IPO Market Unravels
Two short months ago, no one worried about the Internet IPO window; it was big enough to drive a fleet of SUVs through. Since then, the tech-dominated Nasdaq has fallen by a third - and it can't seem to get up. Now, you can almost hear the window slamming shut.
Companies that had rushed into the IPO pipeline are now recoiling. In April, 13 Internet-related companies withdrew planned initial public offerings, equal to the number pulled during the three previous months combined. As of May 18, another 15 had withdrawn. The dropouts range from consulting firms like Zefer to software makers like Iteris to broadband providers such as Jato. Even a company with the name of Cruel World, an online recruiting firm, can't get any respect.
Between April 1999 and March 2000, Net IPOs popped into the market at an average clip of 25 a month. Only 15 made it out in April. And judging from the current pipeline, May will produce no more than an unlucky 13.
The companies that are going public are doing so by slashing back their expectations. An estimated $846 million will be raised in Internet IPOs during May, about a third of 1999's $2.2 billion monthly average.
The few bulls in the IPO market point to companies like Sequoia Software and New Focus, which have gone ahead with offerings and are seeing their stocks rise. Many of them, including Internet broadcasting network iBeam, had to slash their offering price below their original estimates. Contrast that to a year ago, when it was routine to go public above those estimates. Between Jan. 1 and April 1, only 2 percent of IPOs priced below their initial filing ranges, compared with 75 percent since then, says Dan Case, CEO of Chase H&Q.
The result is a humbling experience for many Internet executives. "Talk to executives like me, and we're always blowing smoke and swaggering," says Frank A. Daniels, CEO of Total Sports, which pulled its $57.5 million IPO last Monday. "The last few months have taken a little bit of the swagger out."
Worse, many Internet companies are seeing their stock prices drop below their offering prices in the weeks following the IPOs. Only 88 of the 98 Internet-related IPOs this year are above their offering prices. Last Thursday, shares of Nogatech, a maker of video chips, dropped 22 percent on their first day of trading.
So far this year, Internet IPOs are underperforming the Goldman Sachs Internet Sector Index by 26 percent. So, more than simply avoiding the first-day hype of Net IPOs, investors have shunned new Internet issues in general, favoring older Internet companies instead.
And if institutional investors, who are the biggest buyers of Internet offerings, grow disenchanted with the post-IPO performances of their offerings, the IPO market could get even tougher. Already, many big investors are growing skeptical. "We've been told, 'Don't darken our doors,'" says investment banker Frank Quattrone, who heads Credit Suisse First Boston's technology group.
Even those who dispute the closing of the IPO window detect a shift in the attitudes of investors. "Our accounts are starting to ask a lot more specific questions,' says Brian Anderson, co-head of capital markets at U.S. Bancorp Piper Jaffray. Before March, investors went after sectors, not individual companies. "People ... are digging deeper into the numbers," Anderson says.
Despite the numbers, few will openly say that the window is shuttered: It's as if a screen has been placed over the window, and it allows only the fittest companies - or those in hot new sectors, like optical networking and wireless communications equipment - to pass through.
But for more beleaguered sectors, like online retailing and content, the IPO market is hostile territory. Take the pet-supplies industry, long the poster child for dot-com overpopulation and an area ripe for consolidation. Pets.com was the first in the industry to go public, listing at $11 a share in February. Last week, it was trading at $2.06. Rivals Petopia and PetsMart.com - backed by brick-and-mortar giants Petco and PetsMart, respectively - have also filed for IPOs. Although their registration documents have not been pulled, the IPOs are not likely to go through.
"I don't believe that in these market conditions any player in our space can get out," says Chris Luhnow, president and cofounder of Petstore.com. "I do think that PetsMart.com and Petopia will have to pull their IPOs." Officials at PetsMart.com and Petopia declined to comment, citing Securities and Exchange Commission "quiet period" restrictions.
Internet startups aren't the only ones feeling the change. Companies in traditional industries, from media firms like the New York Times Co. to chain stores like KB Toys, have considered spinning off their Web subsidiaries into IPOs to cash in on Wall Street's infatuation with the Internet. Many executives are now rethinking such moves.
KB Toys pulled the IPO it had planned for its Internet unit, KBkids.com. Competitor eToys (ETYS) is trading around $6, a small fraction of its 52-week high of $86. While KB Toys has agreed to continue funding KBkids, it has also begun to rein in its independence. KBkids this month laid off 30 percent of its workforce - including CEO Srikant Srinivasan.
The cooled-off IPO market also has put some investment banks in a tough spot. Wit Capital, for instance, was downgraded last week by analysts at Thomas Weisel Partners from "buy" to "market perform." Weisel cited a "protracted downturn in the new issuance market."
Some analysts expect companies to pursue mergers and acquisitions as an alternative. But M&A may not cure the IPO blues for all companies. Total Sports, which had been in merger talks with other companies, saw its suitors disappear as the market slid downward.
Last week, two Net health mergers involving publicly traded companies disintegrated. Trizetto, an Internet medical application-server provider, scuttled its "acquisition" of much-larger IMS Health (RX) , a pharmaceutical services company. The deal, valued at $8.2 billion when announced in April, has morphed into a "strategic alliance" with Trizetto's acquisition of an IMS division for $225 million in stock. And executives at online medical-supplies company Neoforma.com (NEOF) say they're in talks to scrap a proposed acquisition of medical software maker Eclipsys (ECLP) .
Some Net executives say putting off an IPO isn't a big setback. Anthony Tjan, founder and executive VP at Zefer, which withdrew its $60 million IPO May 2, insists the company does not need the money right now because it raised $100 million last June. "We have the luxury of waiting for the right time," he says.
The big risk, however, is whether the right time is merely a few months away or years away. In the fall of 1998, a global financial crisis all but stopped the flow of IPOs. But by the start of 1999, a strong pace had returned, thanks in large part to the actions of the Federal Reserve, which lowered interest rates in response to the crisis. These days, the Fed is raising rates, pushing up two key short-term rates a half of a percentage point last Tuesday, a move perceived as directed at asset inflation in tech stocks.
When the stock market crashed in 1987, the IPO flow slowed considerably. It wasn't until June 1991 that the IPO market recovered, although the equity market bounced back before then.
"A lot of practitioners say that the IPO market is seldom in equilibrium, either being too hot or too cold," says Jay Ritter, a finance professor at the University of Florida, and an expert on the history of IPOs. "You have no way of knowing in advance whether a postponement means a four-month or a four-year wait."
Some long-term trends suggest that the window for IPOs won't close entirely. Historically, 10 percent of all venture companies go public. Given that the amount of venture financing to private companies hit a record $48 billion last year, there's plenty of reason to believe strong IPO candidates will continue to be accepted by Wall Street, Ritter says.
What's unlikely to return anytime soon is the frenetic IPO market of the first three months of 2000, when the amount raised by technology IPOs - $40 billion - was roughly equal to the figure for all of 1999.
What will it take for a Net company to get a good IPO reception? Investors are signaling they want better fundamentals: valuations that aren't based on three-digit price-to-revenue multiples. On April 7, for instance, three Net companies that went public - Opus360, LivePerson and Saba Software - had price-to-revenue multiples of 1,185, 367 and 332, respectively. Compare that with New Focus, Nogatech and US Unwired, which had IPOs last Thursday, with multiples of 4.5, 8.2 and 1.5, respectively.
Investment bankers also insist there's still promise in markets believed to be largely untapped, such as optical-networking equipment. New Focus, the first company in this sector to go public in weeks, priced at $20 and closed its first day of trading Thursday at $51.
"There are a number of others, like Corvis and Stanford Microdevices, teed up in this space," says Revell Horsey, director of equities at Banc of America Securities. "We're all sort of crossing our fingers and hoping that the market embraces them."
For most others, their best bet is to lower the amount to be raised. I-Beam, which provides streaming media, decided to raise only $110 million from the public markets, instead of $140 million. It had to give up the idea of pricing in its initial range of $13 to $15 per share, and instead opened at $11.
Says Horsey: "The idea of pricing deals a dollar or two below the range used to be considered a real black mark, and firms would try to avoid a discount at all costs." Now, getting out the door is an achievement.
------------------------------------------------------------------------ Diane Anderson, Megan Barnett, Daniel Helft, Miguel Helft, Mark Roberti, Todd Woody and Eric Young contributed to this story.