NEW YORK – Traveling from venture capitalists through investment banks and ultimately into the hands of the buy-side, the flow of deals through the initial public offering pipeline during the first quarter resembled a well-oiled assembly line.
After a record-breaking 1999 for both VCs and bankers, Wall Street continued to churn out product at a dizzying pace, placing 140 deals and raising $23.7 billion, both record performances during a historically slow quarter, according to Thomson Financial Securities Data.
“Syndicate desks, the SEC and the buy-side were pretty much maxed out during the first quarter,” said Joe Hammer, managing director of the equity capital markets group at Adams, Harkness & Hill. The fuel that propelled such issuance was the performance of a technology-laden Nasdaq composite, which climbed as high as 5,132.5 on March 10, representing a 26.1% year-to-date gain and finishing the quarter at 4,572.8, a 12.4% increase.
“Given the performance of the market, there’s been a lot of pressure to bring new product to market,” said Scott Brown, chief economist at Raymond James & Associates.
A surging market, coupled with voracious appetite for new offerings, also prompted investment banks to become increasingly aggressive when pricing deals. In January, the average IPO priced 7.9% above the mid-point of the offering’s original filing range. The metrix climbed to 10.1% in February and 37.1% in March, according to Thomson Financial Securities Data.
Yet instead of curbing enthusiasm, investors viewed increases in deal price and/or size as an invitation to pile in. Indeed, the 97 IPOs that priced above range showed an average first-day return of 137.9% over offering – with 48 doubling on their first day. First-day returns for deals that were offered below or within range was a more tepid, but still positive at 23.5%. Initial popularity, however, did not necessarily translate into long-term returns.
Reflecting the laws of limited supply and overwhelming demand, public market buyers that missed getting in at offer were forced to pay first-trade premiums of as much as 217%, or more than triple the offering price. However, the market could not sustain those prices. While those stocks generally saw first-day closes 9.5% above that heady first trade, the group slid in subsequent trading, finishing the quarter 13.9% below the glorious first bid.
Harvesting the Rewards
Not surprisingly, offerings that priced at the largest premiums to originally proposed price levels were among the quarter’s top performers. While investors were hard pressed to profit from those deals in the aftermarket, strong reception for offerings from Draper Fisher Jurvetson-backed Selectica Inc., Mayfield Fund-backed webMethods Inc., Oak Investment Partners-sponsored Avenue A Inc. and Crosspoint Venture Partners/Sequoia Capital-backed Avanex Inc., proved instant windfalls for their financial backers.
For example, Selectica, which provides software used by corporations to set up sales platforms over the Internet, took in $120 million in its March IPO, making it, at three times the $40 million originally contemplated in its original filing, the quarter’s most expensive deal. After pricing its four million share offering at $30 through Morgan Stanley Dean Witter, the company’s stock opened trading at 94 and held its first day close at 141 7/32. Although the company’s shares closed March trading at 88 1/4, the offering proved the seventh-best performer of the quarter at 194.17% above offering.
Draper Fisher provided Selectica with $750,000 in seed financing in January 1997 through its Draper International India LP affiliate and made follow-on investments over the company’s next three venture rounds, according to Venture Economics. At quarter end, DFJ’s 11.6 million shares, representing a 40.1% stake, were worth $1.03 billion.
Such heady returns were not uncommon during the first quarter. WebMethods, the top performing stock of the first quarter, saw its market capitalization climb to $7.3 billion. The venture component of that total, which included commitments from Mayfield Fund, which holds an 18.6% stake, FBR Technology Venture Partners, with 10.8%; The Goldman Sachs Group Inc., with 6.8%; and Dell USA, with 8.1%, would have grossed its financial backers a cool $3 billion, based on its price of 241 3/8 at the end of the quarter.
Consolidate and Conquer
The Street’s top underwriters, traditionally powerhouses in the lucrative business of underwriting IPOs, tightened their grip even further during the first quarter. Goldman Sachs & Co., which ranked first in last year’s league tables with 54 deals and $14.5 billion raised, got its 2000 campaign off to a strong start by placing a Street-high $5.6 billion in IPOs for 19 companies.
In managing the books on fully one-fourth of all first quarter IPO volume, Goldman molded its skills to serve both low-tech and high-tech companies. On the New Economy front, the New York-based investment bank won the joint-book mandates on Palm Inc.’s $874 million spin-off, arguably the most influential deal of the quarter – and possibly the year – and the $2.7 billion offering for Infineon Technologies AG. Alongside these trendy offerings, Goldman mixed in decidedly old-world, industrial placements like the $555 million spin-off of Tenneco Inc.’s corrugated packaging operations through Packaging Corp. of America, and a $546.3 million offering for Chinese exploration and production concern PetroChina.
While Goldman rode this bifurcated strategy to the top of the first-quarter rankings, Morgan Stanley, Credit Suisse First Boston, Deutsche Banc Alex. Brown and Salomon Smith Barney predominantly relied on newer blood, including biotechnology offerings, the continued strength of business-to-business software, the Internet, and the emergence of wireless concerns. Together, the Street’s top five underwriters ran the books on over half of the quarter’s deals (77) and 72.4% of the volume, up from 70.7% in the same quarter last year.
When it comes to high-tech offerings, CSFB’s investment bankers have clearly administered a full-court press on the sector. The New York-based bank has a staggering 59 deals in registration, as many deals as CSFB placed all of last year. After 19 deals in the first quarter, up from just seven in 1999, CSFB appears poised to eclipse last year’s total.
A Victim Of Its Own Excess?
So long as the market remains open, the pipeline is filled with companies anxious to jump on board the gravy train. Indeed, in addition to the 140 companies that debuted during the quarter, another 277 companies, 181 of which received venture-backing, joined the queue of offerings in registration, according to Venture Economics.
However, even before the market’s recent correction, many began to question not only the sustainability of valuations for recent IPOs, which finished the quarter an average of 68% over offering, but also the market’s ability to absorb the additional capital.
“The calendar has been for a concern of ours for a while,” said Steven DeSanctis, small-cap analyst at Prudential Securities. Of potentially greater concern heading into a time period when the flow of money into mutual funds usually begins to slow, the $76.7 billion raised through first-quarter IPOs and secondary offerings appears to have sapped the financial resources of fund managers.
“Aggressive growth funds are investing all of their money in stocks,” DeSanctis said, noting that cash reserves for the category had dropped to an incredibly lean 3.6%. In order to make room for the $35.4 billion worth of IPO business registered in the first quarter, and another $14.9 billion of planned secondary placements, fund managers would either have to flip existing holdings or the flow of capital into their funds would have to increase – and this trend is not likely to reverse itself.
“The seasonal money flows have begun to slow,” DeSanctis said. “Last week (March 31), $600 million in cash flowed into small-cap and aggressive growth funds. That’s down from $5 billion in the week before.”
Following the market whipsaw of early April, which saw the Nasdaq composite dip to as low as 28.9% off its highs a month before, venture capitalists are preparing for a potential slow down of the public capital markets.
“We all realized that the market was overheated,” said Tom Hirschfield, a partner at New York-based Patricof & Co. “In the long run, this is very healthy for the market because investors will be forced to look at fundamentals.”
But, regardless of what happens to the public markets, venture capitalists aren’t about to tighten their purse strings. After taking in some $46.5 billion last year, VCs are busily hunting for the next generation of IPO candidates.
“There could be a disconnect between the public market valuations and the private market,” said Stephen Holmes, a general partner at Menlo, Calif.-based InterWest Partners. “But that’s not going to stop what’s happening in the private markets. There’s just too much money in the private market.”
After a combined $76.7 billion was raised in the first quarter through IPOs and secondary offerings – that’s more than double the $31.2 billion placed at this point last year – liquidity is indeed a concern.
“Over the last three years, the investment horizon from initial funding to harvesting has fallen to a year-and-a-half to two years from three to five years,” said Thomas Crotty, general partner at Battery Ventures. The Boston-based firm has three deals in registration and is looking to bring another dozen public in the second quarter. While unwilling to speculate on a postponement for those offerings, Crotty believes the IPO window may be closing just a bit.
“[In terms of an exit strategy], it may be back to the future,'” he said. Of course, any closure or lengthening of the finance cycle would have some important ramifications on the VC community.
“[Exit strategies] may take longer and may be less profitable,” Holmes surmised.