Will These 2 Stocks Pop With a Silicon Valley Bubble?

Is this the top for venture capital-backed startups? Two portfolio managers make their case.

Mar 11, 2014 at 7:00AM


Photo by: Rhett Maxwell

Is Silicon Valley in a bubble?

Could 2014 come to be the next 1999?

Investors who listened to recent conference calls from Fifth Street Finance (NASDAQ:FSC) and Hercules Technology Growth Capital (NYSE:HTGC) enjoyed two very different perspectives on Silicon Valley's hottest start-ups.

Have investors gone mad?
Manuel Henriquez isn't new to the venture capital space. As the CEO of Hercules Technology Growth Capital, he oversees a balance sheet that towers over $1.2 billion.

His company was one of the leaders in venture capital debt financing, and he's worried. On a conference call, he shared his concerns about "frothy" valuations in the technology sector.

"Maybe in your world this is a normal for you, it isn't for me. But when I see WhatsApp being acquired for $19 billion when I see a Dropbox raising money at $10 billion, when I see Palantir claiming valuations north of $9 billion and I can keep on going through a list of companies now that are deemed to be the billion-dollar club, that makes me a little alarmed."

And it's not just venture capitalists he's worried about. He also added that banks were getting their hands dirty in start-ups.

"We continue to see very frothiness in the market. We're seeing banks being overly aggressive on transactions and we're beginning to see some signs of yield compression in the marketplace. "

"We are purposely -- we are the most under invested in technology that we've been in the history of Hercules."

Fifth Street chimes in
Len Tannenbaum of Fifth Street Finance couldn't have a more different opinion on venture lending. Fifth Street Finance recently opened new offices dedicated to start-up financing. And, on Monday, it announced a three deals worth $55 million in venture capital finance.

Historically, Fifth Street Finance financed private-equity buyouts of slow-growing, American companies. High yields tempted Fifth Street to participate in venture capital investments.

"We believe venture loans are attractive because they generally -- they are generally senior in the capital structure, have higher yields than our core portfolio, and may include warrants which could contribute to NAV growth over time, and help offset existing capital loss carry-forwards."

"In fact, one of the more interesting things I found about venture is, a number of the venture companies that we lend to actually have positive [earnings before interest, taxes, depreciation and amortization]."

Are lower returns on the way?
It's hard not to argue that venture capital-backed companies may be enjoying stretched valuations. And when valuations surge, future returns dwindle.

It's interesting to see two competitors have very different perspectives on one market. While Fifth Street Finance is only modestly exposed to venture capital companies, it's Hercules' bread and butter.

How this plays out is something that only time will reveal. But for now, I'm siding with Mr. Henriquez. The premise of billion-dollar IPOs in 2014, and a recent $19 billion buyout of WhatsApp seem to indicate we're closer to a top than a bottom. 

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

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David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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