Before they were execs with publicly-listed merchant bank Difference Capital (TSX:DCF), Tom Astle and Tom Liston were both highly respected sell-side analysts. It was their job to find undervalued situations in the world of Canadian tech.
Difference Capital, often associated with its colorful Executive Chairman, Mike Wekerle, grabbed the public’s attention because of the gaudy amount of money it raised, the veteran banking talent that it was able to attract, and that it declared its focus would be squarely on the innovation sectors. It was an early and strong signal of the sector rotation that has followed.
All that makes the company’s recent share price a puzzle, Difference has fallen from a high of more than three dollars last October to recent lows barely over two bucks. The company has responded with a share buyback program and Wekerle has been an aggressive recent buyer of the stock. We talked to Astle and Liston about the situation.
Gentlemen, Difference Capital has initiated a share buyback and your chairman Mike Wekerle recently bought 250,000 shares at $2.50. Do you think DCF is undervalued?
Heck yes. Our NAV at the end of last quarter was about $3.40 and on top of that we have tax loss assets and a revenue stream from our advisory work that is not accounted for in the NAV.
The Canadian tech sector is on fire and all of your investments are in tech, or are at least IP-centric. Where is the disconnect?
Difference has a three step plan to create value for its shareholders. Step 1 is to invest mostly in private later stage technology/media/healthcare companies; Step 2 is to add value by advising them; and Step 3 is assist with monetizing this value. This all will take time and may not be visible to investors and we are only into step 1 and 2 at this point. We believe the disconnect will disappear as we progress further with this plan and investors get a better look at how our portfolio of investments has come together in the last six months or so.
Do you think your business model is too complex for some to understand? Please explain how you get paid…
We don’t think it’s any more complex than other merchant bank models. DCF shareholders have cost certainty in that it only pays a 2% management fee and a small portion the gains. DCF also keeps 40% of any advisory fees without all of the associated costs. Basically our compensation is tied to performance of the investments and for providing good advise to the investee companies.
How do you recognize the value of assets on your books? Is there room for some misunderstanding there?
We are required to measure our investments at fair value. For our private holdings (the vast majority of our investments) we generally carry them at cost, where cost is considered the best estimate of fair value, until there is strong external evidence to support a change in valuation. An example of strong evidence would be a material third party purchase or trade or a significant change in the balance sheet or P&L. Our external accountants review our financial statements quarterly and our year-end audit includes a rigorous justification of valuations. Finally this end result is reviewed and approved by our Audit Committee, which is composed entirely of independent directors before the full Board signs off.
Your current market cap is about $98-million. You have $183.9-million in investable assets, but just $3.1-million in revenue in your recent Q3. Should Difference be judged on its assets or by the revenue or profit it spins off?
It should be a combination. The portfolio and tax assets will most likely be valued on a NAV approach (i.e. balance sheet) while we believe the advisory stream should be viewed from a profit perspective.
Is there another company out there that could serve as a comparable for investors?
Not 100% comparable, but we like to look at US firms such Hercules Technology (NYSE: HTGC) and GSV Capital (Nasdaq: GSVC) as comps. Hercules trades at a premium to NAV, and GSV at a slight discount to NAV. At $2.50 we are trading at a 25% discount to NAV.