Although Tekcapital has gained 105% year to date, the shares are still undervalued compared to its portfolio company’s net assets. However, focusing on the current net asset value may be a little short-sighted.
Two broker notes released shortly after the MicroSalt IPO suggest the stock has at least 50% upside. And that was when recently listed portfolio company MicroSalt shares traded significantly lower than they are now.
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Rating Tekcapital as a ‘buy’, broker SP Angel analysts said: “The IPO of Microsalt Plc on AIM this month provides further tangible evidence of the deep value in Tekcapital’s portfolio. Tekcapital is trading at a 50% discount to our fair value target of 20p. In our view, the stock trades at a double discount to its long term potential because the underlying prices that constitute the majority of our fair value target are themselves depressed.”
SP Angel has a 20p fair value target while Kemeny Capital sees 29.9p as fair value by applying an adjustment to NAV based on historical premium/discounts to NAV for technology investment companies and other listed entities that hold early-stage companies on their balance sheets.
There is some justification for the market attributing a discount to Tekcapital’s holding in MicroSalt because Tekcapital is locked in for 12 months before they can realise the value by selling shares. However, the market is effectively valuing the rest of the portfolio at less than zero.
At today’s share price of 91p, Tekcapital’s stake in MicroSalt is worth circa £30m. This compares to Tekcapital’s market cap of £23m.
Tekcapital’s holdings in Belluscura and Innovative Eyewear are worth at least £4m and are readily realisable. In addition, Guident has a Net Asset Value of £14m, according to SP Angel.
Guident, the last remaining privately held portfolio company in the Tekcapital portfolio, recently span out its Regenerative Shock Absorber into its own entity.
While Tekcapital hasn’t announced any specific fresh developments for the new company this year, they have previously alluded to the opportunity to recognise the value in the shock absorber technology separately from the teleoperations and for the new entity to satisfy its own funding requirements. This will likely increase Guident’s net asset value and is another important step in crystalising the value for Tekcapital shareholders.
Macro Environment
There are macroeconomic influences for investors to consider. The higher interest rate environment has weighed on the valuation of early-stage technology companies and this is evident in Tekcapital’s share price, as well as the value of underlying portfolio companies.
“Not only is Tekcapital trading at a 50% discount to this fair value figure, but the fair value calculation itself is mostly based on very depressed market prices,” SP Angel analysts said.
As rates start to fall, one would expect the value of Tekcapital’s portfolio companies to lose the valuation risk premium and return to historical averages. This by itself is supportive of Tekcapital shares at 13p.
Some may have preferred more progress in the portfolio companies to date but this doesn’t detract from the future potential the portfolio companies have to create Tekcapital shareholder value.
Tekcapital said they expect multi-million-pound revenue for each of the portfolio companies this year which will represent a step change in the valuation methods for the portfolio. Investors should expect Tekcapital to be valued on portfolio company revenues and profits in the coming years as opposed to the historical NAV.
Tekcapital is an investment company which has established technology companies with substantial competitive advantages and structural intellectual value, and their strategy is inherently long-term.
But this doesn’t mean Tekcapital’s listing on AIM can provide investors with opportunities in the short and medium term. As investors saw in the run-up to the MicroSalt IPO and the immediate reaction to the listing, Tekcapital shares can rerate very quickly on positive news.
Venture capital strategy
Essentially, what Tekcapital does is provide investors with access to knowledge-intensive companies that may otherwise only be available to select private equity venture capital investors.
Venture capital investors are prepared to value and accept risk in early-stage ventures in the pursuit of returns many multiples of their original investment.
Successful venture capitalists only need one or two big winners to make a portfolio. The same can be said of Tekcapital. The two aforementioned price targets of 20p and 29.9p for Tekcapital are academic in that respect.
The lowly public valuations arguably do not reflect the long-term potential of Tekcapital. But, as we mentioned previously, being publicly listed provides the venue for investors to quickly revalue shares. Such an opportunity is only reserved for liquidity events in privately held companies.
Naturally, investing in early-stage companies is risky, but it will only take one company to produce outsized returns to create real Tekcapital shareholder value.