IPO POWER!
Despite an early trend of
fewer deals but better
quality, this year's
technology IPO market will
be as erratic as ever.
By Andrew P. Madden
The Red Herring magazine
July 1998
Calling the technology IPO market
unpredictable is like calling
Microsoft dominant or the Spice
Girls vapid: it's obvious to an absurd
degree. But every now and again,
initial public offerings by technology
companies become alarmingly
predictable--they're either going
through the roof or not happening at
all.
On the heels of a sleepy 1997 for
technology IPOs (the total funds
raised by initial technology issues fell
from $13 billion in 1996 to $7 billion
in 1997), this year so far appears to
be infused with the sort of irrational
behavior that makes technology IPOs
so predictably, well, unpredictable.
With the Dow Jones Industrial
Average having surpassed 9,000 for
the first time earlier this year, 1998
could be a banner year for technology
IPO performance. But a strong start
doesn't necessarily lead to a strong
finish. Moreover, as the biggest
technology companies keep getting
bigger, many young companies will
opt to be acquired rather than venture
into the public markets alone (see
"Robbing the Cradle"). To be sure,
investors in the 1998 technology IPO
market will play their perennial role
as speculators.
The most recent likeness of today's
technology market was seen in 1996.
Led by the data warehousing company
Red Brick Systems (Nasdaq: REDB)
on January 23 of that year, new--and
excessively hyped--issues started
flying through the IPO window. Red
Brick closed its first day of trading up
nearly 70 percent and would be
followed by the likes of Performance
Technologies (Nasdaq: PTIX) on
January 25 (up 36.4 percent after its
first day), Documentum (Nasdaq:
DCTM) on February 6 (up 29.2
percent in its first day), and
CyberCash (Nasdaq: CYCH) on
February 15 (up 77.9 percent after
one day).
The swarm
By the end of March 1996, well over
40 technology IPOs were fighting for
attention in the public markets. The
quick start set the pace for a year that
would see Internet contenders like
Yahoo, CNet, Lycos, and Excite
(Nasdaq: YHOO, CNWK, LCOS,
XCIT) arrive on the IPO scene and
try to capitalize on an exceedingly
heady market.
But by the end of 1996, after a mild
correction in July, the year was, on
balance, tepid. Despite a fast start
and a decent finish, the average
increase in value of technology IPOs
was a disappointing 12 percent,
according to Securities Data.
The first few months of 1998, with
the exception of a flat January, have
likewise seen new technology issues
warmly received. At the beginning of
February, investors started snapping
up deals--and even those
much-maligned Internet IPOs began to
look good to buyers.
According to many of the investment
bankers who are currently dressing up
deals for the catwalk, the rest of 1998
looks promising: the quantity is lower
than in 1996, but the quality looks
better. And investors seem to agree.
Temperature gauge
One way to measure the mood of
investors is to see whether Internet
deals are attracting dollars. These
companies typically show meager
revenues, are posting losses, and
have speculative business models.
When investors accept these realities
and bet on Internet companies
anyway, their optimism usually spills
over into the broader technology IPO
market.
As late as November, Internet deals
appeared to be stalling. The online
travel service Preview Travel went
public (Nasdaq: PTVL) on November
20 to an utterly flat reception. Priced
at $11, the stock proceeded to slide
as low as $6.88 over the ensuing
month. But in 1998 Preview Travel
has climbed as high as $38.13.
On January 30 of this year, the
electronic commerce company
VeriSign went public (Nasdaq:
VRSN) at $14 a share--up around 40
percent from its initial price filing
range of $9 to $11 a share. The stock
jumped 11 points on its first day of
trading, and all of a sudden it seemed
like old times for Internet deals. The
Internet advertising software
company DoubleClick (Nasdaq:
DCLK) followed suit on February 20,
pricing at $17 and opening at $29.25,
up 72 percent on its first trade. The
Internet Security Systems Group
(Nasdaq: ISSX) went public on
March 24, its share price leaping
from $22 to $40.38 in the first day of
trading.
But if this year's IPOs have been well
received so far, 1998 has differed
markedly from 1996 in that fewer
than 20 new technology issues had hit
the markets by the end of March, less
than half the number of tech IPOs in
the first quarter of 1996. The
higher-quality, smaller-quantity
dynamic makes for a more stable
investing environment. This is
particularly true of the Internet sector:
with its two additional years of
maturity, it comes as no surprise that
investors have greater faith (Yahoo's
$5.5 billion market cap is clearly
comforting).
Morgan Stanley, Dean Witter,
Discover recently released a report
that illustrates the maturity of Internet
stocks--at least in terms of their
viability as investments. In February
1997 Morgan Stanley noted that half
of the 42 Internet IPOs that had
followed Netscape's August 1995
IPO (Nasdaq: NSCP) were trading
below their offering prices. The firm
also noted that, excluding Netscape,
new Internet issues had lost more than
$375 million in market capitalization.
As of April 1 of this year, however,
44 of the 68 Internet IPOs since
Netscape's that were tracked by
Morgan Stanley were trading above
their offering prices; the net gain in
market capitalization was $20 billion.
Say what you will about elusive
business models and steep losses.
Deride the vertiginous valuations all
you want. Investors are making
money.
Respected bull
According to Dick Smith, a senior
managing director in equity capital
markets at NationsBanc Montgomery
Securities, the story behind the
Internet sector is now more
believable. "The individual Internet
companies may or may not be more
mature, but the vision of what the
Internet might become is clearer. The
sector is becoming more mature," he
explains. "Who's going to make
money and how they're going to make
it still remains to be seen. But it's
clearer now what you have to do to
be a winner."
Manish Shah, editor of the online
publication IPO Maven, agrees that
investors are growing increasingly
comfortable with Internet
companies--particularly with content
providers--and says that the renewed
faith has contributed to 1998's
promising start. "There is a strong
belief now that the recent increase in
traffic will translate into the
revenues--and eventually into the
earnings growth--that people have
been expecting," he says. Mr. Shah
contends that the market needs to
remember that many of the Internet
content companies are still passing
the same advertising dollars among
themselves. The increase in viewer
traffic is promising, he adds, but the
big Internet companies need to attract
an increasingly broad base of
advertisers. Despite this lingering
concern, however, public Internet
companies like Yahoo and Excite
continue to soar.
So will the market see a correction
this year as it did in the summer of
1996? Mr. Shah believes so, but
largely because of seasonality: "It's
hard to pin down if it will happen in
July like in 1996, but at some point
this summer the IPO market will cool
off. The correction will come." He
hastens to add, however, that the
overall outlook for tech IPOs is fairly
bullish.
What about technology sectors other
than the Internet? Mr. Smith says
companies with any reliance on Asian
business will continue to get a
lukewarm reception this year until
troubled Asian economies stabilize.
On the other hand, Mr. Shah says
communications infrastructure
companies will be very well
received as new issues. Broadcom,
for example, which develops chips
for cable set-top boxes, jumped 120
percent on its first day of public
trading (Nasdaq: BRCM). And, as
VeriSign and ISS demonstrated,
trendy sectors like electronic
commerce and security will usually
draw a crowd.
Will the 1998 IPO market, like
1996's, flash and then fizzle, leaving
investors with only modest gains?
That's like trying to predict whether
the Spice Girls will have another
platinum album. In any event, the
market for technology IPOs will
continue to be fueled by emotion
rather than by any rational metrics.
redherring.com
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