The IPO market has become more active as underwriters try to push through deals before we hit the holiday doldrums. There are only a couple of actionable weeks left until portfolio managers and traders close up shop for the year and liquidity dries up.
One of the most recent companies to take advantage of the liquidity is Archipelago Learning (ARCL) which was offered to investors at $16.50 on November 20. The Underwriters (Bank of America / Merrill Lynch and William Blair) did a good job of pricing the deal attractively for investors and developing interest in the company. On the first day of trading, the stock closed at $18.77, good for an initial gain of 13.75%. Since that time, the stock has pulled back to just above the IPO price, an important level that BAC will likely defend.
Looking at the company, Archipelago has built a line of subscription based online educational products which are predominantly sold to the Kindergarten through 12th grade schools. During the 2008/09 school year, the products were used by 8.9 million students through a relationship with 21,000 different schools in all 50 states. While the company has already penetrated a very large geographical footprint, management estimates that they only represent 17% of the available schools with 94,000 public and 24,000 private schools as potential clients.
As a growth strategy, the company is not only looking to expand into new schools, but also to increase the revenue within its existing client base. The products used by high-school students typically carries a higher price point and stronger margins than lower grade products, and there is potential to develop new products which could assist with the company’s existing initiatives to expand into the college and post-graduate markets.
According to the terms of the IPO prospectus, the company sold 3.1 million shares with selling stockholders also selling 3.2 million shares. As it turned out, another 937,500 shares were sold by the selling shareholders to meet the strong demand for the deal. The primary selling shareholder was Providence Equity Partners which still retains a 54.9% position in the company. Over the next several months, investors are likely to worry that Providence will liquidate its position. But for today, there is a lockup on these shares and so the overhang should not play heavily into the price of the stock.
The company indicated that it would use the proceeds from the sale for “general corporate purposes” which means very little to us as investors. Given management’s desire to grow the company and expand its client base, I would expect much of this capital to be used for marketing and promotional initiatives. The company has $61 million in debt, so the additional capital could theoretically be used to create more financial stability.
Archipelago is at a critical spot where revenues are just barely covering fixed costs and beginning to provide the company with a profit. The pro-forma model for the year ended 12/31/2008 shows that the company would have earned 3 cents a share, and with the lower interest expense this year, the company was able to clear 17 cents per share in the first three quarters. If management is successful at integrating its programs in a wider base of schools, the earnings growth could expand exponentially.
Most IPOs are heavily influenced by the underwriters in the first few weeks of their existence. It’s important to the underwriters that the deals are profitable to investors because that will allow them to efficiently market the next deal and investors will have confidence in the company’s ability to price the IPOs attractively. With that in mind, ARCL is now trading just above the $16.50 IPO price and is likely being supported by Bank of America. This offers us as traders a great risk/reward spot to buy on the expectation that the stock will be bid higher by IPO investors and the underwriters.
If we are wrong and the stock breaks below $16.50, we will quickly sell and realize a small loss. (I would give the stock 20 or 30 cents below the IPO price but not much more room than that.) On the other hand, the potential for the stock to trade back up to $18.50 or even its high at $19.50 is fairly good. I would welcome a trade that allows me to risk 50 cents with the potential for a 2 dollar or 3 dollar gain.
One caveat is that there is very little volume in this new issue. That means it is much easier for large blocks of stock to push around the price – and so we will have to endure more volatility. If the stock breaks $16.50, it could very quickly continue lower before you exit the stock. But by the same token, if it is bought by a large institutional investor, there is a good chance the order would push the stock significantly higher. So consider putting a small amount into this position and maintaining a close stop.
Disclosure: Author does not have a position in ARCL