While we've seen a pickup in initial public offerings of late, most notably in Q4 2010 prior to the holiday slowdown, many people watching the market continue to expect muted IPO market prospects relative to the 1990s. Maybe that's not such a bad thing. The last time there was anything approaching a positive consensus was early 2000, and we know how that ended.
Sarbanes Oxley? Frivolous lawsuits? There are many reasons to stay private if it's a close decision. However, it is no longer a close call. Investor demand for growth and the resultant multiples now available are so compelling that companies young and old (by IPO standards) can no longer afford the luxury of remaining private.
See No IPOs
The IPO markets overall are highly receptive. We just don't see it locally – as reports of IPO volume commonly exclude not only listings on overseas exchanges but also listings of foreign companies (many of them backed by US VCs) here in the US via American Depositary Receipts (ADRs). Listings by non-US companies didn't rally much attention back when Palo Alto's Sand Hill Road was the undisputed champion of the IPO-generation machine, but they're a major factor now that the market's digital and clean-tech debutantes increasingly hark from Beijing or Bangalore rather than Palo Alto. In 2010, US companies accounted for only 85 listings at home, while 45 overseas companies made their public debuts on NYSE, AMEX or NASDAQ. The majority of IPOs, 1,177 for the year, represented international companies listing on non-US bourses.
This phenomenon is not unique to 2010 (Exhibit B). In fact, the 2000 worldwide record of 1,883 new listings was already toppled in 2007, with 2,014 IPOs globally, netting $298.8 billion. While 2010's world total of 1,307 IPOs and $280.1 billion in proceeds is not a new peak, it is multiples of the 85 or so domestic IPOs we see reported here in Silicon Valley.
Looking only at US IPOs, the last decade has seen a drought of biblical proportions. That said, there are two good reasons to believe that the uptick in IPOs at the end of 2010 (US and international) will gain even more steam during 2011: increasing Supply and even stronger demand.
Supply: Previous droughts of even a few years were generally followed by floods of activity (Exhibit C). Moreover, a look back to 1980 reveals that 1999/2000 was not even a one-time peak of US IPO activity – it simply represented the end of a multi-year boom, where the numbers of listings each year wasn't as notable as the nature of companies being listed. The fact that over 80% of listings were unprofitable, and those companies garnered more attention than those in the black, was the hallmark of the Internet Bubble. Profitable and not, the "supply" of list-able companies – after a decade long drought – is significantly greater today than was the case in 99/00 after eight strong years of IPOs had depleted the supply of even the most marginally list-able candidates. The US listings to date this cycle have barely made a dent, and the best (i.e. IPOs of the leaders) is yet to come.
Taking a company public prior to break-even is not uncommon; going public years prior to projected profitability, with additional follow-on financings required keeping the company afloat … that was unsustainable.
Demand: Equity investors are clamoring for growth, as the scramble to obtain shares in Facebook illustrates. In a record low interest rate environment, there is an unfulfilled demand for growth companies to absorb increasing inflows of capital allocated for such investments. If the landscape leading into 1999 and 2000 was particularly fertile for the IPO market, the catalysts for 2011 are far stronger.
Beyond macroeconomic factors, the phenomenal growth, profit margins and network effects promised by some IPOs of the late 90s are not only on the table once again, but the drivers are arguably stronger this time around. A company like Facebook represents a stronger example of financial and competitive accomplishment than even Netscape back in 1995.
Hear No IPOs
The press is littered with the unfulfilled predictions by management teams of an IPO in the near future. Whether it is wishful thinking, bad luck with market conditions or operational stumbles, such pronouncements rarely play out.
On the flip side, the companies who say they won't go public in the near-term, or better yet, don't say anything at all, make up the bulk of the successful listings year in and year out.
The reason we should assume the dam will break, and companies (both over-ripe and still green) will list? The valuations are becoming so compelling that remaining private will simply not be a viable option – particularly if a direct competitor taps the capital markets in the interim.
A Question of When, not If
The SEC interest in feeder funds is just one sign that these companies "should" go public and enjoy the benefits of a listing, as they're already facing many of the related headaches and costs.
If the year 2001 was the year where we looked back and realized we had already listed anything that "could" be listed, the current supply of list-able companies presents an inverse portrait. 2011 should be the year the dam breaks – for all of the companies that "should" have listed (absent the alternative markets which have popped up to provide capital). Over the past decade, we've not only replenished the pool of start-ups, but some of them have been able to ripen well past the point of traditional IPO harvest, nourished by these alternative capital pools.
Foregoing a public listing means a higher cost of capital. Certainly the valuations attached to recent investments in web companies (both direct and via exchanges such as SharesPost and SecondMarket) seem attractive – and they are. But the valuations afforded by the public market are higher – or else these investors wouldn't be making such bets. The December IPO of Chinese online video leader Youku provides a hint of the possible valuations achievable for digital leaders in the public markets. Youku's valuation is not indicative for most IPO candidates. That said, at least for the time being, it appears to be trading at a trailing revenue multiple a few times as high as Facebook is changing hands privately of late. In both cases, those trailing revenue multiples are irrelevant; forward estimates of earnings (accurate or otherwise) are driving valuations – but it is the public/private differential that stands out.
To take it a step further, there's an argument to be made that these firms "must" go public in 2011 (if not a few quarters later). A decision to remain private is not made in a competitive vacuum. Failing to tap the cheapest pool of capital can be a fatal decision if a competitor does and the IPO window closes behind them.
Among the arguments to expect a continued paucity of Silicon Valley IPOs is that there just aren't enough candidates from a bottoms-up perspective. The argument is valid if you make a few key assumptions about who could or should go public. Larger investment banks generally counsel companies to wait until they have ~$100 million in revenues to go public. By that metric, there isn't a wave of IPOs on the horizon. However, if past is prologue, that doesn't account for two factors that occur every major IPO cycle, and at an accelerated pace each successive boom:
Silicon Valley companies can grow at rates that mean a company could have a fraction of that revenue this year but still earn so much on the bottom line, let alone top-line, looking out 1, 2 and 3 years, that they are far more attractive to investors than a slower growing $100M company. For high-growth companies, $50M of trailing revenues is a more relevant benchmark, but even that is not a hard limit. Each cycle, equities ultimately move up to trade at higher multiples (both trailing and forward) than nearly anyone expects in advance. While the exact same excesses of 1999/2000 may not happen again, we have even stronger stimulus for high multiples given the extended zero interest rate environment resulting from the Fed's pledge to err on the side of leaving stimulus in place for some time to come.Size Matters?
With the shrinking number of investment banking firms over the last decade, perceptions of the IPO market are colored by the lens of the few large investment banks left standing. It is true that underwriters prefer to take companies public when the deal size (revenues aside) is at least $100 million.
However, back when the IPO market in the US was far more robust, $50-75 million dollar IPOs were common. This perception that IPOs "should" be at least $100 million to matter has affected the way even third parties measure the market, as many reports on the state of the IPO market exclude listings below $100 million.
IPOs of less than $100 million rose above the 50% level in 99/00, but that wasn't the first time. In fact, even after accounting for inflation, the key difference between this past decade and previous decades is the extraordinary absence of these listings – the bread and butter of the IPO market up until recently.
To butcher an already ignominious expression, it's not the size of the (revenues) boat, but the motion of the (earnings) ocean that matters. Basically, in a low rate environment, a tally of last year's receipts matters little relative to the earnings expected this year and next, as well as the rate of increase beyond.
[Opening image credit: Flickr/rightee]
David Williams is founder and CEO of Williams Capital Advisors, LLC, an investment banking advisory firm serving emerging growth companies since 2002. David has advised on pre-IPO rounds and/or acted as lead IPO underwriter for a number of high growth US, Chinese and Indian Internet/Software companies including NTES, BIDU, and SIFY, among others.
Tags: IPOs
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Source: http://feeds.nytimes.com/click.phdo?i=faa37b0aa9ca7440a7880bc943791d93
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