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 downto 10, and currently has 16 portfolio companies with shares ofClarient, Inc. (CLRT-NASDAQ) being the one current public holding.  Theother 15 investment holdings are mixed between InformationTechnology and in Life Sciences, although there is quite a bit ofconvergence between the two areas.  Four of these are majority held andtwelve of these are minority investments. In these arenas Safeguardreally tries to limit extra risks where the applications and goals arenot really known.

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Since the company liquidated holdings to scale its focus it hasreturned roughly $200 million to the company and has turned around andplaced roughly $100 million in Nine investments over the last Fivequarters.  It also has a go-to market strategy where it relies onoutbound deal sourcing, but some of the deal sourcing comes directlyfrom entrepreneurs.  Since the competition for deals is fierce, ittries to focus where entrepreneurs are under-supported compared toover-supported in many areas in the country.

The company’s earnings are based upon actual holding values and uponrealizing gains, so the degree of profitability varies from period toperiod.  On this metric, Safeguard was profitable in Q4 2005 and wascumulatively profitable for 2006.  The company obviously could not giveguidance for 2007 because it would be too predictive of marketconditions and liquidity events.  The current structure and currentholdings do not require additional funding based on today’s knowledge.

What was most interesting, and not an angle that I had really thoughtof ahead of this session, was that Mr. Boni feels that the company is avalue company for the arena they are in.  The reason for this is thatout of today’s market capitalization rate, its cash and its publiclytraded shares in Clarient (CLRT-NASDAQ) account for roughly 80% of theentire market capitalization.  In a break-up analysis, this wouldtheoretically leave the remaining 20% of the market cap being accountedfor as the other 15 current holdings, its future operations, itsphysical assets, and the approximate $394 million in net operatinglosses carry forward.

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

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

The company is also actively attending conferences to get in front ofinvestors and investment opportunities.  In May alone, the company madepresentations at several broker conferences: Cowen & Co.; Friedman,Billings, Ramsey; and JMP Securities. It used to have virtually noanalyst coverage and now has five boutiques following it (list is fromwebsite): 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 wassomewhere around 75% retail and 25% institutions, but now theshareholder mix is closer to a 50/50 mix between retail andinstitutions.  Some of the top institutions that have added positionsare T. Rowe Price, Gruber & McBaine Capital, Dimensional, FirstManhattan, and Putnam.

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

It is also worth noting that since the company made its Maypresentations, Safeguard has appointed a new CFO.  It appointed RaymondLand, who has 15 years as a public company CFO in the life sciencesarena, and more than 30 years of total experience in financial andgeneral management experience.

POST INTERVIEW CONJECTURE

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

Sure, these companies will continue to be grouped together along withInternet Capital Group (ICGE-NASDAQ0 for some time to come.  But whenyou sit down and speak to officers of a company the differences becomequite clear.  True value investors will perhaps refrain from investingin many $324 million market capitalization rate stocks, but on acomparable 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 themarket price of the Calrient Inc. (CLRT-NASDAQ) share price because itowns such a large piece of it.

Investors looking for any set or exact earnings per share would seem tobe looking in the wrong area because the nature of Safeguard’s earningscomes from sales and capital gains from its investments.  But thoseinvestors that are willing to look at incubator stocks and holdingcompany or investment vehicle stocks appear would seem to have found anice mix in Safeguard: a high net asset value relative to a stockprice, and aggressive management that wants to see exponential growthopportunities.

Jon C. Ogg
June 25, 2007

Jon Ogg can be reached at [email protected]; he does not own securities in the companies he covers.

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