Is there life in the IPO market after the correction in Internet stocks this spring? If the past two weeks offer any indication, investors are willing to embrace some of the more promising candidates, albeit with a sense of caution. In other words, the IPO market is working as it should – for now, at least.
So far in 2014, 115 companies have gone public on US markets, raising a total of $23.5 billion, according to Renaissance Capital. That compares with 74 companies raising $17 billion in the first five months of 2013. Early on, 2014 looked to be the busiest year for IPOs in more than a decade.
Then came the correction. The Nasdaq Internet Index lost 20 percent of its value between early March and mid May, while an IPO index tracked by Renaissance declined by 13 percent. Shares of companies that went public fared even worse. Notably, Twitter fell 44 percent in that period and is down 52 percent so far in 2014.
The correction eased concerns that the valuations of tech IPOs and of tech growth stocks in general were starting to depart from common sense enough that a new financial bubble could be on the way. For now, those concerns seem unfounded. Promising tech companies are still listing, and at valuations that are more easily justified.
“Earlier in the month, only 48 percent of the year’s IPOs were trading above their offer price, but that number has since climbed up to 55 percent, and it is 73 percent for IPOs in the past two weeks,” a report from Renaissance Capital noted. “This could signal the IPO market’s recovery, along with more conservative valuations.”
The turning point came on May 15, when Zendesk went public priced at $9 a share and rose 49 percent on its first day. It looked like the first-day pop that tech IPOs enjoyed routinely in late 2013 and early 2014. But Zendesk, a maker of on-demand customer-service software, priced its offering modestly.
According to the Wall Street Journal, Zendesk’s IPO priced at four times its projected revenue this year, well below the ratio of other recent Internet IPOs and even below the 7.2 price-to-sales ratio of publicly traded cloud-computing companies. The IPO priced right in the middle of its range, in contrast to IPOs like Twitter that priced above their initial range. The discount not only ensured a smooth IPO, it allowed for a first-day pop that signaled that the waters were safe for other offerings.
Since then, other tech IPOs have debuted to welcomes that were warm if not enthusiastic. TrueCar, an automotive-pricing site, priced at $9 a share (below its initial $12-$14 range) and is currently trading at $9.22 a share. Jumei International, a Chinese etailer of beauty products, priced at $22 a share (slightly above its initial range) and trades at $22.80 a share. And another Chinese etailer, JD.com, priced at $19 a share, above its initial range, and now trades at $20.10 a share.
Of these companies, JD.com is the most noteworthy. The company saw revenue of $11.1 billion in 2013 and manged to raise $1.78 billion in proceeds from its IPO, in addition to another $1.2 billion it raised in a concurrent private placement from Tencent, a rival to Alibaba. JD’s public offering is the third biggest Internet IPO in US history, ranking it slightly behind Twitter’s $1.82 billion IPO.
Even better for IPO candidates and their underwriters, JD seems tailor made as a test-case for Alibaba, the Chinese Internet giant that could rekindle a flame under the market for tech IPOs. A key difference seems to be that JD.com is still losing money – it posted a $96 million operating loss last year – while Alibaba is profitable. Although JD’s losses are shrinking, they may account for the cautious tone with which investors received its offering.
The next test case for the IPO market is Arista Networks, a maker of software-defined network switches used in cloud infrastructure. Arista’s revenue nearly doubled in the most recent quarter to $117 million while its operating profit rose 151 percent to $22 million. The company is planning to raise $200 million from its IPO as early as this week.
In tough times, underwriters will cherry pick healthy, growing IPOs and try to offer them at a reasonable valuation to try and ratchet up demand for new offerings in general. They won’t float any big names until it’s clear that demand is robust – otherwise they might have another Facebook IPO on their hands. For now, the IPOs squeaking through are doing their job of priming the proverbial pump.
There is a lot at stake for companies looking to go public. Although Facebook, Google and others have shown they’re willing to pay a hefty premium to acquire companies, startups wanting to remain independent are willing to brave the public markets.
Meanwhile, the list of companies that have filed prospectuses for public consumption or have indicated their willingness to do so is growing. Last week, GoPro said it would go public with a $100 million IPO. It joins Zoosk, Box and others that are trying to time the market for a successful offering. The tech startups going public this month may not be grabbing headlines, but they are tea leaves well worth studying.
[illustration by Brad Jonas for Pando]