WESTPORT, Conn.--(BUSINESS WIRE)--Yakira Capital Management, Inc.(“Yakira”), a long-term significant investor in Safeguard Scientifics Inc. (“SFE”, “Safeguard” or the “Company”) (NYSE:SFE), holding 2.41% of outstanding Safeguard shares, today sent a public letter to the Board of Directors (“BOD” or the “Board”) of Safeguard expressing Yakira’s frustration with Safeguard’s inability to address persistent shareholder value destruction and to adopt vital measures to drive value for the Company’s investors.
The full text of the letter follows.
February 14, 2018
Mr. Robert Rosenthal
Chairman of the Board
Safeguard Scientifics, Inc.
170 North Radnor-Chester Road Suite 200
Radnor, PA 19087
As you are aware, Yakira Capital Management (“Yakira”) is a long-term holder of Safeguard Scientifics Inc. (“SFE”, “Safeguard” or the “Company”), having first acquired shares in May 2011. We currently hold 2.41% of outstanding Safeguard shares, which according to Bloomberg would make us the 10th largest shareholder. Following the private letter we delivered to you dated November 27, 2017 (the “November Private Letter”, “Private Letter”) we welcomed the opportunity to meet with you in December (the “December Meeting”). We left that December Meeting encouraged by your willingness to listen and participate in a constructive discussion of ideas that would benefit ALL Safeguard shareholders. However, since that December Meeting we have grown disappointed by your unwillingness to engage in further dialogue. We feel continued communication is essential to ensure all SFE shareholders will not have to suffer further from the value destruction that the current Senior Management has presided over – with the stock down 31.5% since Steve Zarrilli took over as CEO on November 1, 2012 through the Company’s January 17, 2018 strategy announcement.
During our meeting, you specifically stated that you would personally be involved in all aspects of the search for new/replacement Board members. However, actions speak louder than words. We therefore are perplexed and disappointed to have learned that the potential nominees we have put forth are being contacted and vetted by Steve Zarrilli, the current CEO. We believe this is highly inappropriate, given that one of the key points we have made is that current management must be replaced. We question why neither yourself, nor the Chairman of the Nominating and Corporate Governance Committee, appears to be involved in the interview process for Board members who will potentially be tasked with replacing current management.
As we have previously communicated to you, while we are pleased that you took the most important advice from our Private Letter for creating shareholder value (winding down with no new investments), we believe that to truly MAXIMIZE shareholder value, the Company must still pursue the following vital changes:
- A plan to replace current Senior Management (the CEO and COO) with an individual or team possessing a proven track record of successfully exiting portfolio companies in the VC/PE business.
- A revamping of the Board, reducing the number of directors to five. The new Board should include a minimum of two new independent members identified by shareholders. Compensation of the Board should be reduced to more properly reflect the size of Safeguard, with any incentives vested upon shareholder return targets.
- A new performance-based compensation plan for management which is entirely based on the amount of capital returned to shareholders/share price, with limited upfront cash salary/bonus.
- Additional cost cutting measures. While the original disclosure of $5-$6M of cost reductions is a start, we believe there is significant room for further reduction to right-size the operational expenses of SFE.
We strongly believe that existing management is the reason the Company is currently in this situation. It is imperative that you clearly understand our position: current Senior Management must not be the ones who undertake and oversee this important next phase for Safeguard and its shareholders. In our view, the impetus for any change that has occurred so far has been shareholder pressure, not management’s desire to improve shareholder value. Consider the following:
- After management set out on a new course to increase the number of portfolio companies from 20 to a target of 30, we met with them in January 2016 and explained that following such a course would prove detrimental to shareholders.
- From the end of 2014 through the end of 2017, the share price fell 43.5%, a loss of over $175 million in market value, producing results that were even worse than we expected.
One of the reasons Safeguard’s performance was so poor was that,
concurrent with increasing the number of portfolio companies,
management made a strategic shift in their investment strategy, which
we were not informed of at our meeting.
- The previous strategy was to invest in companies during later rounds of the venture process. Investing later enabled the investment team to better ascertain whether a company was likely to succeed and shortened the time horizon for each investment.
- This new strategy invests smaller amounts (initially) at the very early stages of a company’s development. We believe this will lead to a dramatic increase in the number of write-offs and also significantly lengthens the time horizon for each investment.
- Further, the new strategy put in place by management has required an enormous amount of follow-on capital that has drained cash reserves and limited the Company’s flexibility. This led to Safeguard’s recent financing via a credit facility whereby the Company is paying a rate of 800 basis points over LIBOR. We believe this is one of the worst corporate actions we have witnessed in our 21 years of investing, and we find it unfathomable that management concluded this was a good decision, especially when the Company was in a relatively cash neutral position with more than $400 million of appraised net assets in its portfolio companies. What’s more, the covenants on the credit facility limit Safeguard in the extreme with regard to taking additional actions that might increase shareholder value.
Of the original investments made during Steve Zarrilli’s five-year tenure as CEO, we have witnessed six dispositions. Of those six, three have been complete write-offs and another a partial loss. What originally attracted Yakira to SFE was that, while the Company did not “hit that many home runs”, it had very few substantial write-offs. During our initial conversations with the Company, management boasted that the rate of successful exits was approximately 80%. Of course, that was under the previous management.
This fact pattern leaves us wondering how many write-offs are still to come. In addition, although management’s strategy has significantly lengthened the time horizon for each investment, it has not changed their stated goal of a two-times target return. The result is higher risk, potentially leading to more failures, with a lower return profile.
For nearly 18 months Senior Management has maintained that their focus would be devoted to exits, yet they have been unable to achieve a single positive exit in that time. It seems obvious to us that current management does not possess the right skill set to achieve this stated goal. In addition, as we also pointed out in our Private Letter and during our December Meeting, current leadership has shown an inability to recognize when they are throwing “good money after bad”. They have consistently made follow-on deployments shortly before taking significant write-downs in the same investment, as several case studies illustrate:
- SFE invested approximately $3.4 million within one year of AppFirst’s demise, only to receive $0.9 million at the end, in addition to losing all our original investment.
- In the case of Good Start, management invested an additional $7 million to “protect” its prior investment of $12 million, only to receive a total of $5.1 million upon disposition.
- We see this again with Spongecell, where separate $4 million investments were made in both 2015 and 2016, only to incur a material write-down of the investment in the first quarter of 2017 to a value even less than the total of the new follow on investments.
This string of failures is now an all too familiar pattern. Something is clearly wrong from the top down when management can so poorly judge the prospect of companies on whose boards they sit, and purportedly understand intimately. In addition, in each of these situations, management did not have the wherewithal to structure further investments in such a way as to insure an adequate return of the new capital. In this wind-down mode, it is imperative that capital is not thrown out the door and any investment is sensibly and conservatively spent.
Given what has transpired for the last six years under the current Board’s oversight prior to shareholder activism, we question whether the current Board members have performed appropriately as fiduciaries tasked with representing the best interests of shareholders. The Board has instituted policies which have enabled management to stay on their current course.
The Board has rewarded management with increased compensation including a special bonus for the CEO, despite returns that could not have been much worse. In 2014, the CEO received total compensation of approximately $1.8 million. By 2016, the Board had authorized a roughly 32.7% increase in the CEO’s total compensation to nearly $2.4 million. The Board took this step despite a 32% drop in the Company’s stock price, from $19.82 to $13.45. In addition, the majority of this increased compensation was in cash, not stock.
Despite years of negative returns, we are dismayed as to why it appears the Board is fighting to keep current management in place. As fellow stewards of investor capital, we would no longer be in existence with such poor returns, let alone rewarded for it.
Since our first purchase of Safeguard stock six-and-a-half years ago, up until the Company’s announcement of a change in strategy, Safeguard’s market value had fallen by more than $160 million. Over this period, Senior Management has received total compensation valued at over $25 million while Board members have been paid more than $8 million, or two to three times the amount of comparable companies. This adds up to the unacceptable sum of greater than $33 million in compensation, for a Company with a current market capitalization of only $250 million that has lost shareholders 42% of their value. In fact, it is our belief that the current Board and management appears to have consistently placed their own interests ahead of those of Safeguard’s shareholders.
The sad truth is that the only people making money from this Company are management and the Board –while shareholders have been left losing money during one of the greatest bull markets in history. We believe it is vital that the vast majority of the compensation to future management and Board Members be structured based on SFE’s stock price over the wind-down period, adjusted only for any cash returned to shareholders. We would like to see a laddered (both on price and time) pay for performance option structure adopted, so that insiders win only if shareholders realize gains. The bottom line is that exits should be rewarded, not hypothetical – and yet unrealized – progress on portfolio companies.
In addition, even though the CEO has received compensation valued at more than $10 million since our first purchase, to the best of our knowledge, he has personally purchased fewer than 6,000 shares of stock, despite the dramatic price decline. As for the COO, the second highest paid employee at the Company, he has not personally purchased a single share since the beginning of his tenure. It appears the only stock Senior Management is willing to own in their Company are shares granted to them as compensation.
We gained a lot of respect for you after our meeting and believed that we could work with you on behalf of all shareholders to MAXIMIZE shareholder value, not just increase it. However, based upon the actions we have witnessed since that meeting, we need to remind the Board that it would be blatantly inappropriate for the Company to enter into any new or revamped employment agreements/compensation packages until such time as a new Board has been established.
During our twenty-one year history, we have invested in thousands of companies without ever feeling the need to bypass management and contact the Board of Directors directly. We are surprised and disappointed that, after such a positive meeting, we feel compelled to take this public step to protect shareholder interests and would like to continue what we viewed as a positive dialogue with you. However, we will not hesitate to take any and all actions we deem necessary to protect our investment.
CEO & Managing Partner
Yakira Capital Management, Inc.
About Yakira Capital Management, Inc.
Yakira Capital Management, Inc. is an investment advisor based in Westport, CT. Yakira employs a market-neutral, event-driven arbitrage strategy to invest opportunistically across the capital structure over varying market cycles. Bruce Kallins is CEO & Managing Partner of Yakira.