Portfolio Manager Perspectives

Jeff Benjamin

BDC fund offers IPO investors a way to jump the queue

Keating Capital funnels money into companies before they go public; waiting for the dough

Nov 6, 2012 @ 3:38 pm

By Jeff Benjamin

The initial public offering market has slowed considerably over the past few years, but that doesn't mean there are no good opportunities for patient investors.

That is the general mindset that financial advisers and investors should embrace when considering Keating Capital Inc. Ticker:(KIPO), a business development company that invests in pre-IPO companies.

For starters, a BDC is a hybrid between an operating company and an investment company that both invests money raised during stock offerings and lists shares of the company on a public exchange.

Of the 35 publicly traded BDCs, most focus on high-yield debt, with only about four investing in equity.

Timothy Keating, president of Keating Investments and adviser to Keating Capital, said a portfolio of companies that are on track to go public gives investors a jumpstart on the kind of market activity that drives up share prices during and immediately after an IPO.

“We're looking at companies that ideally will file to go public within 12 months, and then complete the IPO six months later,” he said. “There's a big discount when a company is still private, and that's the stage when we're talking to these companies.”

The positions are all private investments, however, which means the liquidity can be limited inside the BDC. And that could hurt investors.

“We are not interested in investing in companies that don't have a clear and concrete timeline for going public,” Mr. Keating said.

The Keating BDC, which raised $86.6 million between January 2010 and June 2011, has since invested in 20 pre-IPO companies. Of those investments, five companies have filed to go public, three have gone public, and two have since withdrawn the IPO filings.

The biggest risk of the strategy, according to Mr. Keating, is that a company will take too long to go public. “If a company doesn't go public, we end up as a minor shareholder in a private company with no liquidity,” he said. “There's no guarantee a company will go public.”

Mr. Keating doesn't shy away from the risk factor, saying: “We bill ourselves as being a high-risk, high-return investment opportunity, and a replacement for the highest-risk spectrum of a portfolio.”

Shares of Keating Capital have declined by 17% from the start of the year, which compares to a 14.7% gain by the S&P 500.

The strategy obviously is dependent on a hotter IPO market, but the current environment could also represent a contrarian play for investors.

So far this year, there have been 126 IPO filings and 121 pricings.

That compares with the last two years, which saw more than 250 filings each, but only 154 pricings in 2010 and 125 pricings in 2011.

As Mr. Keating sees it, the IPO market is evolving to include larger offerings that take longer to complete, which presents an opportunity for a strategy like his that provides the kind of funding to keep a private company moving forward.

“Twenty years ago, 80% of the IPOs were raising less than $50 million in gross proceeds, but today fewer than 20% of IPOs are raising less than $50 million,” he said. “And 15 years ago, the average time it took from initial funding of a startup to the IPO was about four years, but now it takes about 10 years.”

Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.

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