership, they are not the kind of investment you can make and forget about for 10 years.