What’s behind the IPO market rebound

2013 was so strong, in fact, Renaissance called it “the best year for the US IPO market since 2000.” This year, though, already looks to be even bigger.

In the first two months of this year alone, 42 companies went public in the United States, raising a total of $8.3 billion. That ties with 2007 for the busiest start to a year for initial public offerings since 2000, when there were 77 in the same time period.   

To compare, last year, saw only 20 offerings in the first two months.

To put it another way, if this year’s pace continues, it would reach 252 companies going public by the end of this year, with a total of $49.8 billion raised. Compare that to the 406 IPOs, which raised $96.9 billion in 2000, and we still have a long way to go before we go back the dot-com-era levels. Of course, it’s probably a good thing that we’re not at those levels.

How are Tech IPOs faring?

More importantly, which kinds of companies are going public? Right now it seems to be mostly energy and biotech companies.

This year so far, 26 healthcare companies went public, raising $1.5 billion, while six energy companies did the same, raising $2.3 billion, according to Renaissance Capital. At the same time, there have only been three tech/Internet IPOs, which raised a total of $0.4 billion.

Two of those tech IPOs were Care.com, as well as Coupons.com.

The numbers might not seem strong, but there are plenty more companies rumored to getting ready for an IPO, including: Wayfair, which raised $157 million at a $2 billion valutation; DocuSign, which raised $85 million in the last couple weeks; Square, which is reportedly raising $200 million at a $5 billion valuation; and Dropbox, which raised $350 million of a $450 million round at a $10 billion valuation. 

Other potential candidates whose names are frequently mentioned include Airbnb, Zendesk, Uber,Lending Club, Zoosk, Evernote, Box, Gilt, Jawbone and Pinterest.

It wouldn’t be a shocker if a number of these companies file to go public at some point this year. Remember, we have a long way to go in 2014.

Already two companies have made their IPO filings known so far in 2014: Candy Crush maker King, which is looking to raise $500 million, and food delivery service GrubHub, which is looking to raise $100 million. 

Filing confidentially

Or maybe others have filed and we don’t even know about it!

The thing to remember is that the numbers we’re seeing may not be indicative of how many companies are actually planning to go public as some may have taken advantage of the provision of the JOBS Act that allows companies with less than $1 billion in revenue to file confidentially.

This is what Twitter did last year and what GrubHub did this year.

According to the bill, companies don’t have to disclose anything about their financials until 21 days before the start of its road show, where it will have to market itself to investors, if the company ever even decides to have one.

While the confidential filing makes it hard to know how many companies are in the pipeline, it is also at least partially responsible for the health of the IPO market, Kate Mitchell, Managing Director of Scale Venture Partners, and one of the architects of the JOBS Act, told me in an interview.

The provision helps companies feel more confident that even if they don’t go public after they filed, they wouldn’t have had to publicize their financials, she said. There’s less than a 25% chance for a company that files to go public to follow through with an IPO, she told me. There’s a number of reasons for this, including a geopolitical crisis, like the one in the Ukraine right now, or the company simply can’t get ready. When that happens, “they get none of the benefit of going public, but all the costs of it,” she said, including a potential hit to the company’s reputation.

Now, when a company starts the process, the JOBS Act allows them to have a better path to profitability, with the end being that companies perform better than they would have otherwise.

Ultimately, she said, the provision helps both buyers and sellers, as it opens up a dialogue between the company and investors, who get to see more information during the drafting process.

For example, the confidential filing provision could have helped a company like Groupon, which was hit with public embarrassment after serious accounting errors came to light. 

Groupon filed for a $750 million IPO in June 2011, but in August the company was forced to discard its “adjusted consolidated segment operating income” accounting method which inflated the value of the company by not counting customer acquisition, online marketing, or stock-based compensation. 

“Talking more to investors could have helped Groupon test the durability of its model, as well as its metrics, and readiness,” she said. 

The provision also allows the SEC to make additional comment, as they likely would have over the issues with Groupon’s fudged accounting methods, and still likely would have made an impact. But the company would also have been able to dampen the response by fixing the issues before opening itself up to public scrutiny. 

“Public image factors in a lot,” Ted Tobiason, Managing Director of Technology Equity Capital Markets at Deutsche Bank, told me. “

“When a company is private, they don’t have to worry about meeting quarterly revenue, and they can stretch their goals,” he said. “They don’t have to deal with employees watching stock go down, and competitors and clients interpreting their data.”

Going public, he said, can make teams nervous, so getting to test the waters in front of investors before the road show starts, and seeing how those investors react to their story under changing conditions, can help put them at ease.

Other factors

Of course, not everyone thinks that the JOBS Act is having that big of an effect on the market, includingMichael Ackrell, Managing Partner of Ackrell Capital.

“In theory, big companies will go public no matter what,” he said. “The intent was for smaller companies to be able to be more confidential to spend less money on regulations and ease some of the burden.”

And, so far at least, it doesn’t seem to be helping much, as the median revenue for companies going public in 2013 was $109 million compared to $17 million in 2000, adjusted for inflation.

At the same time, though, nearly 75% of companies that have gone public this year are unprofitable, and just nearly two-thirds have annual sales of under $50 million. Both of those numbers are at their highest in any year since 2000.

Unless the Act is helping facilitate these smaller deals, then it’s not doing its job, Ackrell said.

Ted Tobiason, Managing Director of Technology Equity Capital Markets at Deutsche Bank, also expressed some hesitation over assigning credit to the JOBS Act for the increase in IPO activity.

“In a parallel universe, I can’t say if more or less companies would go public,” he said. “Though if a company is apprehensive about going public, the ability to file confidentially will help.”

Instead, Tobiason pointed to other factors in play that are contributing to the rebound of the IPO market. 

On the supply side, Tobiason pointed to the success of cloud and SaaS companies, which has “created a lot of opportunity.”

Meanwhile, on the demand side, he said that low volatility has been a big factor.

IPOs are, by definition, risky. There are a lot of unknowns, and many immature businesses trying to go public. Right now the volatility index, which is calculated using a formula to derive expected volatility by averaging the weighted prices of out-of-the-money puts and calls, is very low. That makes investors more willing to take the risk.

On top of that there were all of the successful deals in 2013.

“Capital chases performance, which helps predict the reaction to next handful of deals,” he told me. “The risk to adjustment returns have been phenomenal so the willingness to invest is very high.”

Valuations for top line growth stories have been rising. A high growth software company is getting a higher multiple than it would have if it had gone in 2009. 

One good reason for the multiple appreciation is that investors have done exceptionally well buying fast-growing software companies the last few years, such as Workday, which rose 72% on its IPO day in 2012, Rocket Fuel, which nearly doubled its price, and Veeva Systems, which went up 85.8%. 

Of course, with high valuations come high expectations.

Say, for example, if you took a software company that was making $100 million in revenue, and growing at 35%, public in 2009, that company went public at 2 to 3 times its revenue. Now, those companies are going public on 5 to 6 times revenue. On average, investors are paying a median of 14.5 times annual sales.

That’s because the cloud and SaaS companies that went public performed very well and made a lot of money and the investoes now feel as if they could have gotten more from those deals.

The problem with that, though, is that putting a high valuation at the IPO can ultimately be harmful to the company. We all remember what happened to Facebook.

Look out below!

(Image source: ad-exchange.fr)