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LinkedIn-Inspired ‘Low-Float’ IPOs Threaten to Bring Back Bubble

LinkedIn Corp. (LNKD)’s success is inspiring Web companies to limit the amount of shares they sell in initial public offerings, fueling concern that scarcity will inflate stock values and contribute to another dot-com bubble.

Three weeks after LinkedIn made less than 10 percent of the company available in its IPO, Pandora Media Inc. (P) is working on its own “low-float” offering, and Zynga Inc. (ZNGA) is planning a similar strategy with its share sale later this month, according to a person with knowledge of the matter.

Surging demand for new Internet companies, combined with a dearth of available shares, may give the businesses higher valuations than they deserve, said Francis Gaskins, president of industry tracker IPODesktop.com. That’s creating the perception of frothiness in the IPO market, even for growing companies with established revenue, he said.

“You have people overly excited,” said Gaskins, who’s based in Marina del Rey, California. “It’s a supply-demand thing. There’s not that much supply, and there’s pumped-up demand.”

By selling less than a tenth of their shares, LinkedIn, Zynga and Pandora are offering less than half the typical amount. For U.S. technology IPOs in the past year, the average float was 24 percent. Amid scarce supply, LinkedIn’s shares more than doubled in their first day of trading, giving the company a valuation of $8.91 billion.

Pressure’s On

Companies are using the low-float strategy to protect the value of existing investors’ stakes, and it leaves the possibility of raising cash at a higher stock price months later. At the same time, the pop that typically follows a low-float IPO can add pressure on the company to keep a rapid growth pace, said Ryan Jacob, chairman and chief investment officer at Jacob Internet Fund in Los Angeles.

“For the share price to maintain that level, the company is going to have to perform very well,” said Jacob, whose firm manages about $70 million in assets. The risk for investors increases after the so-called lock-up period ends, when insiders can sell their shares, he said. “You’re going to have sellers making sales into a small market.”

Groupon Inc. (GRPN), the largest provider of online coupons, also plans to sell a “small piece” of the company in its IPO, Chief Executive Officer Andrew Mason said in a memo this month to employees. It filed on June 2 to raise $750 million. While the Chicago-based company didn’t disclose a potential valuation, it discussed an amount of as much as $25 billion with underwriters in March, people familiar with the matter said at the time.

Zynga IPO

Zynga, the top developer of games for Facebook Inc.’s site, is in talks to have Goldman Sachs Group Inc. lead its stock sale, according to a person with knowledge of the discussions. The startup has yet to submit an IPO filing, and its plans still may change. Dani Dudeck, a spokeswoman for San Francisco-based Zynga, declined to comment on the IPO or the number of shares that will be sold.

Zynga makes its money from selling virtual items within games -- for instance, a townhouse in “CityVille.” The worldwide virtual-goods market is expected to more than double to $20.3 billion in 2014, from $9.28 billion last year, according to ThinkEquity LLC, a San Francisco-based research firm. Still, Zynga will be the first of its kind on the U.S. public markets.

In a typical IPO, investors receive shares worth 20 percent to 25 percent of the valuation, said Paul Deninger, a senior managing director at investment bank Evercore Partners Inc. (EVR) in San Francisco. That usually lets shareholders buy and sell the stock without creating big price moves, he said.

Retail Investors

The chance of an initial pop is higher when the companies are well-known Internet brands, Deninger said. Those names may be more likely to attract retail investors -- small shareholders who buy and sell stocks for their own accounts.

“The more you constrain demand, the more likely, especially in a retail-oriented name, you’re going to see a spike in price,” he said.

One unintended consequence of this approach is it encourages employees to capitalize on the initial run-up by cashing in their options, Deninger said. And employees hired after the IPO have less chance of seeing major gains, he said. That means there’s less incentive for them to stick around and help the company thrive in the long term.

While investors point to the capital flooding into a select number of hot technology startups as signs of a potential bubble forming, the industry’s publicly traded companies are still relatively cheap.

Low Ratios?

Technology stocks are at their lowest valuations in more than a decade, data compiled by Bloomberg show. As of last week, they were trading for 9.3 times reported earnings before interest, taxes, depreciation and amortization. That’s 1.3 times the index’s multiple -- the lowest ratio since at least 1998.

OpenTable Inc. also relied on the low-float approach to ensure the success of its May 2009 IPO, one of the first dot-com offerings after a financial crisis froze dealmaking the previous year. Now there’s less reason to do it, other than getting a short-term bounce in the stock, said Lise Buyer, founder of IPO advisory firm Class V Group.

“It’s the game de jour,” said Buyer, who helped lead Google Inc.’s 2004 IPO. “It made sense for OpenTable to tread lightly coming out of the recession. Now it’s just gamesmanship.”

Still, the strategy may help persuade investors to start pouring more money into the market, which can be a good thing for the economy, said Tom Taulli, founder of the website IPOByte.com and author of “Investing in IPOs.”

“It could be a catalyst to growth,” Taulli said. “It’s been dead in tech, at least in the public markets, for the past 10 years. Exciting IPOs are a way to get investors back in the market and taking some risk.”

To contact the reporters on this story: Joseph Galante in San Francisco at jgalante3@bloomberg.net; Douglas Macmillan in San Francisco at dmacmillan3@bloomberg.net

To contact the editor responsible for this story: Tom Giles at tgiles5@bloomberg.net

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