IPO Market for Sub $500 million Cap Companies: Hot or Not?




Dan Primack posted an article in Term Sheet last week titled Yelp This: IPO Market Is Killing It. Several well informed observers of the capital markets, including me, strongly disagree with the assertions in that post that lead to the following conclusion: “What we’re seeing in terms of IPO ebbs and flows is about momentum, not structure.”

In my view, it is all about structure– the U.S. equity capital markets for emerging growth companies with market capitalizations below $500 million are structurally broken and systemically dysfunctional.

Responding to these comments in a new post on Monday November 14, IPO Worries Put to the Test This Week, Dan reasserts “my belief that the death of small company IPOs has been greatly exaggerated.” Several readers, including me, again took Dan to task on this because we believe his facts are erroneous.

Dan’s second post did make it clear that there is considerable confusion over the relevant metrics to determine the health of the IPO market for small cap companies.  To wit, Dan used the following examples to make the argument that all id well in the land of underwriting IPO’s:

‘Well, this week may put that complaint to the test. Clovis Oncology is set to price a $160 million offering, despite having a whopping $0 in revenue. Also on the docket is Lashou Group, which only reports $16 million in revenue for the first nine months of 2011. And InterMolecular, with $26 million through the first nine months of 2011. And, just to be sure this isn’t a one-week trend, pre-revenue BioAmber today filed for a $160 million offering. Maybe this week’s low-rev companies don’t price. Or maybe they do so, but only with massive insider support. But, on the other hand, what if they do price with outsider support. In that case, what say you dissenters?’

While I commented again on Dan’s article on Term Sheet, below is a more extensive response with additional facts:

To be very clear, the central issues behind the systemic dysfunction in the U.S. equity capital markets for emerging growth companies are not the current revenues of companies filing to go public or their current profitability levels—the core problems for U.S. securities regulators, investors, and entrepreneurs are (1) the steadily increasing absolute size of the offerings itself; and (2) whether or not the companies raising the public market capital are U.S. companies that will create new jobs in the U.S.

The small growth company is widely recognized as creating new jobs, and, in America, over the past eleven years we’ve witnessed the capital markets death of one of the great job-creation mechanisms in the United States, the sub-$50 million IPO. Between 1991 and 200 80% of IPO’s raised $50mm or less.  Today, the threshold for liquidity demanded by institutional investors requires $100mm plus for an IPO.  And this isn’t just a venture capital problem—this is a major problem for the American entrepreneur—since 1991, 47% of all U.S. IPOs were neither VC nor PE backed.

Why should you care? Because the following list of companies, which were all venture-backed, went public raising less than $50 million at various times between 1971 and 1996: Adobe, Applied Materials, BMC Softare, Computer Associates, Dell, Electronic Arts, Fiserv, Intel, Paychex, Symantec, Intuit, NetApp, Oracle, Western Digital, Xilinx, and Yahoo! These companies raised just $367 million in the public markets, and they account for 470,000 U.S. jobs today. Adjusted for inflation and measured in 2009 dollars, the $367mm in total dollars raised by this group equals $670mm, and only 2 of these 17 companies’ IPOs (EMC $80mm and Oracle $70mm) exceed $55mm in 2009 dollars. While todaythese companies are household names, let’s not forget that they were unknown small cap growth companies when they first went public. How many companies that represent the next generation of household names will be still-born or acquired into obscurity because they cannot access the public capital markets today?

Your sample of companies is perfect in illustrating these points:

Lashou           Chinese company raising ADR’s in U.S. $70mm offering.  No U.S. jobs here.

Clovis Oncology       $130mm offering from latest news report- and note that Life Sciences companies have a completely different business model from IT companies as the public round is typically another “interim R&D” type of financing on the long road to commercialization.

InterMolecular        $120mm -$140 million, reduced from original offering size based on latest news report.

BioAmber                 $150 million offering

To summarize:  actions need to be taken by securities regulators in the U.S. to restore sufficient post-IPO market liquidity and ongoing research coverage for U.S. based companies to be able to successfully raise less than $50 million in an IPO at a market capitalization of $500mm or less.  That will not happen unless it becomes economically sensible for market makers and research analysts to be involved with such companies.

For more background and facts on this topic, please refer to :

http://www.levp.com/cat-bin/filexfer/show/032410_ICAP_Ocean_Tomo.pdf?artist_id=365&folder=news_attachments&file=032410_ICAP_Ocean_Tomo.pdf

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