"The (Hot) IPO Market" or "Do Profits Matter?"
With the apparent resurgence in the IPO market, it seemed timely to revisit my last blog What to know before you IPO and ask, “what’s changed?”
After doing a little digging, it seemed to me there are several points worth making, which haven’t really been front and centre in the popular press. Namely:
- Yes, the IPO market has recovered from the depressed levels of past years, but it’s still at low levels;
- The markets appear to be primarily focused on revenues and less so on earnings;
- High valuation levels being accorded IPOs is at least one of the driving factors of this resurgence and there is a growing gap between valuation of revenues and profits that should provide a cautionary note for investors.
First, the facts: Presumably you’ve read about the hot IPO markets, with successes like the $200mm offering of RealD (riders of the 3D wave and makers of those clunky glasses you use to watch these movies), Smart Technologies ($660 mm - makers of “whiteboards”) and MEG Energy ($675mm – an oil sands producer). Even Skype, the internet phone service, owned by a consortium including our very own CPP, has filed today to access the markets.
The number of IPOs to date in the US (the world’s most active market) is 81 for the first six months of 2010 vs. 18 for the same period a year ago. This is 4.5X higher, and above the entire amount for 2009.
However, if you look at 2010’s performance over a longer time frame, the volumes are still historically low. Have a look at the website of Renaissance Capital, which provides a convenient source for IPO data and trends.
What is the reason for this flurry of activity? Particularly against a backdrop of an uncertain economic environment?
Well, first of all, according to some market observers, profits don’t matter. As David Milstead of the Globe & Mail wrote last week, Forget profits, it’s all about revenues.
This applies to existing companies, i.e. whether or not Apple beat the “Street” estimate for revenues, without regard to EBITDA (earnings before interest taxes depreciation and amortization), or that number you hardly ever see in research reports – net income. It also applies, especially, to new companies. In fact of the three high profile IPOs noted above, only one (Smart Technologies) has a positive EBITDA.
Against a backdrop of the market’s focus on revenues vs. profits, the valuation levels being applied to these revenues is also expanding. An example of this is the pricing outlined in an IPO for Intralinks today. The pricing was 4.6X expected revenues (or rather the most recent quarter’s revenues, annualized) for a company that had accumulated net losses of $65mm+ in the three years that it had been owned by its private equity buyers.
Perhaps the graph below can explain some of the interest in issuers accessing the IPO market. This is for a peer group of “Software as a Service” or “On Demand” software companies. That is, those companies that provide their software product over the internet, rather than as a shrink-wrapped disk sold to their customers.
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Valuation vs. revenue multiples are up 43% over the past 12 months, whereas valuation vs. EBITDA multiples are only up 5% - making it an ideal time for these types of issuers to access the markets – and a time for investors to be cautious.
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