The IPO Market's Golden Mean?
By Timothy J. Mullaney
For a while, it looked like the market for initial public offerings might be starting to overheat again. But in the last few weeks, a slew of IPO candidates have turned tail and run, ditching their plans to go public. On Aug. 4, Palo Alto (Calif.) nanotechnology outfit Nanosys cancelled a planned $100 million IPO. And it's just the latest: 14 IPOs have been shelved so far this year, compared to 111 completed, according to Renaissance Capital, an IPO research firm. Another nine have been delayed but not formally withdrawn.
This is a happy departure from the extremes of the recent past -- the irrational heights of the dot-com bubble and the meltdown and three-year cower afterwards. The IPO market has been remarkably smart since coming out of hiding late last year. Good deals are getting done -- and rewarded with respectable valuations. Bad deals, meaning outfits that are either too young or too undistinguished to be plausible as independent public companies, are getting the back of the hand. Or else the market is forcing them to cut their price: Renaissance says 48 IPOs this year were priced below their announced target range.
The withdrawal of Nanosys isn't hard to explain. The company had 2003 revenues of $3 million and is nowhere near making a profit. It's pioneering a field that so far is a mile wide and an inch deep: The science of nanotechnology promises to manipulate hyper-small particles in ways that will improve the quality and cost of a vast array of products. And Nanosys itself is pretty spread out: It has joint development deals with Matsushita to work on solar-power cells, Intel (INTL ) to research memory chips, and EI duPont de Nemours to study thin-film electronics.
Nanosys' financials show pretty clearly that while it does a lot of interesting things, it doesn't yet do any one thing well enough to make a predictable business. Venture capitalists have argued that many nanotech concerns, like biotechs before them, will come to the public markets early in their lifetimes because their work is so capital-intensive that they'll need the kind of resources only Wall Street can provide. But so far, the market isn't ready to bet aggressively on early-stage research many institutional investors barely grasp.
Other deals having trouble share some, or all, of Nanosys' problems. The two most common: Not enough revenue, or not enough special sauce. Take PlanetOut Partners (LGBT ), which just cut the price range of its IPO 23%, to $9 to $11 a share. Most of the company's $19.1 million in 2003 revenue came from dating-service fees paid by lesbians and gays.
However, the gay dating-service market isn't huge: An exec of a rival mainstream dating service told BusinessWeek Online that even leading dating services like Match.com and Yahoo Personals (which are open to both heterosexuals and gays) are too small to be independent public companies. And the dating field is packed with competition, serving both general and specialized markets, making it hard to see why PlanetOut's prospects would be especially strong.
FIGHTING THROUGH THE CLUTTER.
Much the same is true of the dozens of biotech firms attempting IPOs before they have products on the market. Linda Killian, manager of the IPO Plus Aftermarket Fund in Greenwich, Conn., says many of those deals are getting done -- but at a price. "Early stage biotech companies are going to get priced like options," she says.
Still, outfits doing something truly new, and profitably, have found ways to fight through the clutter. Blue Nile (NILE ) is remaking jewelry-industry economics by using the Net to cut out middlemen and deliver both lower prices and above-average profit margins. Last year, it made $11 million on $129 million in sales. It went public at $20.50 a share in May, rose briefly to $41 and change, and is still above its offering price at $24.73 -- despite a second quarter in which it grew less than half as fast as last year.
Similarly, software concerns Salesforce.com (CRM ) and Blackboard (BBBB ) managed solid prices. Salesforce went out at $11 a share, more than 100 times some estimates of this year's profits, based on optimism that its inexpensive software -- delivered over the Net, instead of running on complex internal corporate networks -- would be a better alternative to customer relationship management software from rivals such as Siebel Systems (SEBL ). Salesforce spiked as high as $17.69 and then settled back to about $11 after it gave guidance for the second half of the year that was below Wall Street forecasts. Blackboard, which makes software colleges use to maintain Web sites for different classes, went out at $14 and is still around $16.
The market is a little too eager to please companies it thinks have high potential -- but it quickly corrects its mistakes. Salesforce and Blue Nile both went, if not into the land of 1999 valuations, to places where other software and retailing players rarely go these days. And in both cases it proved premature. After growing nearly 80% last year, Blue Nile disclosed second-quarter sales growth of just 29% on July 28. And at its peak, Salesforce's market capitalization reached $1.7 billion. But on July 21 the company said it will earn up to $3 million on sales of about $160 million to $165 million for the fiscal year that ends January, 2005. That's well below previous Wall Street forecasts of $6 million in profits on sales of $175 million.
That kind of discipline is keeping the IPO market in a rough kind of check. That doesn't mean investors can indescriminately buy any IPOs that make it to market this year, throw them in a drawer, and assume they'll make money. IPOs traditionally underperform the market but are marked by a few moonshots that make many others worth the risk. They aren't bank deposits -- even in this skeptical market. But the fierce push and pull over which deals get done, and at what price, does tell us that the balances that broke down in the 1990s are back in force.
Mullaney is BusinessWeek's e-business editor