SSSS - SuRo Capital: This Venture Equity BDC Is A Buy On 52% Discount To NAV

2024-01-05 05:44:48 ET

Summary

• SuRo Capital is currently trading at a 52% discount to NAV at the end of its fiscal 2023 third quarter.
• The equity-only BDC realized a $1.06 per share sequential NAV growth during its third quarter.
• Possible Fed rate cuts could drive an upswing in tech valuations as SuRo executes on share buybacks to try and close the discount.

SuRo Capital (SSSS) at its current $101 million market cap is a buy. While I've previously been quite negative on the ticker in my prior coverage , the BDC's net assets at the end of its fiscal 2023 third quarter totaled $212 million , around $8.41 per share. Hence, why are the common shares trading at $4.02 per share? This is a substantial 52.2% discount to NAV just as the Fed is set to embark on interest rate cuts. Further, NAV per share grew by $1.06 sequentially to reverse what has been a broad decline in NAV since the pandemic. SuRo is an equity-only BDC whose investment pitch is fundamentally built around quarter-on-quarter capital gains on its portfolio.

The current discount opens up a material lever for an up to triple-digit investment return on the commons in the event it's closed over the next few years. SuRo has broadly always traded at a discount but the current gap is the most material distance between both points in over five years. The market tends to discount the equity of closed-end investment companies experiencing an erosion of equity value. A possible reversal of NAV gains seen in the third quarter is a core risk to the investment pitch.

To be clear, the current discount is the market stating that it does not have confidence that SuRo's NAV will not dip in future quarters. It's a pre-emptive discounting to reflect the most likely direction of NAV based on historical movement. My buy rating is driven by the possible step change of this zeitgeist offered by 2024 with Fed rate cuts set to deliver a recovery of venture fundraising, technology IPOs, and deals by special purpose acquisition vehicles. SuRo's total investment portfolio at fair value exiting the third quarter was $193.5 million , excluding $93.8 million in cash and short-term US treasuries. It was up $33.2 million sequentially.

Closing The Discount On An Undervalued Portfolio

The jump was led by an increase in the fair value of Learneo. The ed-tech platform owns AI writing and productivity tools and Course Hero, an online learning platform used by millions. It's by far SuRo's largest position, accounting for 33.8% of its investment portfolio at fair value at the end of the third quarter. SuRo's cost basis in Learneo remained at $15 million but the fair value was up from $32.5 million in the second quarter to $65.4 million.

SuRo's top five positions at the end of the third quarter were valued at $117.4 million versus a $49.1 million cost basis and constituted 60.7% of its portfolio value. Publicly listed PublicSquare (PSQ Holdings (PSQH)) formed SuRo's second-largest position at 9.4%. PublicSquare, described as a marketplace of patriotic US businesses, went public via SPAC in the summer of 2023 and has since lost roughly 50% of its valuation but SuRo holds warrants that have returned 6.7x their cost basis. SuRo's management during their earnings call flagged that their objective is to sell their public positions when lockup restrictions expire. Hence, they began selling down the PublicSquare warrants after the end of the third quarter. This should bolster cash and short-term US treasuries and provide a more ample liquidity backdrop for SuRo's ongoing share buyback program. The program saw an additional $5 million share repurchase authorization added during the third quarter.

The Fed Pivot And Baby Bonds

SuRo has year-to-date repurchased 3.2 million shares for roughly $14.2 million and has $20.7 million of outstanding stock buybacks left to execute. This has seen its diluted weighted average common shares outstanding fall 14.88% year-over-year to 25,351,306. This is a huge drop that underscores the extent of the current discount. SuRo should be able to deploy more funds to buybacks in response to the possible continued recovery of its portfolio in 2024.

The Fed's December dot plot showed at least three rate cuts of 75 basis points this year with the market pricing in 2x this amount of cuts. The market's base case for interest rate as per the CME FedWatch Tool is for rates to exit 2024 at 3.75% to 4.00% , a 150 basis points decline from current rates. Any rate cuts would also deliver a boost to SuRo Capital's 6.00% Notes due 12/30/2026 ( SSSSL ). These offer a $1.5 annual coupon for what's currently a 6.35% yield on cost and are trading at a 5.5% discount to their $25 par value.

Critically, the US is already out of a tech recession which saw a record number of layoffs in late 2022 and early 2022. Layoffs have moderated markedly with expectations that the industry will return to growth soon and that 2024 will deliver a bumper year for tech IPOs.

Hence, SuRo is a buy on what's set to be continued share buybacks, a 52% discount to NAV, and a drastically improved outlook for its portfolio as Fed rate cuts look set to deliver a needed boost to tech valuations. Whilst SuRo does not pay a dividend like other BDCs, its capital return profile remains material even in the event the current discount is cut in half.

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