Online Extra: IPOs: Out from the Bunker
The offices of St. Paul Venture Capital in Minneapolis and Redwood Shores, Calif., haven't been particularly festive this year, given the downright dismal market for initial public offerings. So when Lawson Software (LWSN ), one of the VC firm's biggest recent bets, began its launch of a successful $200 million IPO on Dec. 7, the company and its St. Paul backers let the champagne corks fly -- at the market's opening bell. "It was early for champagne, but it felt nice to be celebrating," says St. Paul partner Brian Jacobs. "An IPO is a rare event these days."
Indeed it is. As the broader market has declined by nearly 20% in 2001, the IPO market has plummeted. The number of new offerings is down from 422 in 2000 to around 80 this year, a drop of about 80%, according to Web site IPO Monitor. By yearend, the amount of money raised via IPOs will have fallen by more than 60%, from $97 billion last year to perhaps $30 billion-plus in 2001. Such figures reflect a historically high level of IPO cancellations -- around 160 this year. So it's no wonder VCs are bidding good riddance to the weakest IPO market in 21 years.
Evidence is mounting, however, that IPOs will stage a comeback in 2002. While the full impact may not become evident until the second half, a new determination by VCs to take under their wings only public companies with the strongest fundamentals -- such as revenues and profits -- is already laying the groundwork for a more stable IPO market, analysts say.
Consider some recent offerings: Semiconductor software maker Nassda (NSDA ) jumped 45%, to $16 a share, on Dec. 13, the day of the stock's debut. It closed at $17 on Dec. 19. Prudential (PRU ), the insurance and financial services giant in Newark, N.J., also went public on Dec. 13, selling 110 million shares for $3 billion, which made it the largest insurance IPO in history. It's also this year's third-largest offering, behind Kraft Foods' (KFT ) at $8.7 billion and Agere Systems' (AGR ) $3.6 billion sale. Pru is trading at $30 a share as of Dec. 19, up slightly from its initial price of $29.
Indeed, the fourth quarter of 2001 should produce at least 21 IPOs, up from 13 in the third quarter, according to IPO Monitor. This creates what analysts increasingly see as a head of steam going into the new year. With deal flow picking up, the number of IPOs in 2002 should exceed 150 -- or nearly double this year's total, analysts say. That wouldn't represent a roaring rebound as much as a respectable recovery, but at least it would be closer to the 300-IPO years that distinguished the late 1990s.
An IPO resurgence would be welcome news for investors, who spent most of 2001 with little return -- if any -- on their money. Once IPOs rebound, well-heeled players with connections and an appetite for risk might have a shot at making a killing again. And the overall market could benefit as well. That's because today's IPO market is looking for financial results rather than settling for bright ideas in search of a business plan.
With the emphasis on more mature companies, it'll be harder for a bubble to form as it did around the ephemeral dot-coms of the late 1990s -- and easier for investors to size up the risks. Better yet, while venture capitalists are raising the bar for taking companies public, they're simultaneously rewarding candidates that do make the grade with huge sums of late-stage pre-IPO financing -- which should help guarantee that their coming out won't be a prelude to an early demise.
Because of the fleeting nature of many dot-com IPOs, many investors remain mordantly skeptical of new tech issues. The telecom and Internet sectors are particularly hard to pitch to venture capitalists, say CEOs who have tested the waters. "Investors are saying, 'show me profits, show me products that work, show me customers,'" says Ron Sege, CEO of Ellacoya Networks, a Merrimack, N.H., startup that develops hardware and software for billing customers on the Net. Given that environment, Sege believes that entrepreneurs will be more careful with the funding they receive from venture capitalists -- and will seek a clear path to profitability before considering an IPO.
How long it will take for a revitalized IPO market to embrace riskier companies is still uncertain. One surprising IPO early in the year could be that of PayPal, an as-yet-unprofitable online payment specialist whose fortunes are closely tied to Net auction giant eBay (EBAY ), since many eBay bidders use the service to pay for their items. PayPal moved a step closer to going public on Dec. 18 by setting its estimated initial offering price at $12 to $14 per share. The Palo Alto (Calif.) company said it plans to issue 5.4 million shares in a bid to raise up to $76 million with underwriter Salomon Smith Barney.
Among Internet companies, however, PayPal could be the exception, says St. Paul's Jacobs. "If the economy is sluggish and uncertain, it will be difficult for institutional buyers to make large bets on micro-cap companies that are at higher risk due to continued slowness in corporate purchase cycles," he says. In a sluggish broader market, networking, data security, and medical companies are more likely to mount successful IPOs, he asserts.
For now -- and perhaps for 2002 -- much of the action will be in non-Internet companies in industries such as microchips, insurance, biotech, and engineering. "I would call it a selective recovery, not a broad one," says Steve Eskenazi, a partner at San Francisco-based WaldenVC, of the IPO rebound.
Biotech in particular could have a strong 2002, buoyed by the pending $16 billion marriage of Amgen (AMGN ) and Immunex (IMNX ) -- which implies a decent future for even small biotech players. Overseas issues could boost a budding recovery of financial-services IPOs. One of the most closely watched aspirants is the Hong Kong arm of the Bank of China, says analyst Kyle Huske of IPO.com. It was set to go public this year both in the U.S. and Asia but pulled back because of the unfavorable market conditions. A public offering is more likely in 2002.
Meanwhile, Citigroup (C ) said on Dec. 19 that it plans to spin off its Travelers property casualty insurance unit, which has $4 billion in annual sales, in a first-quarter IPO. And even though telecom is finishing its worst IPO year in recent memory, Verizon Wireless could spark a flame in that sector if it presses ahead with its planned offering. Huske says Verizon Wireless could fetch in excess of $5 billion, making it one of the five-largest IPOs in history.
While IPO.com sees the fourth quarter of this year as a catalyst for the public offering market, Huske anticipates the bulk of the recovery arriving later in 2002. "The first quarter should look a lot like this year's fourth quarter, so the faster, steadier pace of activity may not happen until the middle of next year," she says.
However many companies come to market in 2002, the IPO game is settling into a more stable rhythm. The renewed emphasis on quality companies could provide reassurance for investors. And while IPOs are but a small piece of the mix for most portfolios, the reemergence of a bustling new-issues environment next year should help improve the health of the broader market in 2002.
By David Shook in New York