To use a roller coaster as a metaphor for the 1998 initial public offering market would be a cliche. But sometimes the reality of the market leaves no other option. Although 1998 produced just 77 venture-backed IPOs – a 42.5% drop-off from 1997 and the lowest year-end output since the measly total of 42 in 1990 – the year provided investors with quite a ride.
Last year featured eye-popping thrills, such as the meteoric rise of technology companies like eBay Inc. or Inktomi Corp., as well as nerve-rattling chills, such as the excruciatingly quiet third quarter. But just when venture capitalists feared their nearly decade-long ride up had come to an end, they witnessed an unexpected takeoff in late November, when the market suddenly stormed back – despite the holiday onrush which traditionally bogs down new issues – an encouraging end to a jittery year.
What do the 1998 IPO market’s twists and turns mean to venture investors in the long run? In many ways, sources say, absolutely nothing. With money pouring into venture funds at a record pace, VCs will have no shortage of capital to offer sound companies – public market performance notwithstanding. And exit options remain strong: the experts believe that the best businesses will still find their way to the public market, albeit with more caution than they did two or three years ago. And, for the weak of heart, there is always the pony ride of mergers and acquisitions.
Through the third quarter of 1998, venture-backed M&A activity continued to outpace even the record-breaking figures in 1997. According to Venture Economics Information Services (VEIS), a data company affiliated with VCJ, the 119 M&A deals through September 1998, compared to the 107 in the same period the year before, seemed poised to eclipse the annual mark of 156 set in 1997.
Perhaps even more telling was the widening gap between venture-backed IPOs and M&A sales through the third quarter – 71 to 119 in 1998, compared to 102 to 107 in 1997 (VCJ, January, page 7).
Mark Jensen, consulting giant Arthur Andersen’s firm-wide director of high technology and managing director of its Silicon Valley office, believes that the number of M&A transactions will continue to rise at the expense of the IPO market. “As businesses continue to be more global in scope,” he says, “it’s going to be harder and harder to go it alone.”
However, the blame for the decline in the number of IPOs may not entirely be on the inability of young VC-backed companies to leave the nest, Mr. Jensen adds. It makes sense for companies like Cisco Systems Inc. and Sun Microsystems Inc. to gobble up businesses that several years ago might have opted for an IPO.
One reason is a balance sheet issue: adding a hot new technology in the form of an acquisition can save a large company like Cisco millions of dollars in research and development. Along the same lines, it may also prove to be infinitely more cost-effective than trying to ward off a big competitor down the road through bigger, more costly mergers. Corporate venture investment programs also illustrate this point. “Intel is one of the largest VCs in Silicon Valley,” Mr. Jensen says.
However, many sources are not so quick to agree that an increase in M&A activity should ease the fears prompted by a waning IPO market.
“As the IPO window becomes a little bit [narrower], it clearly slows some paths of liquidity,” says Harry Rein, a managing partner at Rowayton, Conn.-based Caanan Venture Partners.
Dave Golden, co-director of investment banking at Hambrecht & Quist in San Francisco, agrees. “[M&A sales are] not to the detriment of the public market,” he says. “Sizable companies need to sustain their growth rates.”
Like the IPO market, M&A activity is dependent on the relative health of a particular industry. According to VEIS, hot spaces like software/services and communications see the best of both worlds, racking up 21 and 11 IPOs, respectively, while also generating the most merger activity, with 51 and 17 through the third quarter.
“There’s no doubt the Internet is changing the way commerce is done,” Mr. Golden says. Investors, he adds, have become aware of the Web’s importance, and a public market froth has been driven by online daytraders hoping to cash in on Internet stocks’ gaudy debuts. Meanwhile, the same frenzy that drives up the valuations of Internet stocks also encourages private businesses in the sector to rush to the public market themselves.
The results have been otherworldly. Online auctioneer eBay went public in September at $18 a share. On December 31, it was trading at $241.25, a 1,240.3% increase from its offering price. Inktomi, a network software application developer, did not quite reach eBay’s extravagant heights, but its $129.38 year-end close was a nifty 618.8% higher than its $18 offer price in July.
Not every business is the next eBay or Inktomi, however, and venture capitalists must choose the best exit strategy for their portfolio companies. The liquidity decision between a sale or an IPO comes down to logistics. “If you’re creating a market segment and you’ve got first-mover advantage, I think you should run like hell to an IPO,” says Dave Fleming, a general partner at Atlanta-based Alliance Technology Ventures. “If you’re saying, I’m a good quality house … but not fundamentally creating a new market space,’ … you should probably think M&A as a possibility.”
Thus, early-stage companies with a novel technology or concept that can not find their way to the public market also have been able to cash in on the Internet craze through quick sales to aggressive suitors, particularly search engines and portal companies.
Not every sector, however, can take solace in the burgeoning M&A market as a substitute for IPOs. Down-on-their-luck industries such as biotechnology – with its meager six IPOs in 1998 and seven M&A sales through September – watch the carnival from outside the fence as they seek alternative forms of financing such as another private equity round.
Many industry insiders pin biotechnology’s troubles on its inability to produce a new superstar, one wildly successful business that will help win back investors’ confidence and spur the kind growth seen by the Internet industry. “[In Internet and information technology], we can point to lots of [successful] paradigms,” Caanan’s Mr. Rein says. “What it takes is the establishment of a track record.”
Until biotechnology can again draw investors’ attention, VCs that specialize in the industry have turned to less traditional means to find the best valuations available: investing in public companies (VCJ, January, page 42). A slew of perhaps premature companies rushed to IPOs in headier times, and their difficulties on Wall Street have curtailed many new biotech issues and relegated a fair amount of fundamentally sound companies to sulking in the public markets at bargain-bin prices.
San Francisco-based Alta Partners in March 1997 launched Alta Biopharma Partners with just such companies in mind. “It takes 15 years to put biotech companies together,” says Jean Deleage, a general partner of the firm, noting the huge expense involved in R&D and clinical trials, all of which must come before a biotech company will produce any revenues.
“I think we were pretty innovative when we started [Alta Biopharma] at the beginning of last year,” he adds. “Now we’re starting to see other [similar funds].”
But while many sources will caution that limited partners will not accept excessive public investments by their G.P.s – many limited partnerships contain a provision that outlaws more than an infinitesimal amount of investments in public companies – the trend is undeniable. And it makes sense – the valuations of public biotech companies have never been better for venture investors, H&Q’s Mr. Golden says. “The alternative is less appealing … in the private market [investors] must be very patient.”
The mere fact that venture capitalists would even need to scour the public markets for deal flow seems to suggest that there is plenty of capital to be had. And that money needs to be invested somewhere, whether it be a private company that goes through an IPO or a sale, or a public company that may have needed another round or two of private equity before testing the public waters.
Trends such as the rise of M&A sales and VCs investing in public companies should not be cause for alarm for investors monitoring their exit strategy options. “What’s new is the scale of what we’re doing,” Caanan’s Mr. Rein says, noting the growth not only of funds under management by familiar names, but also the rise of new firms. “It’s more a reflection of the growth of the entrepreneurial industry.”
And, listening carefully, one can almost hear investors lining up for another ride. “I was one of the ones who believed in the third quarter that the window would be closed for awhile,” says Alliance’s Mr. Fleming. “But good deals can get done in any market.”
A return of a generally bullish attitude among investors, at least within the VC industry, after the second half of 1998’s setbacks seems to bode well for the last year of the twentieth century – even if the IPO market does not return to the dizzying heights of 1995 and 1996.
“I think we’re going to see that 1999 is better than 1998,” H&Q’s Mr. Golden says.
Top 10 IPOs for 1998 Ranked by % Increase
IPO IPO 12/31/98 Percent
Offer Size Price Stock Price Change
Company Name ($Mil) ($) ($) (12/31/98)
eBay 63.0 18.00 241.250 1240.3
Inktomi 40.6 18.00 129.375 618.8
Exodus Communications 67.5 15.00 64.250 328.3
VeriSign 42.0 14.00 59.125 322.3
Visual Networks 43.8 12.50 37.500 200.0
Carrier Access 36.0 12.00 34.438 187.0
Terayon Communication Systems 39.0 13.00 37.000 184.6
EarthWeb 29.4 14.00 38.875 177.7
BindView Development 37.5 10.00 27.500 175.0
Mercury Computer Systems 36.8 10.50 28.125 167.9
Source: Venture Economics Information Services
Bottom 10 IPOs for 1998 Ranked by % Decrease
IPO IPO 12/31/98 Percent
Offer Size Price Stock Price Change
Company Name ($Mil) ($) ($) (12/31/98)
BMJ Medical Management 28.0 7.00 .063 -99.1
USN Communications 102.4 16.00 .188 -98.8
Aspec Technology 78.0 13.00 1.313 -89.9
Evolving Systems 64.4 14.00 3.563 -74.6
Merge Technologies 11.4 6.00 1.750 -70.8
IOMED 12.8 7.50 2.188 -70.8
Horizon Medical Products 50.4 14.50 4.375 -69.8
Symphonix Devices 27.6 12.00 4.125 -65.6
Nanogen 42.9 11.00 4.000 -63.6
ViaGrafix 28.6 13.00 4.750 -63.5
Source: Venture Economics Information Services
Top underwriters
Total Offer Size
or Proceeds Mkt. # of
Managers ($mils) Rank Share Issues
Goldman, Sachs & Co. 802.1 1 21.2 13
Bankers Trust 420.6 2 11.1 8
Hambrecht & Quist 317.1 3 8.4 6
BankBoston 263.8 4 7.0 8
Morgan Stanley Dean Witter 240.9 5 6.4 5
Bear, Stearns 226.4 6 6.0 2
Deutsche Bank 204.3 7 5.4 5
Salomon Smith Barney 183.5 8 4.9 2
Merrill Lynch & Co. 147.9 9 3.9 2
Lehman Brothers 145.6 10 3.9 1
Bank of America Corp. 137.0 11 3.6 5
Credit Suisse First Boston 131.9 12 3.5 3
Prudential Securities 108.8 13 2.9 2
Donaldson, Lufkin & Jenrett 82.3 14 2.2 2
CIBC Wood Gundy Securities 65.0 15 1.7 1
Societe Generale 63.6 16 1.7 2
Adams, Harkness & Hill 59.1 17 1.6 1
Morgan Keegan 36.0 18 1.0 1
JP Morgan & Co. Inc. 29.4 19 .8 1
Southwest Securities 28.6 20 .8 1
Needham 16.2 21 .4 1
Gruntal & Co. 16.1 22 .4 1
EVEREN Securities 12.8 23 .3 1
Volpe Brown Whelan & Co. 12.4 24 .3 1
H. C. Wainwright & Co 11.4 25 .3 1
Top 25 Totals 3762.6 – 99.5 76
Industry Totals 3780.0 – 100.0 77
Source: Venture Economics Information Services
Industry Performance for 1998 Venture-Backed IPO’s
Average Average Total
Total # IPO Price Close Price IPO Size Total %
Industry of Cos. ($) (12/31) ($mils) Change
Communications 11 13.32 20.78 746.7 56.0
Computer Hardware 9 14.61 36.20 496.6 147.8
Computer Software & Services 21 12.52 22.33 914.3 78.3
Semiconductors/Other Electronics4 10.25 8.16 190.4 -20.4
Biotechnology 6 8.83 6.80 147.0 -23.0
Medical/Health Related 7 11.21 9.46 273.3 -15.7
Consumer Related 12 15.67 38.25 795.0 144.1
Industrial/Energy 1 6.00 9.63 16.2 60.4
Other Products 6 11.00 13.96 197.4 26.9
Total 77 76.2
Source: Venture Economics Information Services
1998 IPO’s per Company by Region
PCT AVG MED AVG MED
NUM PCT OFFER OF OFFER OFFER AGE AGE
Company OF OF AMOUNT OFFER AMOUNT AMOUNT @IPO @IPO
Region IPOs IPOs ($MIL) AMOUNT ($MIL) ($MIL) (YRS) (YRS)
Mid-Atlantic 4 5.19 171.0 4.53 42.8 44.6 6.5 4.0
Midwest 3 3.90 181.8 4.81 60.6 68.0 8.7 12.0
Northern CA 24 31.17 1021.4 27.05 42.6 70.6 5.3 12.0
Northeast 13 16.88 672.9 17.82 51.8 59.5 7.3 2.0
Northwest 3 3.90 146.8 3.89 48.9 33.0 7.7 14.0
Rocky Mountain 7 9.09 321.0 8.50 45.9 126.5 0.9 2.0
Southern CA 4 5.19 200.8 5.32 50.2 38.5 7.8 11.0
Southeast 13 16.88 563.8 14.93 43.4 48.9 3.8 4.0
Southwest 6 7.79 496.9 13.16 82.8 74.6 4.5 5.5
TOTAL 77 3776.4 49.0 33.8 6.2 2.0
Source: Venture Economics Information Services
IPOs per Company by State
PCT AVG MED AVG
NUM PCT OFFER OF OFFER OFFER AGE AGE
Company OF OF AMOUNT OFFER AMOUNT AMOUNT @IPO @IPO
State IPOs IPOs ($MIL) AMOUNT ($MIL) ($MIL) (YRS) (YRS)
Arizona 1 1.30 49.8 1.32 49.8 49.8 6.0 6.0
California 28 36.36 1222.1 32.36 43.6 70.6 5.6 12.0
Colorado 5 6.49 295.9 7.84 59.2 36.0 9.6 6.0
Connecticut 1 1.30 72.0 1.91 72.0 72.0 4.0 4.0
Delaware 1 1.30 16.2 .43 16.2 16.2 15.0 15.0
Florida 5 6.49 231.4 6.13 46.3 48.9 2.6 4.0
Georgia 3 3.90 141.4 3.74 47.1 66.0 6.3 4.0
Idaho 1 1.30 12.4 .33 12.4 12.4 4.0 4.0
Illinois 1 1.30 102.4 2.71 102.4 102.4 4.0 4.0
Massachusetts 5 6.49 159.8 4.23 32.0 33.8 11.2 2.0
Maryland 1 1.30 43.8 1.16 43.8 43.8 5.0 5.0
Minnesota 1 1.30 68.0 1.80 68.0 68.0 12.0 12.0
North Carolina 2 2.60 42.3 1.12 21.2 21.2 2.5 2.5
New Jersey 2 2.60 222.9 5.90 111.4 111.4 1.5 1.5
Nevada 1 1.30 59.5 1.58 59.5 59.5 3.0 3.0
New York 5 6.49 218.2 5.78 43.6 59.5 6.4 2.0
Oklahoma 1 1.30 28.6 .76 28.6 28.6 8.0 8.0
Pennsylvania 2 2.60 111.1 2.94 55.5 55.5 3.0 3.0
Tennessee 2 2.60 111.2 2.94 55.6 55.6 1.5 1.5
Texas 4 5.19 396.5 10.50 99.1 68.5 4.8 7.0
Utah 1 1.30 12.8 .34 12.8 12.8 24.0 24.0
Washington 3 3.90 146.8 3.89 48.9 33.0 7.7 14.0
Wisconsin 1 1.30 11.4 .30 11.4 11.4 10.0 10.0
TOTAL 77 3776.4 49.0 48.9 6.2 4.0
Source: Venture Economics Information Services
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