Monthly Funds focus: Molten Ventures, Yellow Cake

This month we have three main ideas for fund investors. The first is a closer look at the UKs’ premier, tier 1 listed venture capital firm which sits on a huge discount. A substantial discount does make sense, but the current level is way out of kilter for what is a business with a world-class portfolio of growth businesses. We then follow up with a leftfield way to play the nuclear thematic – an AIM-listed stock that owns a huge stock of uranium oxide. Lastly, we ponder the virtues of buyback exchange-traded funds. These niche funds involve focusing on sound businesses which also distribute cash to investors – as a strategy it has been proven to be a successful long-term strategy. The downside is that there are very few funds that follow this approach.

Molten Ventures is looking sensibly priced

I’ve been very bearish about the listed venture capital for most of the last 12 months. I’ve maintained that it’s not unreasonable to apply haircuts of between 70 and 90% to peak valuations in 2021 in net asset value terms. I also think that we’ve not seen the bottom of the VC valuation cycle, with possibly at least another six, if not 12 months, of pain to come.

But at some stage, investors willing to take a risk on an inherently very turbulent asset class have to stop trying to call the bottom and focus instead on whether you’ve got enough margin of safety in terms of current valuations. On that score I think we’re there at listed VC Molten Ventures, one of the largest and most diversified VCs in Europe. It used to be known as Draper Esprit and listed back in 2016. In the last 18 months, its share price has suffered a brutal downgrade and it currently trades at a 65% discount to net asset value. As I noted above, I think that net asset value for the portfolio businesses is likely to be lower in the next 6 to 12 months but I think that 65% discount gives you some protection on the downside, not least because the business has already taken a red marker pen to existing valuations.

First though some background. Molten Ventures, formerly Draper Esprit PLC, is one of the most well-known Tier 1 venture capitalist firms in Europe. In portfolio terms, it remains very diversified with major positions that include:

• Fintech businesses providing services into the sector (Thought Machine, FintechOS)
• talent development (CoachHub)
• cancer diagnosis and treatment (Endomag)
• internet of things (HiveMQ)
• construction supplies logistics (Schüttflix)
• artificial intelligence (MostlyAi)
• engineering simulation (Simscale)
• global positioning systems (FocalPoint)
• satellite technology (SatelliteVu)
• carbon markets (BeZero) and
• delivery by air (Manna)

Back in March, the VC released its FY23 trading update (to end March 23) which showed the NAV down 17% to around 775p. Molten’s core of around 17 businesses (over 60% of the portfolio) seems to be in rude health, with those businesses experiencing a 40% value-weighted revenue growth in the previous calendar year. Crucially these core holdings seem to have enough cash to get them through the next 18 months at least.

It’s also interesting to note that some of the investments have actually been upgraded in valuation terms i.e there were valuation uplifts. One other key point to note is that most of the positions in the portfolio are structured as preference shares which means that there’s more protection for the shareholdings if there is a down round i.e valuations are cut. The company had £23m cash and £60m in undrawn revolving credit facility at end-March 2023 (its EIS/VCT funds had £58m available for investments), as well as c £10m in listed holdings. It’s also worth noting that its operating costs net of fee income were c 0.1% of period-end NAV, ie visibly below the targeted 1%.

Talking to the management, it’s clear that they’ve not been slow in marking down valuations, with valuations in their core portfolio of 17 businesses already marked down by around 40% in enterprise value terms since the peak. Also, most of the remaining 55 companies in the portfolio are still marked in at cost.

Key Numbers at a glance:

• Ticker: GROW
• Share price 288.40p
• Gross portfolio value £1450m, net assets £1280m
• 775p NAV
• £112m deployed in HY23, £56m in new companies
• £28m in group cash
• £150m debt facility

Given the low level of cash, you might think that Molten has stopped investing in new businesses. You’d be wrong though – Molten argues, convincingly I think, that it’s precisely in this depressed market that it needs to deploy cash on earlier stage investments. In the last six months, Molten has invested in the following businesses:

• HiveMQ (enterprise software, Series A) – a messaging platform designed for the fast, efficient and reliable movement of data to and from connected internet of things (IoT) devices (the company entered Molten’s ‘Core’ portfolio alongside Fintech OS and Schüttflix in H123).
• Friday Finance (formerly Airbank, enterprise software, Series A) – finance management software for companies and start-ups.
• &Open (enterprise software, Series A) – a corporate gifting platform
• SettleMint (enterprise software, Series A) – a platform for building blockchain applications.
• Altruistiq (climate tech/enterprise software, seed funding) – a climate tech company providing a SaaS platform that enables enterprises to automate sustainability data measurement, management and exchange.

So, to recap. Unlike so many of the listed VCs on the London market – and I include VCTs in this – Molten is a tier 1 VC, with a strong brand in Europe and access to world-class deal flow. That places it in a powerful position to ride the growth of European venture capital investment – the size of the European VC market is 39% of the US (YTD 2022), so there’s a great deal more growth ahead.

Molten has already been active in downsizing valuations – and probably has further to go. It has enough cash to fund its core businesses and its management is also very focused on realisations where appropriate to free up more cash. That said, its also has not reacted to the VC Ice Age by shutting up shop to new investments – arguably now is the exact right time to be making investments in earlier stage private businesses. I’m also impressed with its reining back in of management costs and I like its recent list of priorities for the coming year :

• Remain on track for £150m deployment (deployed £117m in FY23 to date), and expect a lower deployment in H2
• Preserve capital and continue to look for realisations in H2
• Work closely with our portfolio; ensuring they continue to extend their cash runway and support them as they grow
• Continue to build 3rd party assets and income
• Find the best companies to invest in as the current enterprise technology trends that make up the basis of our portfolio show no signs of abating

I would also argue that Molten has been especially badly hit by heavy selling by private investors – around 20% of its shareholder book are private investors – and by index funds selling what is a FTSE 250 constituent business. I think the margin of safety is now big enough to justify buying into the shares, on the understanding that valuations in the portfolio could go lower and that it will be a bumpy ride for the next 12 months. My own rough yardstick would be that a 50% discount on is that a 50% discount to the NAV at 775p would be reasonable for a cautious investor in the next 12 months, implying a short-term target of around 385p. As for the long term, if you are interested in investing in growth technology businesses, then I can’t think of a more reasonably priced way in currently than buying Molten Ventures shares.

Uranium Prices and Yellow Cake

One of my core long-term portfolio bets is that I maintain that nuclear power isn’t going away and is in fact likely to benefit from long-term growth in the developing world. This will focus investors’ attention on the supply of enriched uranium to nuclear power operators. The vast majority of these supplies have tended to be sourced via long-term contracts, many of them with states in the former Soviet Union (notably Russia). These market dynamics have meant that the spot market hasn’t been a primary driver of supply and it also meant that spending on new supplies of uranium has failed to keep up with increased demand. It also doesn’t help that developing new uranium mines is an expensive, heavily regulated business.

Over time though I would maintain that this market will change and the spot markets will become ever more important, as will Western suppliers of materials (enriched or not). This might result in increased spot market prices as anxious power station operators look to top up supplies. Growing financial interests, largely by hedge funds, in this space will also focus attention on uranium prices.

One of the easiest ways of buying into the uranium re-pricing story is through AIM-listed physical holdings firm Yellow Cake – this is a holdings vehicle that owns 18.81 million lb of U3O8 uranium oxide. Like many listed investment funds this sometimes trades at a substantial discount, triggering aggressive share buybacks by the firm.

This discount – a disconnect between the uranium spot price and Yellow Cake’s share price – frequently moves around greatly and in recent months it’s been as high as 17% before moving back into its current 10% level (this assumes a spot uranium price of US$ 53.75/lb U3O8, against an implied Yellow Cake price of US$48.23/lb U3O8). According to Nick Lawson of Ocean Wall, an alternative assets advisory service that works with many hedge funds, Yellow Cake tends to initiate buy backs when the discount heads closer to 20%. You can track this discount/disconnect on the Yellow Cake website – www.yellowcakeplc.com. Look to the middle right of the page where the share price is noted. There you’ll see in green, the various relevant price metrics. My guide is that anything above 15% in discount terms might trigger a buyback. More pertinently, YellowCake is a great way of buying into the nuclear story at a discount.

Buyback strategies – ignored but effective

The idea of focusing on fundamental measures in order to construct an index – which can then be tracked by a cheap ETF – has been around for decades. Perhaps the most popular variant of this fundamental approach is an index built around stocks that pay a generous dividend. The idea with dividend strategies, especially those that focus on corporates that progressively increase their dividends over long periods of time and also screen for financial health, is that dividends and subsequent dividend reinvestment have been shown to be the major component of long-term returns. Within this dividend indexing space, I thoroughly recommend the tried and trusted Dividend Aristocrat indices pioneered by S&P Dow Jones. You can find out more about this gaggle of indices HERE. Here in the UK, State Street offers a range of cheap trackers.

One challenge with dividend strategies is that over time fewer and fewer businesses have chosen to pay a dividend, especially in the US where there are tax challenges. Many US corporates in particular have opted to focus their cash distributions on buyback policies instead – in fact, there’s far more money spent on buybacks in the US than dividends. From 1980 to 2018, the proportion of dividend-paying companies decreased from 78% to 43%, while the proportion of companies with share buybacks increased to 53% from 28%.

In reality, the decision to focus on either dividends or buybacks is driven by narrow, practical issues, and arguably in capital efficiency, it doesn’t really matter as an investor how you receive your cash from the corporate. But it’s also a highly politicized issue with the US Democrats’ very anti-buyback while dividends are seen as private investor friendly. I’ll leave it to the reader to decide which they prefer (I have some sympathy for anti-buyback policy schools but I also think their negative impact is massively overstated). What is less up for debate is that a corporate that is producing bumper levels of cash which can then be distributed to shareholders (via dividends or buybacks) is worthy of closer inspection from a stock selection point of view.

This brings us nicely to the idea of an index – and an ETF – which screens not for dividend aristocrats but for stocks that pay out a disproportionate amount in share buybacks. Theoretically, we know that a dividend aristocrat approach (focus on progressive dividend payers with solid balance sheets) should outperform over the long term, so businesses with a similar buyback profile (increasing buybacks over time while boasting a solid balance sheet). But is there any evidence this is true in reality – especially after we include transaction costs?

S&P Global researchers have stepped up to the challenge and analysed whether buyback portfolios outperform benchmark indices (say the S&P 500) and the evidence seems fairly clear – they have “ historically generated positive excess returns over their parent indices in the U.S. market over a long time horizon. “. Here’s their exec summary in more detail:

• “All buyback portfolios generated higher average monthly excess returns over their benchmark indices in down markets than in up markets, regardless of weighting methods.

• Compared with dividend portfolios, buyback portfolios tended to have lower dividend yields and most of their outperformance was driven by capital gains rather than dividend income. Buyback portfolios achieved more balanced win ratios and excess returns in both up and down markets, which is a good complement to defensive portfolios that focus on strategies such as dividends and low volatility.

• The equal-weighting method employed in the construction of our buyback indices enhances win ratios and excess returns in up markets, making the outperformance of buyback indices more balanced in both up and down markets. The impact of equal weighting is more significant in the large-cap space than in the mid and small-cap spaces.

• Both equal-weighted and market-cap-weighted buyback portfolios were tilted toward high earning yield in the past 20 years that ended Dec. 31, 2019. The overlay of equal weighting gives the portfolios an extra small-cap bias, especially in the large-cap space.”

There are some important caveats to add at this point. The first is that S&P Dow Jones produces these indices so it can sell the methodology to ETF providers – thus you might have some questions surrounding their enthusiasm for this methodology (ie they are not a wholly disinterested party).

I’d also add that there’s less evidence that this approach works outside the US where buybacks are much less common – and dividends more prevalent. Lastly, the devil is always in the detail when it comes to implementing these fundamental screening strategies i.e. you might have a world-class theoretical engine powering an index but stick it in an ETF and it can easily fall over.

That said, it’s worth looking at the chart below which shows one of the US Buyback ETFs available here in the UK – this is from Amundi and has the ticker BYBG. The ETF was launched back in 2015 and the return from the ETF is in black, compared to the return from the S&P 500 index which is in red. As an aside the benchmark S&P 500 index outperformed the ETF after Covid through to the end of 2022 (all those surging tech stocks) but has since been comprehensively trounced by the buyback ETF.

There is one last challenge – there are only two buyback ETFs that I can see on my screen available in the UK: they are

–          Amundi ETF S&P 500 Buyback ETF, ticker BYBG, AuM £65m, TER 0.15%

–          Invesco Global Buyback Achievers ETF, ticker SBUY, AuM £35m, TER 0.39%.This ETF was launched back in 2014 and has an equally impressive record, consistently outpacing MSCI World trackers

So, just two ETFs with a combined AuM of just £100m.  It’s not exactly a huge vote of confidence by investors for what seems like a brilliant fundamental strategy.

David Stevenson

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