Safeguard Scientifics CEO Interview: "Small Cap Value Stock" (SFE, CLRT, CMGI, ICGE)

Stock Tickers: SFE, CLRT, CMGI, ICGE

Late last week, 24/7 Wall St. got the chance to interview Peter J. Boni, President & CEO of Safeguard Scientifics, Inc. (SFE-NYSE).  Mr. Boni has been President & CEO of the company for roughly 22 months, and it may be worth noting that at the end of August 2005 the shares of Safeguard have risen from $1.62 at the end of that time to its current price of $2.68.  I did get a chance to discuss many issues with the company, and the first and foremost issue is worth noting:

Part of our interest in interviewing Safeguard was because of the recent interest in CMGI Inc. (CMGI-NASDAQ) and other incubators.  QUESTION: So without taking away from your own company in a comparison, what is the difference and do you have plans to transform into more of an operating company that also has an incubator?  If not, is this something you would consider?

For starters, we did not spend too much time discussing the merits of other incubators and other holding company investment vehicles.  But Mr. Boni did want to be clear about the incubator term being very much in the past when the investment climate was in the tech bubble days; and now they are operating solely as a holding company with gains on investments being the primary goal for each investment.  Safeguard has a 50-year history and has been a public company for close to 20 years.  The focus is entirely on investment opportunities in information technology and in life sciences.  Without being able to predict returns, the “Goals” were fairly clear: look for opportunities that are in the 3X to 5X returns that come from a liquidity event, with a longer-term outlook, staying diversified, and by looking at opportunity stages that are between the first round stage and the private equity stage.  The company also has a managerial structure that compensates managers based on the company’s market capitalization of the company, and the long-term vision is to try to make the company a $1 Billion company in the coming years. 

Outside of the differences and similarities, we did have numerous questions for the operations and holdings.  Some questions of course could not be answered because they would be too ‘prediction-oriented,’ but you will see in the comments later that many of the areas were covered.

ADDITIONAL QUESTIONS: What sort of investment activities are you currently focusing on, and does the company have any plans to raise cash or leverage the balance sheet any more?  What is the current value carried on the books of the cash and the public company shares you own? How much more value do you ‘guestimate’ as the private companies?  Would the company consider any special or one-time dividends or other shareholder friendly initiatives? What do you think the company can do to garner more research following from traditional boutique brokerage firms?  What do you identify as your largest opportunities and what are your longer-term goals?

The company previously had 40 portfolio companies that it scaled down to 10, and currently has 16 portfolio companies with shares of Clarient, Inc. (CLRT-NASDAQ) being the one current public holding.  The other 15 investment holdings are mixed between Information Technology and in Life Sciences, although there is quite a bit of convergence between the two areas.  Four of these are majority held and twelve of these are minority investments. In these arenas Safeguard really tries to limit extra risks where the applications and goals are not really known.

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Since the company liquidated holdings to scale its focus it has returned roughly $200 million to the company and has turned around and placed roughly $100 million in Nine investments over the last Five quarters.  It also has a go-to market strategy where it relies on outbound deal sourcing, but some of the deal sourcing comes directly from entrepreneurs.  Since the competition for deals is fierce, it tries to focus where entrepreneurs are under-supported compared to over-supported in many areas in the country.

The company’s earnings are based upon actual holding values and upon realizing gains, so the degree of profitability varies from period to period.  On this metric, Safeguard was profitable in Q4 2005 and was cumulatively profitable for 2006.  The company obviously could not give guidance for 2007 because it would be too predictive of market conditions and liquidity events.  The current structure and current holdings do not require additional funding based on today’s knowledge.

What was most interesting, and not an angle that I had really thought of ahead of this session, was that Mr. Boni feels that the company is a value company for the arena they are in.  The reason for this is that out of today’s market capitalization rate, its cash and its publicly traded shares in Clarient (CLRT-NASDAQ) account for roughly 80% of the entire market capitalization.  In a break-up analysis, this would theoretically leave the remaining 20% of the market cap being accounted for as the other 15 current holdings, its future operations, its physical assets, and the approximate $394 million in net operating losses carry forward.

As far as the goals the company’s investment target is a holding and investment outlook of three to five years and opportunities that can potentially give a 3X to 5X return.  Safeguard wants to grow to more than $1 Billion in market cap from today’s levels.  They are not a regulated investment company and can offset gains, so unless some of the portfolio companies generate drastically excessive returns it would seem to be a long time before paying taxes on the gains.

On a dividend or shareholder enhancement front, the company would consider a return of capital or shareholder value creation but by and large that would only occur if Safeguard ever became overly flush with capital.  For the time being and in the current climate, Mr. Boni feels that Safeguard has plenty of opportunities where they can keep investing in there 3X to 5X potential return opportunities.  That being said, a value investor here would still be investing in Safeguard for returns via capital gains rather than via dividends.

The company is also actively attending conferences to get in front of investors and investment opportunities.  In May alone, the company made presentations at several broker conferences: Cowen & Co.; Friedman, Billings, Ramsey; and JMP Securities. It used to have virtually no analyst coverage and now has five boutiques following it (list is from website): Susquehanna International Group, LLC; Monness, Crespi, Hardt & Co., Inc.; Henley & Company, LLC; CJS Securities; Boenning & Scattergood. 

When Mr. Boni came into the Safeguard, the shareholder make-up was somewhere around 75% retail and 25% institutions, but now the shareholder mix is closer to a 50/50 mix between retail and institutions.  Some of the top institutions that have added positions are T. Rowe Price, Gruber & McBaine Capital, Dimensional, First Manhattan, and Putnam.

The final goal is opportunity with diversity in the Information Technology and the Life Sciences arena.  It also will continue on its current focus with no single investment being too large of an event risk, so that it maintains a portfolio balance.   

It is also worth noting that since the company made its May presentations, Safeguard has appointed a new CFO.  It appointed Raymond Land, who has 15 years as a public company CFO in the life sciences arena, and more than 30 years of total experience in financial and general management experience.

POST INTERVIEW CONJECTURE

It is quite rare that you get a CEO that is willing to state goals out of an established company that would imply a 200% return if the goals are achieved.  Butthat was my take on what Safeguard wants to reach. The initial interest here was from the recent trading activity over the last 6 months that has been seen in CMGI Inc. (CMGI-NASDAQ).  The good news here is that Safeguard has no intentions of trying to change into a “me too” competitor. 

Sure, these companies will continue to be grouped together along with Internet Capital Group (ICGE-NASDAQ0 for some time to come.  But when you sit down and speak to officers of a company the differences become quite clear.  True value investors will perhaps refrain from investing in many $324 million market capitalization rate stocks, but on a comparable basis there really is a current value play in the stock. The caveat to the value is that much of this value is tied to the market price of the Calrient Inc. (CLRT-NASDAQ) share price because it owns such a large piece of it.

Investors looking for any set or exact earnings per share would seem to be looking in the wrong area because the nature of Safeguard’s earnings comes from sales and capital gains from its investments.  But those investors that are willing to look at incubator stocks and holding company or investment vehicle stocks appear would seem to have found a nice mix in Safeguard: a high net asset value relative to a stock price, and aggressive management that wants to see exponential growth opportunities.

Jon C. Ogg
June 25, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he does not own securities in the companies he covers.