The days of the IPO bubble appear to be returning as new tech companies sporting tremendous revenue growth but little to no profits continue to garner huge valuations. This time around, things are different and it appears that investors are more cognizant and wary of these companies—well at least to a certain extent. While companies such as LinkedIn (LNKD) pop the days immediately after the public offering, these companies tend to fall in anticipation of the expiration of their lock-up periods.
Perhaps, even if these investors are cognizant of the irrationally high valuations these companies are receiving, the small float released by these companies’ IPO’s artificially props up the stock price. For example, LNKD released only 9.24% of its shares outstanding, Pandora (P) about 9.2%, Zynga (ZNGA) about 14%, and HomeAway (AWAY) about 11.4%. Despite the strong performances that these new tech and internet companies have had in the short term, their gains are quickly erased in anticipation of the expirations of their lock-up periods. Here's a chart that demonstrates the point with ten recent IPO's:
For example, AWAY released an additional 18 million shares eligible for sale, 21.8% of its shares outstanding, after its lock-up release. AWAY's share price fell from $30.82 on November 21st to $19.90 on December 23rd, just 3 days before the lock-up expiration. Moreover, AWAY plans to have its Black Out release in February 2012 where they plan to release 54 million shares, amounting to 66.8% of its total shares outstanding with vested options of approximately 5.5 million. This Black Out release does not bold well for AWAY's short term share prices.
Some people such as Paul Bard, director of research at Renaissance Capital, argue that the benefits of a higher stock price outweigh possible money left on the table because “investors that make money in the IPO are more likely to come back to the company for future follow-up offerings.” This seems like a poor attempt to justify a higher stock price based not on fundamentals, but on a supply-and-demand psychology that only lasts for the immediate short term before these companies' lock-up periods expire.
Now we should discuss some fundamental problems with the huge growth projections for AWAY.
First, AWAY simply does not have much in a comparative advantage over its competitors. The potential for increased competition from travel search services and online search engines is an ever-present threat. Online lodging search services such as Expedia, Orbitz, and Hotels.com currently do not list vacation home rentals. Moreover, according to Credit Suisse equity research, an estimated 60% of lodging marketers list “search” as the primary tool that drives traffic to their properties. The potential threat of increased competition does not bold well for a company without a strong comparative advantage in an industry that makes product differentiation difficult.
The other problem is the growth projections themselves. Using a DCF, which inputs a 10% WACC and 3.5% terminal growth rate, Credit Suisse’s Equity team put a Neutral rating on AWAY that projects a 57 PE ratio in 2013. That is to say, despite lofty growth projections for AWAY, an investor would still be paying a huge premium for AWAY for years to come.
Let’s also note management’s October 27th earnings call, which raises some red flags about the company as they attempted to talk down consensus estimates:
“Monetary and debt concerns in Europe have impacted the business with respect to foreign currency. Approximately 40% of our revenues … were generated outside of the U.S. The strength of the euro and British pound relative to 2010 has actually been contributing to year-over-year growth in 2011. However, as these currencies have recently weakened against the dollar, our 2012 results will likely be impacted versus our prior expectations…I am watching the economy very closely and we could see some impact in pockets of our business next year if the macroeconomic environment continues to worsen.”
Regardless, consensus estimates went bullish after the call. Revenue projections rose to $288.8 million from $286.7 million and adjusted EBITDA estimates increased to $83.6 million from $80.7 million. Even if AWAY’s revenues continue to grow at this tremendous rate (revenues went up 37% in Q3 and 41% in Q2), the company has yet to prove it can turn a profit. During these same quarters profits went down 85% and went negative during Q2 and Q3 respectively.
AWAY is certainly a company to stay from except to short and to buy puts. Investors should stay away unless they want to end up like the baby in AWAY’s Super Bowl commercial.