All signs point to a big Facebook IPO this year, which could trigger a wave of new growth issues that institutional investors are ready to lap up. What are the catalysts to expect? The IPOs to seriously consider - or avoid? Will we see Sarbanes Oxley reform this year? And what about the international IPO picture?
We hosted a live discussion on these topics with three expert panelists:
Paul Kedrosky is an investor, speaker, writer and entrepreneur. He was one of the first technology equity analysts at a major brokerage firm, and now is an active investor in private and public tech companies. Paul's recent articles on IPOs include The 2010 Tech IPO Boom and Charting Hong Kong's IPO Dominance.
Paul Bard is Vice President at Renaissance Capital LLC, which provides independent research and investment management services on newly public companies. Recent articles from Renaissance include IPO Market Ready for a Return in 2010 and Venture-Backed IPO Market Comes Back to Life.
Bill Simpson is an independent investor and newsletter author who focuses on the IPO market. Bill's outstanding analyses of new issues are regular must-reads on Seeking Alpha. Bill's recent articles include Team Health Holdings' IPO Seems Priced to Work and 7 Days Group Goes Public at a Very Reasonable Valuation.
Catalysts for an IPO revival in '10
Mick Weinstein, SA Editor: Let me start things off by expanding a bit on some of the articles you've all written on IPOs in 2010. Both Paul Kedrosky and Paul Bard have written that there's a chance that we'll see a big revival in the IPO market this year. What do you see as the catalysts for this at this point?
Paul Kedrosky: The catalysts for an IPO revival are: 1) Improving general confidence in the capital markets. 2) Maturity (revenue/profit) of companies in the private market. 3) Prospects for a few breakout IPOs (a "Netscape moment") catalyzing things. The mistake people make in looking at the IPO market is to talk in terms of "windows" or "averages". Both are silly. The IPO market is episodic by its nature.
Paul Bard: I agree with Paul Kedrosky's assessment, although I would add that I think there is currently a confluence of two key forces that will help power what we would characterize as a "growth IPO" revival. The first is on the supply side - there probably has never a been a time when there have been as many mature VC-backed companies, companies with a combination of proven profitability and strong growth prospects. VCs are also facing pressures to return funds to their limited partners, so that represents an added nudge.
Bill Simpson: The performance of the small and mid cap tech IPOs over the past year have been quite solid. That has really opened the door for a number of similar tech IPOs in 2010. A number of under the radar tech deals have performed extremely well. SolarWinds (SWI) and Fortinet (FTNT) are two examples - that should allow for a number of these VC backed tech companies to come out in 2010.
Paul Kedrosky: Pace Paul Bard and Bill, these are all the pieces we need - successful recent examples, mature privates, and appetite. All the pieces are there.
• • •
Facebook, Twitter and a Tech IPO Resurgence
Bill Simpson: Paul, do you expect to see Facebook and/or Twitter come out this year?
Paul Kedrosky: I expect a Facebook IPO in 2010. 20% chance of Twitter too.
Paul Bard: Yes I do think we will see Facebook. Twitter is more of a wildcard given its stage of development at this point. Many of these companies made the strategic decison in late 2008/early 2009 (with advice from their VCs) to hold off on moving ahead with an IPO -- I guess it can debated whether or not the market would have been accepting.
Paul Kedrosky: There is an important caveat though. First, the IPO ecosystem has changed dramatically. The four IPO horsemen are gone. Second, the amount of capital invested in private companies has shrunk, so trade sale exits can be cheaper and faster than IPOs.
Paul Bard: On the demand side (which few have been talking about -- although Paul Kedrosky has alluded to this in his posts), institutional investors are craving growth and new ideas.
Paul Kedrosky: To Paul Bard, yes, that is important. Institutional investors badly want new ideas -- meaning new equities.
Paul Bard: As Bill talked about, "growth" IPOs had little trouble pitching themselves in 2009. In fact, if you look at the 15 or so tech IPOs completed in 2009, all priced within or above their ranges and have produced returns averaging close to 30% -- huge outperformance relative to the rest of the IPO landscape.
Bill Simpson: I have been impressed with the quality overall of the tech deals we've seen recently also.
Paul Bard: I agree with Paul Kedrosky that to some extent structurally Wall Street has changed/adapted, but I'm not convinced that this is the reason we are not seeing IPOs. Investment banks will not turn business away -- particularly of the quality that is out there in the VC-backed community. I believe the negating factor has been more from the good companies not wanting to go until now.
Mick Weinstein: To both Pauls - why are you convinced that Facebook will go public this year?
Paul Bard: As Paul Kedrosky has talked about, Facebook is making all the tell-tale signs of going ahead with an IPO. Also, with an $11B valuation (if that is accurate), few companies could actually acquire it. If you are a company with venture backers and several hundred million in sales... also the dual class share structure speaks volumes about their intentions. So for Facebook, the question is really when, not if. Barring a major disaster in the equity markets, Facebook is a prime IPO candidate. A Facebook IPO would be in huge demand by institutional investors.
Paul Kedrosky: Right, Paul Bard has it. They are making personnel moves in that direction, we're seeing the usual private market signs -- unnecessary raises at high valuations -- and, most importantly, they (apparently) have the numbers. To that point, keys to watch for are always public markets finance hires, strange raises from late-stage funds at high valuations, etc. Those are the giveaways.
Mick Weinstein: We haven't of course seen Facebook's financials or deal terms for IPO, but if it were priced in line with some recent growth companies, would you be inclined to invest?
Bill Simpson: I expect a valuation for Facebook out the door would far exceed the recent tech IPOs.
Paul Kedrosky: Mick, I would, but remember that I bought Google on IPO and sold at $120. Let's not fixate on Facebook, either. Linkedin is likely as well, plus many others. If you look in private portfolios the revenue numbers can be surprising, with many at $50m-plus.
Paul Bard: Recall that with Google, its earnings power ended up being 3-4x the initial forecasts at the time of its IPO. That is what made it so successful. It will be interesting to see how conservative/aggressive expectations will be for Facebook's growth/earnings.
Paul Kedrosky: That is my concern with Facebook. Where is the leverage here as a public company? The optimist in me sees Facebook as a kind of Mastercard/Visa of next gen tech: a platform for transactions globally, whether micro-payments, or apps sales, or whatever.
Mick Weinstein: Regarding the growth companies, do you think they'll get a 'recession discount' for performance over the past year or two?
Bill Simpson: Oddly, I don't believe they will. As Paul Bard noted, the tech growth companies that came public in '09 all priced strongly. We are seeing the discounts in the more mature private equity deals coming public, but not in the growth names.
Paul Kedrosky: Yes, I don't see a discount in growth names at all. If anything, a premium. The key -- and you can't say this often enough -- is a few big early successes. It takes nothing to deflate investors' risk appetite if we have a few early flops. That was the point of my repeated refrain of a "Netscape moment", which is what Facebook, or Linkedin, etc. can represent to markets. IPO markets -- when they yawn open -- are inherently emotional, requiring a catalyst, and requiring junior i-bankers to be told by senior i-bankers to be told by investors "get me more of those!" Lots of interesting smaller companies to watch for too, like Yelp which may show up in pipeline as this gets going. Recall, Yelp aborted an alleged Google acquisition not long ago. That doesn't happen unless a better option comes along, like the public markets at a higher price.
Paul Bard: The value in Facebook will be its massive sticky user base and the types of services it can then layer on top, which can probably be a number of things. Leverage should be huge from a sales/marketing perspective and even R&D. The key will be what type of capital investment has been required to maintain and grow its business, i.e. how much it is spending on capex. Think about how much more profitable Google would be if it didn't spend billions of dollars on its data centers and servers. These companies require big computing infrastructure.
Mick Weinstein: So Paul Bard, at this stage you think institutional investors would *have* to get in on these deals?
Paul Bard: Yes Mick, that type of thinking will happen to some extent. Facebook would represent one of a few (if not the only) pure plays on the social networking space. Although we can debate weather or not it deserves it's own "industry" category, the fact is that the scarcer a business or stock is the greater the interest (assuming it's a business investors believe in). Also, institutional investors were busy picking up large cap companies on the cheap in 2009 as the markets rallied strongly. Now that valuations are back to more normal levels (or perhaps full), they will focus there attention more on the IPO market.
Paul Kedrosky: The stuff to run from as IPOs come across transom are Mortgage REITs, SPACs, and such. That is old-word, financial engineering, mostly David Copperfield trickery and should be shunned.
Bill Simpson: Agree 100% Paul, I avoid those two groups across the board.
Paul Kedrosky: This graphic from Grant Thornton (click to enlarge slightly) shows how flat the new issues market has been in the U.S., especially compared to elsewhere. It speaks to underlying drivers for institutional appetite for new offerings. To be clear, not new issues, but total listed companies on U.S. markets vs elsewhere. We have gone through an epic of ticker consolidation:
Paul Kedrosky: For anyone curious about my "Netscape moment" thesis, this is the piece I wrote about it.
Paul Bard: About your Netscape moment (by the way, I'm a huge fan of The Big Lebowski -- great post!) -- do you really think there is enough supply out there to create a "wave" of activity without compromising quality?
Paul Kedrosky: Like all such waves, this will contain good and bad and will end when the supply is mostly bad. But there is enough to get things going, which is something we haven't been able to credibly say in some time.
Mick Weinstein: Question sent in from Sara Behunek of The Deal: "I would like to know whether Paul Kedrosky thinks there is any danger of another tech bubble starting to build in 2010."
Paul Kedrosky: Danger? We should be so lucky as have another tech bubble starting in 2010. The IPO market and the early-stage funding market both need something to be enthusiastic about. Look at last year's VC fund-raising data. But, the companies in portfolios can legitimately go public. This is not Pets.com.
Bill Simpson: Or Snowball.com. That was my favorite in the "how in the world can this come public" days.
Paul Bard: Not to jump in for Paul Kedrosky, but there are too many high quality IPO candidates to create a "tech" IPO bubble in my opinion. Also, the market has shown us that it is still selective with respect to what small cap/tech companies it will get behind. (VITC) and (OMER) are two examples.
Bill Simpson: I see little danger of a bubble anytime soon. It would be nice to just get back to a normalized IPO market.
Paul Bard: We have really yet to see the "wave" in new tech IPO filings. We started to see some late in the year. I think we could see an explosion over the next 3 months.
Paul Kedrosky: Paul Bard: Every Valley venture investor I talk with is crafting legal filings. Every single one. There will be a flood.
Mick Weinstein: Scenario: Facebook or LinkedIn floats and it doesn't do well. Let's say the whole market tanks then. What happens to the rest of the tech issues?
Bill Simpson: The door shuts in that scenario. I don't expect that to happen though. I would expect Facebook to be warmly received.
Paul Kedrosky: Mick: That would do it. We need a positive catalyst, so if big names come and fail, we're done for 2010.
Paul Bard: Mick, I will be utterly shocked if that scenario unfolds. But if it does, the IPO market is probably the least of everone's worries. But I think it's worth noting that Facebook or no Facebook, the IPO market for tech/growth IPOs will be better in the months ahead. Everyone asked at the time if Google's IPO would spawn a tech IPO revival, but it didn't. So my stance is that a successful Facebook IPO would be great for the IPO market, but it will not open the floodgates. Those gates are already set to open for the reasons we have already discussed.
Paul Kedrosky: But the reverse is more interesting: What if LinkedIn, Facebook and Twitter all come, plus Yelp and a host of others, and Nasdaq bubbles in an absurd way. Who is positioned for that? Not me.
Bill Simpson: Paul, I agree. I would bet most out there are not even aware that these tech/growth IPOs recently have done as well as they have.
• • •
Sarbanes Oxley reform this year?
Paul Kedrosky: As an outlier, I'm expecting a strong push for SarbOx reforms this year. That would create more momentum.
Mick Weinstein: Why would SarbOx reform suddenly happen this year?
Paul Kedrosky: The Obama administration is under pressure for job creation, talking a better game on entrepreneurs and job creation from growth companies. It is a natural next step to facilitate the going public process for such companies. I keep hearing Congressional/Admin buzzing.
Paul Bard: We agree that the rules should be moderated and are overly cumbersome for small issues. But I don't believe they are to blame the current lack of IPO activity. There are plenty of VC-backed companies that have the financials in place to go public today.
Paul Kedrosky: Totally agree, Paul. Blaming SarbOx for IPO death is like blaming square grooves for my crappy golf game. But there is a sentiment/confidence issue that could help.
• • •
Private Equity backed IPOs
Mick Weinstein: Lots of talk of private equity-driven IPOs this year (outside of just VC-backed). What do all you think of that as a catalyst?
Bill Simpson: It all depends how much of a discount they price the private equity deals. Most of them are debt laden and need nice discounts to work.
Paul Bard: We expect a continued flow of private equity-backed IPOs as well, but the pricing/trading dynamics will be different.
Paul Kedrosky: I cordially loathe most Private equity IPOs. They are generally debt-burdened, cynical, over-engineered, and get-rich-quick schemes. They are no catalyst, other than for panicky private equity general partners who want to raise their next fund.
Paul Bard: 13 of the 22 private equity IPOs in 2009 priced below their initial expected ranges. So clearly there is a lot of valuation sensitivity on the part of investors.
Paul Kedrosky: As there should be on private equity IPOs. Investors have learned that there is much there than meets the financial eye. Too many balance sheet and income statement tricks.
Bill Simpson: They finally discounted some of the private equity deals enough to work late in the year. And every now and again there is a good one in there. Usually, though, I skip any deal in which 20%+ of operating profits go to service debt, and too many of the private equity deals fall into that category.
Paul Bard: The more leveraged, slower-growing private equity deals will face the most valuation pressure. Others that have a growth angle (a la Dollar General) will be the most successful. The good news is that the private equity-backed IPOs have performed reasonably well in the aftermarket. So the discounted pricing has worked at least initially.
• • •
China, Emerging Market IPOs and IPO Research
Bill Simpson: We should also see a number of non-venture capital backed China deals as well. I think you can put the 2010 IPOs in a few broad areas. 1 - The VC backed growth companies, 2- the Private Equity related deals and 3 - the smaller China IPOs.
Mick Weinstein: Hong Kong led in new issues last year (by money raised) and Shanghai was relatively strong too. Will those trends continue this year?
Paul Kedrosky: Turning to China, I'm admittedly uneasy. Recent IPOs have seen uneven reception, hugely levered to state spending, and bubble-icious valuations.
Paul Bard: Agree 100% with Paul Kedrosky. Performance from China has been interesting given the fact that they have fallen on opposite ends of the spectrum -- they dominated the list of best performers as well as the list of worst performers in 2009. Investors really need to do their homework. Just because it is a Chinese company, it doesn't necessarily mean it is a slam dunk.
[Comment From Abbi: ] How do you do your homework on China IPOs? Where do you get reliable information about these companies?
Bill Simpson: Abbi, those listed in Hong Kong will generally have financials in English on their corporate web sites. Those listed here file with the SEC like all the others. I sit down with the SEC filings for every deal every year. It is a thrilling job, but someone has to do it! Actually it is how I make my trading decisions and would tell anyone interested in IPOs to dig through them in that fashion.
Paul Bard: For those interested in viewing the gap in IPO performance from US-listed Chinese companies, see this. Hong Kong and the US are two of the most transparent markets in the world, which is why we have seen the most IPO activity here. Bill is correct - anyone can get access to an English HK prospectus. Although beware that we have found many of these documents to approach 1,000 pages.
Paul Bard: Keep in mind that the US IPO market will benefit from a continued flow of Chinese companies. The US is still the top choice for many Chinese firms because of the status associated with listing on a major US exchange.
Mick Weinstein: That status remains in place, Paul?
Paul Bard: Yes. The US is still the most liquid market in the world and companies recognize that it will give them access to the highest quality investor base.
Paul Kedrosky: Showing how skewed things were in 2009, a little more than 70% of IPO market value last year came from two countries, Brazil and China.
Bill Simpson: There was one huge Brazil deal in there too that skews it a tad - BSBR.
Paul Bard: The discrepancy in IPO capital raised really speaks to both the state of those economies -- there are many more large private companies -- in areas like infrastructure and finance. Also we see privatizations as fueling a lot of IPO activity overseas.
• • •
Biotech and Cleantech
Paul Bard: I find the pickup in biotech filings quite interesting. Any thoughts?
Paul Kedrosky: I worry, Paul, that the pickup in biotech filings speaks more to a problem in the private fund-raising market than to the likelihood of higher quality issuers, or to investor appetite for revenue-less, binary lottery companies.
Paul Bard: Almost 10 biotech filings in 2H09, easily accounting for the largest % of VC-backed filings in that timeframe - see our data.
Bill Simpson: I tend to avoid the development stage bios as too many things can go wrong on the path to commercialization. The pick-up though tells us a bit about the general shape of the IPO market improving.
Paul Kedrosky: I honestly think biotech filings are uncorrelated with anything important. They are like the pilot fish of the IPO market, grabbing hold of moving objects and hoping to get sucked out into better feeding terrain.
Paul Bard: Let's also not forgot about cleantech. A lot of VC money has been put into this area and many of these companies are more capital intensive than the typical tech IPO. The A123 deal was impressive given its numbers. It will be interesting to see how the market responds to Solyndra -- another cleantech company spending tons of cash but with help from the government.
Paul Kedrosky: Cleantech is up there with early-stage biotech for me: Capital-intensive lottery tickets. I'm worried that we could have some big speculative bombs in private market cleantech this year, including one in Texas we all know well. That would keep the door shut.
Bill Simpson: A123 has done very well. I am in Paul Kedrosky's camp though in that I tend to shy away from those burning cash as quickly as A123. I missed out on a good deal, but the financials are scary there.
Paul Bard: A few months back Bill Gates made some insightful comments at Columbia Business School. He said Cleantech will bring us some great technology down the road, but probably won't be the best sector from an investment perspective (in other words, lots of failures). What A123 showed is that there is demand for early-stage, speculative growth if it can tell the right story. Also, don't underestimate the amount of investment funds that are being mandated to put dollars to work in this space. That may have further contributed to A123's success.
• • •
Mick Weinstein: What are your thoughts on Symetra, with Berkshire Hathaway backing?
Paul Kedrosky: Symmetra is somewhat interesting, a cut above the usual financial riff-raff of REITs and SPACs.
Paul Bard: Symetra has received some lukewarm press, although I believe it is coming to market close to (if not below) book value. So if you believe the worst is behind the insurance industry...
Bill Simpson: On Symetra - insurers tend to get valued fairly accurately short term out the chute. I wouldn't expect too much there initially. The deal should work though, assuming they do not get carried away on pricing.
• • •
Looking forward to 2010
Paul Kedrosky: Broadly, and I see this in the questions, investors need to carefully bucket prospective IPO investments: growth tech in U.S.; other growth in the U.S.; private equity; China IPOs; Euro IPOs; and other. I'm mostly interested in U.S. growth, which is where the dearth has been and where the highest quality of supply is latent.
Bill Simpson: I tend to focus on US growth as well. We've seen some very good looking growth IPOs in 2009 and 2010 should bring even more.
Paul Bard: Our "shadow" backlog of potential US growth/tech IPOs is well in excess of 50 and my guess is there is at least 2-3x that number that are capable of completing IPOs at this point.
Paul Kedrosky: Similar to Paul Bard, my list of prospective quality companies is more than 40 now. Fairly remarkable, with some real catalysts in there. Someone recently asked me what to watch for as a warning sign. As usual, the inevitable BusinessWeek cover: "The Return of the IPO!"
Mick Weinstein: OK, we're going to wrap up here, thanks so much to the panelists. Lots of optimism. It'll be interesting to see it play out.
Paul Kedrosky: Thanks all. Good chatting.
Bill Simpson: Thanks all.
Paul Bard: Thanks everyone! Looking forward to an exciting year for IPOs!