Rocket Fuel IPO May Be A Dud

| About: Rocket Fuel (FUEL)

Rocket Fuel (NASDAQ:FUEL), an ad tech decision-making firm with a great name, plans to raise some $102 million this week through its upcoming IPO. The Redwood City, California based firm will offer 4,000,000 shares at an expected price range of $24.00-$27.00. Assuming a price at the midpoint the expected range at $25.50, the firm would command a market value of $981 million.

FUEL filed confidentially on May 24, 2013.
Joint Managers: Citigroup (NYSE:C), Credit Suisse
Co-Managers: Needham & Company, Oppenheimer & Co., Piper Jaffray, BMO Capital Markets, LUMA Securities

Founded in 2008, Rocket Fuel is an ad tech company that has developed an Artificial Intelligence and Big Data predictive modeling platform designed to handle decision making in digital advertising exchanges. These exchanges support tens of billions of trades daily, which simply are too great in volume and speed for timely human analysis. Rocket Fuel's platform allows for the efficient automated purchasing of targeted ad space.
The firm has shown spectacular revenue growth in recent years; for the years ending December 31 2010, 2011, and 2012, revenues were $16.5 million, $44.7 million and $106.6 million, respectively. However, FUEL has reported increasing losses over that period, as well.

FUEL is one of only 20 firms authorized to purchase ad space through FBX, Facebook's online ad exchange, and as such holds a coveted position among ad tech firms.

FUEL offers the following figures in its S-1 balance sheet for the six months ending June 30, 2013:
Revenue: $92,581,000
Net Income: ($11,911,000)
Total Assets: $99,781,000
Total Liabilities: $66,900,000
Stockholders' Equity: $32,881,000

FUEL occupies a very specific niche and may be one of the most technologically advanced company within that niche. The market for online advertisements is exploding, having grown some 15.1% in the past year, and will only continue to grow, likely leading to greater demand for FUEL's platform. FUEL's access to FBX, gained in Q4 of 2012, and the soaring revenues that have accompanied it, are encouraging signs.

FUEL competes with Google (NASDAQ:GOOG), Yahoo (YHOO) and Facebook (NASDAQ:FB) and other well established and better funded companies that are currently making money.

All that said, the company's failure to turn a profit remains troubling, and may point to underlying organizational concerns. Access to FBX should have let the company turn the corner, but it continues to record losses on a similar or even greater order than it had before FBX.

DUE to huge losses, major profitable competitors and limited visibility on future profits, we can't recommend buying into FUEL. We are rating the offering at the $25.50 level a neutral to negative, even though we love the name. We will keep our eye on this company and wait for the well paid management team to show us the money. Though the company's product occupies a role that seems destined to become more and more valuable over the course of coming years, its advances have thus far been accompanied by greater losses, possibly indicating problems within the business model - rapid revenue growth can be difficult to manage, and the FUEL's incredible growth rate may be more than the young firm can handle. As of June 30, 2013, the company had an accumulated deficit of $35.5 million.

Artificial Intelligence development is expensive, as it requires both highly trained personnel and pricey equipment, and it isn't yet clear that FUEL will ever be able to make those investments pay off. As more competitors enter the field and web ad markets grow ever larger and more complex, there's no guarantee that Rocket Fuel will be able to keep up. If and when FUEL's income numbers are in the black, it will may become a buy; until then, we will continue to sort through the many upcoming IPOs.

Like many ad tech companies, FUEL relies upon the ability to place cookies on computers in order to track user behavior and understand the best placement for advertisements. Unfortunately, internet users are increasingly rejecting cookies, clearing them from their computers and depriving companies like FUEL of vital data. Many anti-virus programs now reject cookies wholesale, and some popular browsers will ask users for permission before allowing cookies to be placed or can be easily modified to reject all cookies. European Union law requires that cookies only be used with the express permission of users, and there is a risk that other countries will adopt similar standards. The recent furor over NSA electronic surveillance will no doubt lead many users around the world to reject data collection to a greater degree than ever before.

Rocket Fuel's IPO could receive a boost from the Twitter's upcoming IPO. The failure of Facebook's IPO had led to some anemia in ad tech companies seeking to profit through social networks. Additional funds from a Twitter IPO would allow Twitter to experiment with new ad platforms, increasing demand for firms like FUEL.

CEO and co-founder George John has an impressive background in various dimensions of marketing. He previously worked with experienced teams to optimize marketing at firms like Yahoo!, (NYSE:CRM), and IBM (NYSE:IBM), and has worked in the marketing field in engineering, sales, marketing, and management. The firm is also backed by quality institutional investors.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: IPOs can be high risk investments and I would recommend that investors read the prospectus and consult with their investment adviser. This article was written for informational purposes.

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