Smash Hit Or Trash It: Gigamon's Upcoming IPO

| About: Gigamon, Inc. (GIMO)

"I think you should call your broker immediately so that you can try to get some shares in the IPO… I expect it to be red hot." So said the bombastic CNBC host, Jim Cramer, in reference to yesterday's debut for Milpitas, California-based Gigamon (NYSE:GIMO). Given that Cramer is a tad prone to over-hyping a situation (it's what attracts viewers, right?), let's step back for a moment and give reason a chance to prevail.

Let the Record Show…

Not that I'm keeping track or anything, but I did beat Cramer to the punch – singling out Gigamon as an IPO to watch back in December 2012. And the reasons for my optimism couldn't be more straightforward… The company is leveraged to one of the most promising "forever growth" trends: Big Data. As I pointed out to Tech & Innovation Daily readers recently, the amount of data we create and share continues to boggle the mind. Based on the latest estimates, it's expected to more than triple by 2015.

Gigamon fits into this trend nicely, as it helps companies manage their networks and the flow of data across them. Specifically, its patented Flow Mapping Technology helps blue-chip companies ensure the reliability, performance and security of their network infrastructure. This isn't about simply being positioned to grow, though. It's about growing in the here and now. And Gigamon is doing that rapidly. In the last quarter, sales increased an impressive 55%.

The company is profitable, too, which is a true rarity in the world of tech IPOs. Gigamon reported annual earnings per share in 2010, 2011 and 2012 of $0.19, $0.58 and $0.21, respectively. On such merits, I have to agree with Cramer (even though I hate to admit it). The company does, indeed, possess the potential to be "red hot." Not to mention that it's coming to market at precisely the right time…

Up, Up and Away

According to Renaissance Capital, a total of 74 companies have gone public so far this year, raising $17 billion. On average, they've rallied 19% over their offering prices, which is a tad better than the performance of the S&P 500 Index. However, digging into the data reveals that technology IPOs – particularly those tied to the cloud-computing space – have fared much better.

Take Marketo (NASDAQ:MKTO), for example. It's up 66% from its IPO price of $13. And then there's Tableau Software (NYSE:DATA), which is up 78% from its IPO price of $31. It's important to put those gains in perspective, too. Both companies debuted less than one month ago. So, again, Gigamon appears to be hitting the market at a time when investors' appetite for tech IPOs is rabid.

The key question remains, though: Is it attractively priced?

If the Price is Right…

By the time you read this, underwriters will have already priced Gigamon's IPO, and trading will be set to begin later this morning. For the purposes of our analysis, though, let's assume that it priced at $20 per share (the high end of the proposed range). That's being conservative, mind you. As John Fitzgibbon of IPOScoop.com said in a note to subscribers yesterday afternoon, the deal is possibly five times oversubscribed.

So anyone who followed Cramer's advice to call their broker for an allocation wasted their time. There won't be any shares available for us lowly retail investors. And we're bound to see pent-up demand for shares once trading begins (more on that in a moment).

For right now, let's work with numbers we can reasonably expect. At $20 per share, Gigamon would debut at a valuation on par with its peers – Infoblox (NYSE:BLOX) and F5 Networks (NASDAQ:FFIV) – based on their enterprise-value-to-sales ratios. Of course, there's a slim chance that the stock will begin trading anywhere close to where it officially prices. It's common for compelling IPOs to "pop" once trading begins. Especially when (as I mentioned above) there's so much interest leading up to the debut.

That's what happened with Tableau Software. Despite pricing at $31 per share, the first trade in the aftermarket crossed the tape at $47 per share (52% higher). Same goes for Marketo. It "popped" 25% out of the gate to trade at $20 per share. Now, Gigamon is growing sales at nearly identical rates to both Marketo and Tableau (at around 60%). So it's certainly a possibility that Gigamon will experience a similar opening day boost. That would put shares in the $25 to $30 range when trading begins and we finally get a shot to buy.

Bottom line: Again, I hate to admit it, but Cramer is right. Gigamon represents a compelling "Buy" under $25 per share. That being said, I typically insist on a profit potential of at least 25% when investing in IPOs. So we should look for a pullback closer to $20 per share before entering a position. I doubt we'll witness that in the first day of trading. But it's worth putting Gigamon on your watch list for an opportunity to buy on the dips in the coming weeks.