Public market investors don’t appear to have lost their senses, but don’t be surprised if they turn ebullient in the not-too-distant future.
Call it the LinkedIn effect. Since the business networking company filed in late January to go public in a $175 million proposed offering, the market has been going giddy over new issuers and registrants.
One of the newly public companies is private equity-backed Kinder Morgan, a Houston-based fuel pipeline company that was taken private in 2007 by a syndicate that included Goldman Sachs and The Carlyle Group. When it went public the second week of February, its shares were quickly pushed slightly above their $30 share price, where they’ve remained.
The $2.9 billion IPO was the biggest-ever IPO for a U.S. company backed by private equity firms. More remarkable is that the record Kinder Morgan broke was established in January, when private-equity backed Nielsen Holdings NV raised $1.9 billion in an IPO.
Even unprofitable biotechs, which have largely performed poorly in recent years, are sensing opportunity and barreling ahead with IPOs. One of them is VC-backed Fluidigm, a self-described biotech tools company that went public on Feb. 10, more than two years after pulling its previous bid to go public.
The company lost $13.8 million on revenue of $23.2 million in the first nine months of 2010, but rather than punish the company, shareholders have boosted its share price roughly 50 cents per share from $13.50, where it debuted.
Consumer Web companies, such as LinkedIn, may be the single biggest driver of the market uptick.
“There’s been so much news about Facebooktrading on secondary exchanges and Goldman Sachs’ deal and them setting up for an IPO early next year,” says Matt Therian, an analyst at Renaissance Capital in Greenwich, Conn. “[Excitement over LinkedIn] is a reflection of investors really wanting to get into this whole social networking sector.”
The excitement is warranted, too, Therian says.
“Any company that’s doubling revenue and has 20% EBITDA for the nine months ended [last September] is pretty impressive,” he says. “I think investors are excited [about LinkedIn] because it’s a profitable and fast-growing and it already has a huge network in place.”
Therian says that it would be vastly overstating things to call the market’s expectations of LinkedIn or other prospective issuers unrealistic. “Investors really are paying attention to the numbers,” he says. “The market is nowhere close to getting overheated.”
Therian isn’t alone in that view. Scott Sweet, senior managing partner of the Lutz, Fla.-based advisory firm IPO Boutique, is also quick to talk about the relative health of the market right now.
Sweet says rather than welcome just anyone with some backing and a half-baked road map, the market is very much focused on three main criteria these days: year-over-year increasing revenue, decreasing losses and low to no debt.
And while IPO hopefuls no longer need to be producing a substantial amount of revenue—a bar very much in place several years ago, at least for tech companies—Sweet says that plenty of startups with revenue “well below $100 million” are coming out and performing “very well.”
The late-January IPO of the online content creator DemandMedia is a prime example. Though the 5-year-old company has never turned a profit, its stock soared the day after its IPO, rising 35% to $22.61, which gave it a market valuation of $1.9 billion.
Investors have since knocked some value off the company. As of VCJ’s press time in late February, the company’s shares were trading at $19. But that still gives DemandMedia a market cap of $1.63 billion, more than the $1.5 billion market cap of the New York Times.
Steve Fletcher, a managing director with GCA Savvian in San Francisco, says many of the digital media companies coming public are good bets for investors, not least because of their scope. (DemandMedia’s prospectus, for example, claims that its sites attracted 105 million unique visitors last November, making it the 17th-largest Web property nationwide.)
Fletcher applauds both LinkedIn and DemandMedia for waiting until they were at least billion-dollar market cap companies to file for offerings. “I think that’s a very healthy thing for the market, and shows [the market] will be receptive to scaled, profitable companies with good businesses and a lot of momentum.”
Still, Fletcher says he’s already seeing some underwriters acting egregiously, privately calling out one investment bank for recently filing an IPO for “an auto and real estate lead [generation] company that’s a terrible company.”
He says it’s not a question of whether the broader market will grow overly frothy but when.
“When the IPO market gets hot, everybody thinks they can get through the window,” Fletcher says. “You’ll see mediocre companies that can’t sell themselves to acquirers say, ‘The IPO market is hot, let’s take a shot and go public.’”
As history has shown time and again, the mediocre companies are never the worst of it.
“Markets loosen and valuations rise,” says Venky Ganesan, a managing director at Globespan Capital Partners. “Then the big companies go out, then the imitators, then the idiots. When the idiots go out, then you know we’re at the end of the cycle.”