Investors Wise Up To First-day Tech 'Pops'
It has been a strong start to the year for technology flotations. Venture capital backers have had their best year for issuance in five years, raising $1.5bn in the first quarter, according to industry figures.
These deals have performed well, also averaging a first-day gain or "pop" this year of 17 per cent. If sustained, that performance would be the best in over a decade, says Dealogic.
Since the start of January, shares of companies that have gone public in the past two years are up 15 per cent, according to the FTSE Renaissance US IPO index. That is the best opening to a year since at least 2003.
The omens do not look promising, however. One warning sign is that shares in many technology or web-based companies that have seen solid debuts in the past year are being sold short by traders, who believe that they priced too aggressively, or have artificially high prices because they floated a relatively small number of shares.
Investors and bankers remain cautious on the wider new issue market in the US. Overall, despite solid corporate earnings, US new issuance totals just $12bn so far this year. Companies are on track to raise the smallest amount since 2003.
That wider sluggishness reflects the broader macroeconomic worries that are weighing on the equities rally after a strong start to 2012. With the S&P 500 index up 10.5 per cent since the start of the year, there are fears stocks could repeat their performance of last year, declining in the second half.
"The secondary market has been incredibly strong, but the new issue market has been uneven," says JD Moriarty, co-head of technology equity capital markets at Bank of America Merrill Lynch. "There has been an open window for high-growth tech companies. The more significant question is, will that window open for non high-growth tech companies?"
The strong performance has also been highly concentrated in a very narrow sector, primarily software groups that have predictable future revenue streams. Of the twelve deals that have priced above their projected price range this year, nine have been software companies, according to Deutsche Bank. That includes Splunk, which analyses large amounts of data for companies, and Bazaarvoice, which measures return on investment in social media.
"Investors are willing to pay strong valuations for companies with high margins and a great deal of visibility. And that is clustered around subscription-based software companies," says Ted Tobiason, head of technology equity capital markets at Deutsche Bank.
But "companies that have heavy customer concentration, or are consumer sales based, are struggling", he adds.
This latter group includes some companies that had enjoyed a strong initial performance, but have subsequently found themselves among the most heavily shorted. Groupon leads the way. It jumped 31 per cent on its first day, but now has 42 per cent of its free-floating shares on loan and sold short, according to Data Explorers.
The online reviews sites Angie's List (up 25 per cent in its first-day trading) and Yelp (up 64 per cent), are also heavily bet against, with 28 per cent and 17 per cent, respectively, of their free floats shorted.
That compares to an average of 3.1 per cent short interest for the S&P 500 and 7.5 per cent for IPOs in the past year. The scale of the shorting has helped keep the market from achieving the over-enthusiasm seen at the height of the dotcom boom more than a decade ago.
"The market is behaving a little bit more rationally than it did in the late-1990s," says Steven Spencer, a partner at SMB Capital, who has been short some recent IPOs. "A lot of retail investors are still not involved in the market, and it's when they got heavily involved in the 1990s that the market started to get frothy," he adds.
Also, the strong average first-day "pop" is being driven by companies selling the smallest percentage of their shares at any point in the last decade. The average float of 37.9 per cent last decade has fallen to 27.5 per cent this year, according to Dealogic.
David Cowden, an analyst at Dealogic, has found a "strong correlation" between small float size, which creates a scarcity and concentrates sales of IPOs only to the most bullish investors, and first-day trading performance.
The best software IPO in 2012 as measured by first-day gain, Splunk, which carries out analysis of large data sets for companies, rose 108 per cent but only sold about 15 per cent of its shares.