By David Sterman
It's essential that a newly public company remain in focus for investors. With enough attention, these new issues can climb steadily higher as the appearance of success draws more investors in. But if a company stumbles after an initial public offering (IPO), then it can start to drift lower and lower as many investors simply lose interest. Analysts become disenchanted as well, as their clients don't want to hear about the dud IPO anymore, so the analysts often just stop covering the company.
But this is exactly when you should start paying attention.
You can often lump these "busted IPOs" into the same group. They typically pull out all of the stops to deliver strong quarters just before and after the IPO comes to market. But soon thereafter, reality sets in as quarterly results lag overly optimistic forecasts and shares fall out of bed. The good news: Many of these companies still possess bright long-term futures, and their post-IPO stumbles can create fresh openings for investors who are just getting up to speed.
In the table below, you'll find a select group of 2011 IPOs. Each one of these IPOs is now at least 25% below its offering price. In many cases, they actually traded up on their debuts and are closer to 50% off the 52-week high. (I weeded out stocks that are now worth less than $200 million.)
Some of these deals were seen as "can't miss." For example, for-profit hospital operator HCA Holdings (HCA) was such a large and well-established company that many assumed it would find a stable home in the portfolio of many mutual funds. But investors have cooled to HCA and its peers for fear that government reimbursement rates will soon fall. Merrill Lynch considers HCA to be the best play in the health care facilities sector, thanks to prodigious cash flow, but concedes that "2012 will once again be a tale of two cities, as operationally, double-digit earnings growth is in the cards, but stock performance should lag most of the year as government reimbursement concerns weigh on stocks."
Even George Soros Makes Mistakes
Back in June, I noted how George Soros spent more than $300 million on South American agriculture play Adecoagro (AGRO). He may not have guessed that Argentina would subsequently contemplate restrictions on new purchases of Argentinean farmland by foreign entities. That concern has pushed this stock down more than 30% from its 52-week high, and Soros is now underwater with this trade (He sold some stock recently but maintains most of his position.) The good news: The restrictions would only apply to new purchases, so Adecoagro's current holdings are safe.
Just a snapshot of the current business -- assuming zero-growth prospects -- makes this stock look quite appealing now that it has shed a third of its value (from the peak). The company owns farmland appraised at $900 million, its sugar/ethanol refining operations throw off more than $120 million in annual EBITDA (and would be worth $600 to $750 million on the open market, assuming a 5x-6x EBITDA multiple), and its other farming operations generate roughly $80 million in annual EBITDA.
Add it up, and you've got a set of assets that are worth well more than the current $1 billion market value. That real estate, by the way, will only appreciate in value as Adecoagro continues the process of converting cattle-grazing land into productive farmland. George Soros may be underwater with this name, but he stands to reap ample profits as the Latin American agricultural boom gains steam.
Although Adecoagro looks like the most intriguing play of the class of 2011's broken IPOs, a few more stocks are worth additional research.
Yandex (YNDX): This Russia-based web portal has been hurt by concerns that the Russian business climate is growing harder to navigate as Vladimir Putin strengthens his grip. The converse also applies. If the recent Russian protests yield tangible electoral reform, then the perception of the Russian business climate will sharply improve, and Yandex remains the best "Russia play" for U.S. investors.
Yandex controls 60% of the traditional Russian search-engine market, though Google (GOOG) is the dominant player in mobile search. Shares have weakened on concerns that Google will extend its mobile search dominance into desktop search dominance, an issue worth exploring before buying into this name.
RPX Corp. (RPXC): This is an unusual "patent troll" firm. It seeks to buy up the rights to many technology patents and then get companies to pay for licenses to use the patents. But unlike some firms in this niche, RPX doesn't look to simply find patent infringers and sue their pants off. Instead, it tries to work collaboratively, generating subscription revenue for the patents. The model seems to be working. RPX now has 103 clients, up from 65 a year ago, and is generating about $40 million in high margin revenue each quarter.
Still, it's awfully hard to figure out a value for this business. Investors in other patent-owning firms such as Rambus (RMBS) and Acacia Research (ACTG) have always had to model future cash flow that may or may not come to pass.
RPX was a very popular stock when it went public in May, and its shares briefly moved above $30. The euphoria has since worn off (perhaps because investors couldn't figure out a price target), and shares have slumped to just $12. Merrill Lynch sees a rebound coming, back to $28, which would be 34 times their projected 2012 earnings-per-share forecast of $0.83. Why such a rich multiple? Beats me. Then again, with shares trading for less than half of Merrill's target price, this busted IPO is surely worth more research.
Risks to Consider: Broken IPOs can languish for an extended period, until the underlying business trends are so solid that the valuation disconnect can no longer be ignored.
Young companies go through a predictable life cycle. These recent freshman are already well into their sophomore slump, but like many students, results should improve as they become upperclassmen.