Are Bankers’ “Bizarre” Choices Spoiling the IPO Market?

All of two venture-backed startups have gone public this year, and both have been disappointments. Despite what seemed like an auspicious lead-up to its debut, Internet advertiser QuinStreet — advised by Frank Quattrone’s Qatalyst Partners, no less — wound up slashing its shares to $15 from $18, according to SEC filings. Those shares, which began trading earlier this month, are now trading at $13. Drug maker Ironwood Pharmaceuticals also priced below its expected range this month, selling 16.7 million shares for $11.25, after initial plans to sell them for between $14 and $16. They’re now trading at $12.50.

So much for a robust 2010.

For more perspective on how what recently seemed like a promising market has turned so dismal, I chatted earlier today with Scott Sweet, senior managing partner at the five-year-old advisory firm

Six of the seven companies to go public this year are trading below their debut prices, and no one has high hopes that Anthera Pharmaceuticals, scheduled to go out tonight, will be any different. What’s the biggest problem, in your view?

I question the rather unusual — you might even say bizarre — choices in companies that the underwriters are deciding to bring out right now. They’re bringing out, in many cases, PE-backed firms with enormous debt loads — in some cases, well over a billion dollars in debt. Graham Packaging [which makes plastic containers for consumer products and went public the second week of this month after cutting the size of its offering in half] had over $2 billion in debt, and its shares, priced at $10, are barely holding up.

Right now, it’s a buyers’ market and buyers don’t want debt-ridden companies, especially when many other companies with clean balance sheets are a value right now.

There doesn’t seem to be any aftermarket speculation in the IPO market right now. Why is that?

There hasn’t been any since December. Before that, it was a pretty decent IPO market because the overall market had improved. But suddenly, [bankers] started overpricing the deals, and now the quality of the deals are suspect. It’s a tried-and-true adage that any IPO should have a stream of increasing revenues, decreasing losses, and/or increasing profits and low debts. We’re not seeing that.

So there’s little chance for new biotech companies to perform well. Is that about right?

Well, Anthera, for example, has Phase III drugs. We’re talking about FDA approval in 2012 at the earliest. Why would anybody buy that right now when they can get a good price in the open market with FDA-approved drugs that are selling in the billion-dollar range? It makes no sense.

What’s it going to take to keep 2010 from being a crummy year for tech IPOs? Does Facebook need to get out there? Silver Spring Networks?

Of course, there was a lot of speculation last year that some high-profile companies would come public: Facebook, Twitter, Yelp, Zynga. But one by one, they are saying no. Solyndra has announced; Tesla has announced. But there is no buzz, no chatter, about anything in the IPO pipeline.

If Facebook filed, I’d say there would be pandemonium, and hopefully it would instill some confidence and speculation back into the market. But that’s not going to happen right now.

So what should VCs be hoping will happen?

Everyone is always enamored with big-name VCs like Kleiner and Sequoia and Norwest. They’re also interested in niche stories with high barriers to entry. Those three things make it much easier to find an audience [of shareholders]. Certainly, a company like Yelp would have done well, though that’s off the table now [that Yelp accepted a $100 million commitment from Elevation Partners in late January in order to grow on its own].

Which is having the most damaging impact: the comparatively low-quality companies that are being brought forward, or the very public decisions of the most sought-after companies to wait?

I think it’s really the pie-in-the-sky approach of bankers who thought that easy money would continue, and who didn’t even take any geopolitical events into account.

The major underwriters need to retool their entire thinking and almost set up a completely different pricing mechanism to make these deals work because right now, the returns are not there, which isn’t fair to their clients. The IPO market is inherently speculative by nature; if someone is going to do an IPO, they want a pop. Bottom line.