The IPO Market’s Baby Boomlet

SATURDAY, AUGUST 3, 2013

The IPO Market’s Baby Boomlet

By JACK WILLOUGHBY | MORE ARTICLES BY AUTHOR

IPO activity is heating up, as the Facebook disaster fades into memory. On the horizon are Twitter, Dropbox, and Spotify, among others.

This is a golden era for initial public offerings. More of them priced in the second quarter of 2013, 44 in all, than in any period since the final quarter of 2006. A strong small-cap market has helped push these fledgling-company shares to new heights: The average first-half deal jumped 16.97% on its first day, gaining a total of 39.16% by the end of July. “I’d characterize the IPO market as white hot,” says Tim Keating, CEO of the Denver area’s Keating Capital, which invests in private offerings of companies on track to become public. If you remember, there was nothing white hot about last spring’s IPO market. Facebook(ticker: FB) had just raised $16 billion in May, the biggest Internet IPO of all time. The deal was overpriced, a technology glitch at Nasdaq caused shares to be misallocated, and a number of buyers accused the company and its bankers of selectively disseminating earnings revisions to bigger investors. Very few IPOs of any sort got done for awhile afterward. It’s fitting, then, that last week Facebook’s share price, in this year’s stronger market, got back to its original offering price of $38, after falling as low as $17.55.Ripples from the Facebook deal haven’t spent themselves yet. For the first six months of 2013, the new-issue market priced 67 IPOs, raising $18 billion, compared with 59 deals worth $25.2 billion in the same period a year earlier, according to Dealogic, which tracks stock and bond offerings. But then again, Facebook’s offering accounted for nearly two-thirds of 2012’s first-half volume.

Conditions this year are more balanced and healthy. U.S. stocks generally have gained, with a blistering pace set by the small-cap group that most IPOs join. The Russell 2000 Index, the small-cap benchmark, rose 15% in the first half, well ahead of the S&P 500’s nearly 13% gain. At the same time, the markets have been less volatile, giving bankers, issuers, and investors a little more breathing room to value the deals and the market (see the best- and worst-performing deals, in the Easy Money graphic below). The question is how long this supportive environment lasts.

For now, at least, the result is not just more deals, but also more diverse and mature issuers. Rather than Facebook and a smattering of finance deals in 2012, this year has seen health care, construction, technology, and finance/insurance all account for more than 10% of dollar volume (see table below headed “A More Diverse, Balanced Mix of IPO Issuers”). Issuers have ranged from Norwegian Cruise Line Holdings (NCLH) and Noodles & Co. (NDLS) to Coty (COTY), ING U.S . (VOYA), and SeaWorld Entertainment (SEAS). (Dealogic’s complete list of first-half 2013 IPOs, with pricing terms and returns through mid-July, is available here.) The average age of an IPO company is now a robust 17 years.

“THE STRENGTH HAS COME FROM the backlog of supply built up over the last couple of years. The IPO market was shut down in part because of the European financial crisis” as well as the U.S. mortgage crisis and banking problems in both areas, says Linda Killian, a portfolio manager at Renaissance Capital, a Greenwich, Conn. firm that runs an IPO fund and researches new offerings. “This is the first time in a number of years that we’ve been able to put together several quarters of uninterrupted deal flow.”

Within this flow have been more of the classic venture-capital-backed deals, notes Keating, who counted 21 of them in the second quarter, up from eight in the first. Renaissance, too, noted the shift toward VC-style growth deals and away from megaofferings where buyout firms are returning portfolio companies to the public markets. “Institutional investors have shifted from being risk averse, seeking yield and blue-chip stocks, to seeking growth,” says Killian. Another aid was the 2012 passage of the JOBS Act in Congress, which has eased some of the regulatory and filing burdens on small firms, generally regarded as the best generators of new employment opportunities.

Biotech, which accounted for about 20 IPOs in the second quarter (the most since 2000), has been a big beneficiary. Venture money has become more important to these high-risk businesses because government, big pharmaceutical companies, and academic institutions have either withdrawn from early-stage development or cut back generally on biotech investments. Also helpful: a streamlined, cost-saving drug-approval process recently passed by the Food and Drug Administration,

Venture-funded bluebird bio (BLUE), a prime example of biotech’s renewed popularity, came public on June 19, opening at $25.50, 50% above its initial price. The Cambridge, Mass.–based firm concentrates on innovative gene therapies for several genetic and orphan diseases such as ALD, which was highlighted in the movie Lorenzo’s Oil.

Chief Executive Nick Leschly explains that his company and others now get more support from investors with the scientific expertise to invest confidently at earlier stages. As a result, IPOs are “less a financing event and more a value-creation event,” part of a company’s development, rather than an end in itself, he says.

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Its backer, Third Rock Ventures, is among a handful of biotech venture capitalists. “Bluebird and other biotech offerings represent product investment in disruptive areas of science and medicine that result in significant premiums in both the IPO and the merger markets,” says Kevin Starr, a co-founder of the Boston-based firm, and also an early sponsor ofAgios Pharmaceuticals (AGIO), another biotech that priced last month.

RECENT BIOTECH FILINGS INCLUDE cancer-treatment developer Foundation Medicine (backed by Third Rock and Google Ventures, among others) and protein-therapy developer Five Prime Therapeutics (backed by Pfizer [PFE] and Domain Associates).

Oft-rumored IPO candidates such as Dropbox, which enables sharing of files such as photos and videos, and Twitter, the social-media site likely to receive Facebook-like publicity, will have to decide soon if they want to cash in on this market.

Others facing this decision include Chegg, which provides online textbook rentals, homework help, and access to scholarships for college students; Violin Memory, which makes flash-memory arrays; Sugar CRM, an enterprise-software outfit whose functions include sales-force automation and customer support; Foursquare, a social-networking site for mobile devices that alerts others to your location and gives tips on what to do at specific venues; Spotify, a subscription-based music-streaming service that lets you choose songs or listen to the song collections of others, including recording artists; and King, a game maker for mobile devices.

More traditional businesses such as retailer Neiman Marcus, home builder LGI Homes, and dining chains like Cheddar’s Casual Café have all filed preliminary papers to go public.

But can the small-cap market handle the stampede? The multiple on the Russell 2000 is a hefty 19 times next year’s projected earnings, well above the large-cap benchmark S&P 500’s 14 times.

With each passing quarter, it becomes more likely that the two-year small-cap rally will slow down or even reverse course, says Henry Ellenbogen, portfolio manager of the T. Rowe Price New Horizons fund (PRNHX), with assets of $12 billion.

That means the clock is ticking for a lot of CEOs of small, growing businesses, says Richard Peterson, a director at S&P Capital IQ, a research firm and data collector in New York. For these corporate chieftains, Peterson says, “The issue is: Why are you waiting? The markets are now at record highs; if you can’t do an IPO now, when can you do it?”