SSSS - SuRo Capital: Selling For 43 Cents On The Dollar For A Reason

2023-05-25 10:40:00 ET

Summary

• SuRo Capital is down around 17% year-to-date with its discount to net asset value moving to 57%.
• The composition of the equity-focused BDC's portfolio is broadly unchanged from last year as continued macroeconomic headwinds continue to pressure tech valuations.
• A high dependency on just five positions will form a major bottleneck for SuRo's net asset growth as VC exit activity remains constrained.

SuRo Capital's (SSSS) net assets came in at $215 million , or $7.59 per share, as of the end of its fiscal 2023 first quarter. Whilst this was up sequentially by 20 cents from the fourth quarter, it was a 38% decline from $12.22 per share in the year-ago comp. The equity-focused BDC has built minority equity stakes in a portfolio of mostly tech companies and differs from debt-focused BDCs in that shareholder returns are driven by an appreciation of their equity stakes. SuRo's current market cap at $85 million, around $3.28 per share, comes at a roughly 57% discount to its net assets. This discount to book value has remained persistent since the start of 2022.

However, SuRo has always traded at a discount to its underlying book value but with the pandemic opening up a temporary zeitgeist that saw this close. That catalyst has since long melted away with the marked rise in the Fed funds rate and the subsequent pullback in the valuation of small and medium-cap tech companies that its portfolio derives much of its comps from. This discount to book opens up the first core avenue of positive future shareholder returns as a possible move back to book would see shares more than double their current level. However, this move would be dependent on net assets fully stabilizing from what has been a consistent decline since early 2021.

Net Assets Start To Stabilize As Discount Stays Sticky

SuRo recently published earnings for its fiscal 2023 first quarter. The BDC held 37 companies, of which only four were publicly traded. However, the portfolio is relatively concentrated with its top five positions accounting for 59% of the total investment portfolio at fair value. What type of companies are you buying for 43 cents on the dollar? Learneo , an ed-tech platform, forms 30.8% of the portfolio.

This platform holds CliffsNotes, Course Hero, LitCharts, QuillBot, Scribbr, Symbolab, and LanguageTool. Course Hero, valued as much as $56.7 million as recently as SuRo's fiscal 2022 third quarter, rebranded to Learneo in December last year to better reflect its recent acquisitions and push into artificial intelligence. It owns QuillBot, an AI-powered writing platform that allows students to paraphrase, grammar check, and summarize their work. Symbolab is an AI-based mathematics resource and most recently bought LanguageTool, a multilingual spell checker.

Ed-Tech forms the bulk of SuRo's investment portfolio at 37.6% with financial technology at 29.8% and marketplaces at 15%. The BDC has significant stakes in special-purpose acquisition companies with the sponsor for Colombier Acquisition Corp ( CLBR ) forming its second-largest position with a $14.8 million fair value. The SPAC announced earlier this year that it would be combining with PublicSq, a conservative values-based marketplace at a $258 million enterprise value.

Whilst SuRo has made dividend payments in the past, these have been abnormal and mainly driven by positive realized returns from exits. The IPO market has dried up and VC exit activity has cratered to a more than 5-year low as of the fourth quarter of 2022. This exit bottleneck has meant a huge headwind for SuRo and has been a significant factor driving the current discount to book.

The 2023 Outlook

Critically, an investment in SuRo is built on the promise of the US IPO market recovering. This is difficult against the current macroeconomic context with the Fed funds rate at its highest level since 2008 at 5% to 5.25% and with inflation still so far above the Fed's target. SuRo has had to move to buy back its shares to return some value to its shareholders. The BDC completed a modified Dutch Auction tender offer to purchase three million shares of its common stock at $4.50 per share. This was roughly 10.6% of its outstanding stock and was completed using cash on hand. Average diluted shares outstanding are down roughly 7.4% over the last year, reversing what had been a marked increase in the common shares outstanding since 2020.

SuRo is down around 17% year-to-date with the outlook for the rest of 2023 likely set to continue to be highly defined by macroeconomic disruption, flagging equity valuations, and a dearth of IPOs. The BDC held cash and short-term US treasures of $124 million as of the end of the first quarter, this formed 43% of their assets.

Overall, I'm not a fan of SuRo's portfolio or its capital return strategy. There are VC-focused debt-BDCs that pay out a dividend yield far in excess of inflation and the current headline interest rate. For example, Horizon Technology Finance ( HRZN ) pays a 10.2% yield monthly and has a materially more diversified portfolio. Hence, it's hard to see what SuRo's broader investment fit is. Its portfolio is too highly concentrated with an odd allocation to SPACs and an over-dependency on just five companies. I'm not a buyer here but this isn't a clear sell based on the discount to book.

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