Silicon Valley Hears Echoes of 1999
Not many executives have seen their companies double in value in one day. Peter Bardwick has seen it twice. Bardwick was chief financial officer of financial news site MarketWatch when it started initial trading on Jan. 15, 1999, at $17 a share. By day’s end it hit $97.50, for a market value exceeding $1 billion. Fourteen years later, on Sept. 20, 2013, Bardwick, now CFO of digital advertising firm Rocket Fuel, watched its stock almost double in value on its first day of trading.
Amid such Day One stock pops, high valuations, and buoyant equity markets, warnings of an asset bubble are again echoing across Silicon Valley. Nasdaq’s 38 percent climb last year, and deals such as Facebook’s recent agreement to spend as much as $19 billion on fledgling messaging service WhatsApp, have added to worries about a crash like the one that sent the Nasdaq Composite Index plummeting about 80 percent from its March 2000 peak. By the end of 2004, 52 percent of dot-com startups that had sought venture capital—including investor darlings Pets.com and Webvan.com—were extinct, according to research by the University of Maryland and the University of California at San Diego.
“The real question is whether a crash will occur now or after the markets rise another 30 percent,” says Ian D’Souza, an adjunct professor of behavioral finance at New York University who co-founded Tri-Ring Capital, a technology-focused equity fund. Other investors, bankers, and venture capitalists say too much has changed to put the initial public offering market in danger of imploding now. “Investors have become more discriminating and more focused on the individual businesses,” says Bardwick. “In the ’90s, everything was just going up, and when that stopped, it happened in a really bad way.” MarketWatch never exceeded its opening-day value, falling to a low of $1.26 in 2001 before Dow Jones acquired it in 2005 for $18 a share, just above its IPO price. Rocket Fuel remains at almost double its IPO price.
Last year 208 companies went public in the U.S., raising more than $56 billion, according to data compiled by Bloomberg. Their stocks rose an average 21 percent on their first day of trading, the biggest annual average increase since 2000. In their debuts in November, Twitter jumped 73 percent and Zulily, a shopping website, rose 71 percent.
Companies and bankers are setting initial prices at reasonable levels, according to data compiled by Jay Ritter, a finance professor at the University of Florida. IPOs were priced at a median of 30 times sales in 2000, compared with 5.2 times last year, the data show. MarketWatch traded at 46 times 1999 sales on its first day, while Rocket Fuel’s valuation was 7.6 times 2013 revenue.
Thanks in part to the Fed’s low interest rate policies, startups have been able to delay IPOs while receiving repeated rounds of funding from hedge funds, private equity funds, and institutional investors. That means businesses are older when they go public and have longer sales and profit histories, making it easier for investors to value them accurately. Businesses backed by venture capital or private equity firms were 12 years old on average in 2013 when they went public, compared with six years old in 2000 and four years old in 1999, according to Ritter’s research. Twitter was seven years old at its IPO. “You want to make sure you have a company of reasonable scale before you go public, which ensures much more certainty in the planned financial results,” says Doug Leone, a managing partner of venture capital firm Sequoia Capital.
The median annual revenue for companies going public in 2000 was $17 million, compared with $109 million in 2013, adjusted for inflation, Ritter’s data show. And fewer companies are doing IPOs with no profits. Last year 64 percent of all initial offerings were done by profitless companies, compared with 80 percent in 2000, according to Ritter’s data.
The high cost of going public is a hurdle that discourages smaller companies and may lead to a more stable offerings market. The Sarbanes-Oxley Act, passed in 2002, requires extensive financial disclosure, raising the cost spent on auditors and legal work. “There’s just a much higher bar today,” says Ron Codd, a consultant to companies on the IPO track.
Another element missing this time: The boutique banks that underwrote many of the Internet IPOs in the 1990s don’t exist independently today. They were known as the “Four Horsemen”—Hambrecht & Quist, Montgomery Securities, Alex. Brown & Sons, and Robertson Stephens. None remain independent. Technology IPOs today are underwritten by the larger banks, primarily Goldman Sachs and Morgan Stanley, which tend to decline underwriting IPOs of smaller companies, says Ritter.
While bankers and venture capitalists are confident about today’s IPO market, the shadow of the dot-com bust lingers. “Now in the Valley, the idea of a bubble is a practical conversation,” says Ted Tobiason, who worked at Robertson Stephens beginning in 2000 and now heads equity capital markets for the technology industry at Deutsche Bank. “It’s a healthy discussion, which gets people to think about risk and not just potential upside.”