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When Will the IPO Market Return?

Economy also puts damper on acquisitions

By Margo McCall

Not since the 1970s has the market for initial public offerings been so dismal. By StartupsThomson Reuters and the National Venture Capital Assn.’s estimation, there was just one venture-backed IPO during the third quarter, and only six so far this year—the worst showing since 1977.

That doesn’t mean there aren’t promising startups poised to go public. According to IPO expert Renaissance Capital, the global pipeline is ready to burst. Some 190 companies have IPO filings with the US Securities & Exchange Commission, and a substantial number have filed in other countries as well.

Exits blocked

The world’s current financial woes have put a damper on acquisitions too—blocking yet another avenue for venture capitalists to recoup their investments. This year has seen fewer than 200 mergers, compared with 359 in 2007 and 369 in 2006. Valuations are also way down: this year’s deals with disclosed valuations came in at a mere $11.3 billion, nearly one-third the $28.4 billion of 2007’s deals with disclosed values.

And without exit strategies, the whole venture-funding game comes to a screeching halt.

Startup funding is still trickling through, though, particularly for later-stage companies. Nonvariant, a Silicon Valley provider of GPS-based industrial guidance systems, recently won US $40 million in funding in a round led by Investor Growth Capital. Silicon Valley widget maker RockYou secured an additional $17 million in investments from Softbank and others. Sweden’s Replisaurus won more than $9 million from Noble Venture Finance to integrate its clean chip packaging technology into high-volume manufacturing. And Sunnyvale, Calif.-based security and network infrastructure startup Palo Alto Networks attracted $10 million in third-round financing from JAFCO Ventures, JAIC, and Northgate Capital to increase its market presence and achieve profitability.

Late-stage funding

With no exits in sight, venture capitalists have no choice but to keep feeding their current investments, playing a waiting game until the IPO and merger picture brightens. “Should the current situation be prolonged into 2009, we can expect fewer new investments by the venture industry as they will need to spend their time with these later-stage companies that are waiting to go public or be acquired,” warned NVCA President Mark Heesen in a statement.

In order to understand when the IPO market will open up again, Renaissance Capital analysts searched for answers in the 1973-74 US recession, when the IPO market also ground to a halt. In that situation, the activity dried up following a long period of negative IPO returns, and came back only after an equally long period of positive returns. In 1974, there were only nine offerings, all of them in the first half of the year.

According to Renaissance Capital, IPO activity and returns were strong from 1970 to 1972, soured in 1973, and continued to be flat through 1976. However, the following year they rebounded and kept performing well through 1980. In addition, this period produced some of the most powerful IPO returns. Tandem Computer’s 1977 IPO, for example, generated a 30 percent first-day spike and a 260 percent three-year gain. Cray Research’s 1976 IPO yielded a 29 percent first-day spike and a 63-percent two-year increase.

March 2009 rebound

Renaissance Capital analysts predict a similar bounceback by March 2009 at the latest, fueled by companies’ pent-up demand for capital. Such a bounceback, they note, doesn’t require a strong overall stock market. But it does require realistic pricing of offers and startups with solid stories.

“Right now, private equity, venture capitalists, and management teams are anchored in a prior valuation reality and refuse to face the facts,” wrote Renaissance analysts in their report. “They are like homeowners who are stuck emotionally on getting 2006 prices in a 2008 market.”

It bodes well that the sole US IPO in the third quarter was a technology company. Rackspace Hosting’s $187.5 million Aug. 8 IPO priced at $10 per share. They may well spike after the predicted bounceback. But for now at least, shares of the San Antonio, Texas-provider of website development and computing-as-a-service are trading at half their opening level. CW (September 2008)