Venture-Backed IPOs Make a Comeback –

The first six months of 1999 produced 96 venture-backed initial public offerings – more than three times the 29 IPOs completed the preceding half year, according to Venture Economics Information Services (VEIS), a data company affiliated with VCJ. January through June also saw larger deal sizes, soaring average first-day run-ups and younger companies taking the public market route.

No half year period has generated as many initial public offerings since the IPO frenzy of mid-1995 through 1996 – indeed, this first half produced more IPOs than all of 1998, which yielded 78. That said, this year’s upswing did not come close to the 131 IPOs in the second half of 1995 or the whopping 154 venture-backed initial offerings that took place in the first half of 1996. The IPO boom continued in the second half of 1996, with 126 venture-backed offerings and then ended.

Explanations for the recent limp IPO market point to a volatile stock market in 1997 and concerns about Asia’s financial crisis, as well as investors’ worries about low inflation and unemployment. The glut of IPOs that came before the falloff also pushed investors toward blue chip stocks (VCJ, February 1998, page 32).

With the IPO window considerably narrower in the last two years, mergers and acquisitions inversely increased as the exit of choice. At the height of the IPO market in 1996, 101 venture-backed companies were sold, a figure that increased to 160 in 1997 and 186 in 1998 (VCJ, April, page 47.)

Tom Kippola, co-author of The Gorilla Game: The Investor’s Guide to Picking Winners in High-Technology and managing director of the Chasm Group consulting firm, sees the desire for Internet stocks by consumer investors – and their knowledge of Internet companies as end-users – as helping to drive this year’s IPO market. Additionally, he says the advent of online trading has made it easier for individuals to buy and trade stocks.

In addition to the sharp increase in the number of IPOs, there were other impressive first-half figures. IPO offering sizes, for example, averaged $74 million, far surpassing the previous year’s $49.2 million, according to VEIS. The average offering in 1997 was $35.9 million, a drop from $43.6 million in 1996 and $40.7 million in 1995. At the close of their first-day of trading, companies saw first-half IPO valuations averaging $419.7 million, almost double 1998’s $229.1 million and more than two and a half times 1997’s $164.3 million average. The average valuation was $209 million in 1996 and $154.1 million the year before.

Venture-backed companies that went public prior to July 1999 saw their stocks trading an average of 122.2% above their offering prices at the end of June, but it must be noted that big winners such as Healtheon Corp. and drove up averages, making them dubious indicators of “normal” performance. By comparison, the median valuation increase was only 79.38%.

At the same time, the mean stock price increase without the top five performers is 96.9%, and removing the top 10 companies from the average would put the stock price boost at 82.27%.

Healtheon, a health-care information-technology company, was the first half’s big winner when it ended June 30 trading at $77 – an 862.5% increase from its $8 offering price.

Reverse auction site came in second, with a 622.3% jump when it climbed to $115.6 a share by late June from a $16 offering. VerticalNet Inc., which operates online communities centered on various businesses, came in third, offering its stock at $16 and closing at $105 a share at the end of June – a 556.25% hike. Median performer Digital Island Inc., an international Internet access company, offered its stock at $10 a share and closed at the end of June on $17.94, an increase of 79.38%.

Forty-one of the 96 venture-backed companies that held IPOs in the first half increased their share price by at least 100% by the end of June, according to VEIS. Sixteen companies, however, suffered a less desirous fate, falling below their offering prices at the end of June.

COMPS.COM INC., which serves as a matchmaker for the commercial real estate market, offered its shares at $15 and closed on $7.4 at the end of June, suffering the worst blow with a 50.8% loss.

NetObjects Inc., a maker of Web page design software, closed June at $8.1 a share, a 32.8% decline from its $12 offering price. Smith-Gardner & Associates, which makes hardware and software to help manage high-volume sales on e-commerce sites and for catalog and mail-order companies, also fell to $8.1 from $12.

Young Companies More Vulnerable

The usual sectors dominated the IPO market in the first six months of this year, with software companies comprising 52, or more than a half, of 1999’s venture-backed IPOs. Communications companies came in at a distant second with 16 IPOs, followed by consumer-related businesses, which saw 14 offerings. These top three categories also dominated 1998.

Software reigned in 1997 as well, but medical/health and biotechnology companies claimed the second and third most prominent slots, respectively. Consumer companies and communications enterprises took the fourth and fifth spots that year (VCJ, February 1998, page 32).

In a sign of these fast-paced times, companies averaged 5.4 years in age when they came to market in 1999, compared with eight years in 1995. In 1996, the figure had dropped to 6.9 years, and while the number climbed to 8.2 years in 1997, it again fell to 6.2 years in 1998. For greener companies – as well as their venture backers and their limited partners – the option of going public sooner rather than later has its pros and cons.

Young companies want to take advantage of a booming IPO market and the access to capital that accompanies it, notes Lynn Martin, managing director of Warburg Pincus Credit Suisse Asset Management. But such companies take risks in doing so. Once public, they must expect VC-backers to shift their attention to private companies in their portfolios, largely leaving the newly public companies to fend for themselves.

Additionally, New Enterprise Associates General Partner Dick Kramlich points to the danger of young companies going public because they become vulnerable to the whims of the public market even as they continue developing their enterprises and proving their business models.

Mistakes and missed milestones that might have taken place while the companies were still private now take place after the companies have gone public, forcing them to face the full glare of investors and analysts. The public market can boost a company’s valuation but then, if disappointed, can cut down 30% to 50% of that value in one day, Mr. Kramlich explains. He does not, however, expect young companies to stop going public.

Mr. Kippola acknowledges the risks that a young enterprise might faces in becoming a public company, but he thinks the risks of not going public are greater, at least for companies in certain sectors, including the Internet.

Going public gives companies both “cash and cachet,” he explains. The cash helps the company defend its space and the cachet attracts customers and makes other companies with complementary products or services more willing to be acquired by the public company.

Mr. Kramlich has sat on the boards of Healtheon and Juniper Networks, a networking business that went public earlier this year and saw its stock price rise more than 300% by the end of June. Mr. Kramlich’s firm also backed CareerBuilder Inc., a site that matches job seekers with employers. The company went public a few months ago, and its share price ended June at $13.13, a modest increase from its $13 offering price. CareerBuilder received an investment from Microsoft Corp. shortly before its IPO, and Mr. Kramlich had expected that stamp of approval to make the offering more successful.

But CareerBuilder’s fate isn’t that unusual.

Not All Homeruns

Harvard Business School’s Paul Gompers, who has studied the long-term performance of IPOs since 1972, confirms the idea that very few venture-backed companies are “homeruns” and that the median performer actually does “pretty poorly.”

For short-term purposes, venture capitalists could fare better by taking their weaker companies public to generate some level of return. In the long run, however, VCs do not want to gain a reputation for taking too many duds to market, Dr. Gompers says.

On the flip side, companies can develop extraordinary value in the public market. Indeed, according to Dr. Gompers, 85% of a company’s value is created post-IPO, making a VC’s timing of distributions and a limited partner’s decision to hold or sell very important.

With distributions leaning toward stock rather than cash, managing the potential upside and downside of post-venture stocks falls in the hands of L.P.s. Some turn to outside groups such as Credit Suisse Asset Management, formerly Warburg Pincus Asset Management, or Shott Capital for help.

Glen Schwartz, senior investment officer at the San Francisco City and County Retirement System, does not take lightly the responsibility of wisely managing VC-distributed stocks. The $10 billion pension has entrusted Credit Suisse with that job for several years and has loosened its restrictions on the group to maximize returns. San Francisco previously insisted that Credit Suisse not hold more than 10% of the pension’s account in any one stock and had restrictions requiring diversification by industry. The plan is now more flexible, Mr. Schwartz says.

“While the number of venture-backed stocks may be quite large, there is a much smaller subset of ones that do very, very well,” Ms. Martin says. “So if you identify the really good ones, you can make a lot of money.”

The Post Venture Capital Index, maintained by Warburg Pincus and VEIS, tracks the performance of venture capital and buyout-backed companies for 10 years following their IPO.

The index listed 1,180 companies at the end of May, but one quarter of the index’s value was generated by just two companies – Cisco Systems Inc. and America Online Inc. – and 25 companies comprised half the index’s market capitalization, illustrating the concentration of growth and success.

Brentwood Venture Capital Partner John Walecka sat on the board of three companies that went public in the first half of this year – and three other companies also were sold during that time. Two more of his portfolio companies filed for IPOs in late June, and Mr. Walecka anticipates the market’s pace to continue as investors still search for the next Cisco Systems Inc. or Microsoft Corp., he says. “I think we’ll continue to see awesome momentum.”

Mr. Kippola predicts a shift in IPOs from business-to-consumer e-commerce companies to business-to-business companies, especially “commerce exchange” businesses that help multiple buyers connect with multiple sellers of goods or services. Mr. Kippola acknowledges that he is an investor in such companies.

Overall, Hambrecht & Quist Managing Director Cristina Morgan thinks that, in aggregate, the market is quite good, although it is still volatile. She predicts the IPO market in the second half of this year will not be quite as frenzied, but she admits to being wrong in the past.

VEIS Managing Director Jesse Reyes also expects the IPO market to slow toward the end of year, in part because of market fears related to the Year 2000 bug.

Although he says the high-flying IPO market “scares the bejesus” out of him, he does not predict a crash. He does, however, worry about investors and their perceptions of the market’s safety. “I don’t think that the average investment consumer is attuned to the risk that they are taking on,” he says.

Additionally, Mr. Reyes has heard pundits suggest that the current market cycle is “different,” in that it could last forever.

“When I start hearing that on The Street, and I start hearing that on the radio, then I start sensing some irrationality because history does repeat itself,” he says. “We can’t remain insulated from the rest of the world economy forever, and the rest of the world isn’t doing that hot.”

At press time, about 100 companies were registered to go public.

Top 10 IPOs for 1999 Ranked by % Increase

Pct Change in

Offer Stock Price Stock Price

Issuer Price at 06/30/99 to 06/30/99

Healtheon Corp. 8.000 77.00 862.50 Inc. 16.000 115.562 622.269

VerticalNet Inc. 16.000 105.00 556.25

Redback Networks Inc. 23.000 125.562 445.926

PLX Technology Inc. 9.000 47.375 426.389

Brocade Comm Sys Inc. 19.000 96.438 407.568

Covad Communications Group Inc. 18.000 53.313 344.275

Juniper Networks 34.000 149.00 338.235

Star Media Network Inc. 15.000 64.125 327.50

Ariba Inc. 23.000 97.25 322.826

Source: Venture Economics Information Services

Bottom 10 IPOs for 1999 Ranked by % Decrease

Pct Change in

Offer Stock Price Stock Price

Issuer Price at 06/30/99 to 06/30/99 Inc 23.000 20.875 -9.239 10.500 9.50 -9.524

Value America Inc 23.000 19.00 -17.391

Launch Media Inc 22.000 17.875 -18.75

FlyCast Communications 25.000 19.125 -23.50

Alloy Online Inc 15.000 11.438 -23.747

Packaged Ice Inc 8.500 5.938 -30.141

Smith-Gardner & Associates Inc 12.000 8.063 -32.808

NetObjects Inc 12.000 8.063 -32.808

COMPS.COM INC 15.000 7.375 -50.833

Source: Venture Economics Information Services

Industry Performance for 1999

Venture-Backed IPOs

# of IPOs

Computer Software Companies 52

Communications Companies 16

Consumer Related Companies 14

Financial/Insurance/Real Estate Companies 5

Business Services Companies 3

Source: Venture Economics Information Services

Top Underwriters

# of IPOs

BankBoston Robertson Stephens 13

Credit Suisse First Boston 13

Morgan Stanley Dean Witter 11

Donaldson, Lufkin & Jenrette 10

Goldman, Sachs & Co. 9

Source: Venture Economics Information Services

IPO Statistics for Venture-Backed Companies

Total Average

Total Raised Post Offer Post Offer

IPO Valuation at Average Valuation at

# IPOs Offerings IPO Date Offer Size IPO Date

1H99 96 $7.1B $40.2B $74M $419.7M

1998 78 $3.8B $17.8B $49.2M $229.1M

1997 138 $4.9B $22.7B $35.9M $164.3M

1996 280 $12.2B $58.6B $43.6M $209M

Source: Venture Economics Information Services