TCS Daily


Irrational Public Offerings

By Dominic Basulto - December 12, 2003 12:00 AM

With the Nasdaq up nearly 40% in 2003, speculation is already rampant about which technology companies will have splashy IPO debuts in 2004. There's Google, of course, as well as a handful of Internet high-fliers such as Orbitz, Salesforce.com and Blackboard that are often mentioned as the prime candidates to break open the IPO logjam. Almost without exception, these companies are profitable with proven business models. However, there are also a number of unprofitable (albeit fast-growing) Internet companies that are knocking on the IPO door in the hopes of capitalizing on the sudden enthusiasm for technology stocks. Moreover, a number of companies, languishing in the portfolios of venture capitalists for years on end after squandering tens of millions of dollars, are suddenly being mentioned as prime IPO candidates. The risk, of course, is that these lower-quality issues will shunt aside the higher-quality issues and stunt any long-awaited recovery in the IPO market.

Quite simply, any recovery in the IPO market will only occur if bankers and venture capitalists continue to bring high-quality issues to market. However, long-suffering investment bankers (eager for underwriting fees) and venture capitalists (eager for liquidity events) are already showing signs of capitulating to the basest of human instincts: greed.

 

Take the example of Wine.com, which landed $5 million in VC financing in early December. As any casual observer of the Internet boom knows, Wine.com absorbed over $200 million from Napa Valley-inspired VC investors in the hopes of selling wine over the Internet. By 2001, the company was considering a bankruptcy filing, and it looked like the market for online wine retailers was finally dying a slow death -- just as the market for online pet food retailers (Pets.com anyone?) died a deserving death. Yet, investors were not willing to walk away -- they noticed that RedEnvelope.com (an online luxury goods retailer) had earlier filed for an IPO. Moreover, they noticed that ProFlowers had recently changed its name to Provide-Commerce (in an attempt to position itself as an "e-marketplace for perishable goods") and had also filed with the SEC for an IPO deal. So, why not re-capitalize Wine.com with another $5 million in equity and $3 million in debt and re-position the company as a luxury gift basket retailer? That's exactly what happened -- and now the company is floating an IPO trial balloon.

 

In addition to these failed dot-com plays of the late 1990s, there are a number of other speculative plays on the table -- such as the Chinese Internet stocks and the biotech stocks. Chinese online gaming firm Shanda Networking is preparing a $300 million IPO for early 2004; in addition, Chinese instant messaging company Tencent (no relation to rapper 50 Cent) is mulling over an IPO. In October and November alone, seven companies in the life sciences sector (biotech + health care + pharmaceuticals) went public -- but only one (Genitope) is still trading above its offering price. Moreover, a number of companies that don't need the money -- such as Dolby Laboratories -- are suddenly being encouraged to test the IPO market. Already, market insiders are warning of "bubbles" and "bubbles within bubbles" (whatever that means).

 

Consider the way that "hot" New York City nightclubs succeed -- nightlife impresarios build hype for a new establishment, and then rely heavily on party promoters to invite only the "right" people (the A-list). Some night clubs would rather go empty, rather than let in the "undesirables." That's the whole point of the velvet rope in front of these clubs -- to create impossibly long lines and generate even more buzz and hype. After all, what would happen if, heaven forbid, an A-list patron might encounter a ne'er-do-well inside the club? The nightclub would lose its buzz, and the ever-fickle in-crowd would find new ways to spend their time and money.

 

The IPO market works in the same way -- the promoters and bankers put together an A-list of the best companies, create buzz, and then set up the velvet rope. Unlike nightclubs, however, there are no bouncers to keep out the undesirables. (Well, there's the 'invisible hand' of the marketplace, but that's a pale comparison to the 'visible' hand of a burly 300-pounder with tattoos) Without a bouncer to keep an orderly flow of companies into the market, the IPO market will quickly fill up with a lot of B-list and even C-list companies that had a hard time going public even during the Internet mania of the late 1990s. Wait until the Google IPO -- that's when things will get interesting. Let's hope that investors continue to press for only the highest-quality new stock offerings and that the invisible hand of the market restrains many of the most speculative new issues.
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