Cold Reality in Some Hot I.P.O.’s
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By GRETCHEN MORGENSON
THE NEW YORK TIMES
April 1, 2007
Would you rather own stock in a company that is profitable or one that is merely promotable? Lately, investors buying initial public offerings have chosen sizzle more than steak.
So far this year, according to IPOhome.com, 53 companies have offered shares to the public for the first time, up 20 percent from the same period last year. But just one in four of the companies making those offerings is profitable. By contrast, almost three-quarters of all companies with I.P.O.’s in 2006 actually had income hitting the bottom line.
To anyone with a memory going back more than five minutes, this year’s ratio of profitable to unprofitable I.P.O.’s is something of a danger sign. Sure, the market for new offerings is nowhere near as frothy as it was in the dot-com heyday; back then, the number of companies selling shares for the first time was roughly double the current rate. But the percentage of unprofitable companies being brought public today is just as high as it was in 1999 and 2000.
Of course, the pattern of the first three months of 2007 may not hold for the rest of the year. But the trend is alarming, according to Brian Hamilton, chief executive of Sageworks, a financial information services company in Raleigh, N.C. “It demonstrates that when people buy these companies, there is almost a lottery-ticket mentality,” Mr. Hamilton said. “If you look historically, companies that have done really well both pre- and post-I.P.O. are those that were profitable for a long time before coming public.”
In the 1970s and even the 1980s, he said, there were rational guidelines for the level of sales and profits a company should have before it should consider going public. They included such basics as four consecutive years of profitability and at least $1 million in annual profit.
Such standards look quaint today. Consider Salary.com, a provider of compensation management applications that issued shares to the public in February. Revenues are growing nicely at the company — in its last fiscal year, sales were $15.3 million, up 53 percent from 2005. But the operations lost $3.1 million in fiscal 2006. At the end of last year, Salary.com, founded in 1999, had accumulated losses of $25 million.
Mr. Hamilton pointed out that while the company has an impressive asset in the form of intellectual property, the value of the data has not translated into improving financial performance. Investors don’t seem to mind: the stock, issued at $10.50, closed in regular trading on Friday at $11.13.
Ken Goldman, chief financial officer of Salary.com, said that his company was not like the dot-com offerings of seven years ago. “What investors are buying in our case is revenue growth,” Mr. Goldman said, “which has risen historically north of 55 percent per year.”
A MAKER of telecommunications components, Opnext, issued shares in February. The company turned a profit of $925,000 in the first nine months of 2006 but has lost $281 million since its inception in 2000. Among the risk factors identified by the company in its prospectus is the possibility that it might not generate sufficient cash flow from operations to cover its capital needs.The company offered shares at $15 in mid-February; the stock closed on Friday at $14.79.
“We are part of the telecom industry, and as the telecom bubble burst we were affected,” said Rebecca B. Andersen, an Opnext spokeswoman. “But as the industry has come back we worked to increase our profitability, which was shown in the past few quarters.”
Clearwire, a wireless broadband service provider, offered shares at $25 on March 7. It closed last week at $20.47. Revenues of $100 million in 2006 were triple those of the previous year, but it still lost $284 million. Since the company was formed in 2003, it has lost a total of $460 million.
A spokeswoman for Clearwire did not return a telephone call seeking comment.
Aruba Networks brought its shares public at $11, well above the pre-offering range of $8 to $10. It closed on Friday at $14.67. The company lost $11.7 million in the six months ended Jan. 31 and has lost $88 million since it was formed in 2002.
And so on, and so on, and so on.
“These are not bad companies, they’re just going out too early by a year or two,” Mr. Hamilton said. He added that the value of the asset an investor is buying is very difficult to determine. “If you asked me to buy a piece of real estate or machinery, you’d have to be able to show me how that thing is going to generate a positive return.”
An Aruba Networks spokesman declined to comment, citing the so-called quiet period after an offering is made.
On average, said Renaissance Capital, the parent of IPOhome.com, this year’s I.P.O.’s are up 6 percent from their offering prices. But last week brought signs that the euphoria may be fading.
On Thursday, Wall Street firms managing three offerings had to cut their prices to generate investor demand. Super Micro Computer was priced at $8, well down from an earlier range of $9.50 to $11.50. GSI Technology, a maker of integrated circuits, issued shares at $5.50; it had hoped to receive $6.50 to $8 a share. Finally, SenoRx, a health care company, was priced at $8 a share, considerably below an earlier range of $11 to $13.
At the end of the week, two of those companies closed above their offering prices: Super Micro Computer closed at $8.99 and SenoRx finished at $8.19. GSI Technology, closing at $5.25, had fallen below its offering price.
Only 9 of the 53 companies coming public this year were issued at prices below the ranges that investment banks had assigned to them, according to Renaissance Capital.
You can’t blame companies for wanting to cash out when the getting is good. And you can’t rely on investment banks, which generate juicy fees on these deals, to delay the offerings until the companies can show more solid financial results.
Investors, therefore, are on their own and must show some discipline when scrutinizing nascent companies as portfolio possibilities. New-issue prospectuses provide loads of details on the risks associated with these companies and their financial pictures. But few investors bother to read the documents.
“People tend to get caught in the psychology of a trend rather than looking at company fundamentals,” Mr. Hamilton said. “They forget the lessons of history.”
And they often pay a hefty price for it. |
