Tech Start-Ups Shifting Strategies as Public Markets Cool
Are Orange County IPOs now DOA?
Uncertainty over the future of tech stocks is tightening the spigot on public capital, leading many observers to advise companies hoping to perform today’s corporate rite of passage,or even raise money in follow-up public offerings,to file a backup plan instead.
Two of the first casualties are biotech firm Interpore International Inc., Irvine, which called off a secondary offering of 4 million shares this month, and Internet services company Nexgenix Inc., Irvine, which withdrew an IPO it had hoped would raise as much as $57.5 million.
Nexgenix officials wouldn’t comment for this report, but most observers say stock market conditions would make it nearly impossible for a money-losing operation to spark investor enthusiasm. Nexgenix, which lost $171,000 last year on sales of $32.4 million, planned to use the IPO proceeds to pay down debt, provide working capital and make capital improvements.
Experts say companies that went public only a few months ago,such as online computer seller Buy.com Inc., Aliso Viejo, and low-cost PC maker eMachines Inc., Irvine, whose share prices have tanked in recent weeks,probably would have to deep-six IPO plans entirely in the current market.
“We’re seeing a relatively dramatic effect,” said Mike Quain, senior vice president and manager for Imperial Bank’s Orange County emerging growth division. Quain said more early-stage companies are asking for bridge funding as they hold out for a better environment for public offerings. He added that he’s noticed stirrings of increased activity that would indicate more mergers and acquisitions, a natural result of reduced IPO activity.
Once Darlings
A darling of the long-running bullmarket, the IPO vaulted to new prominence when Netscape Communications Corp. shares doubled on their first day of trading in late 1995, setting a precedent for new economy firms that continued almost nonstop until a few months ago.
With the hammering that tech stocks have taken since March, tech IPOs have become more dicey propositions, with several posting only single-digit gains or actually falling in their debuts. Last week, chip maker Integrated Circuit Systems Inc. followed suit, opening at $13 to close at $12 in its first day of trading.
“The only companies that are still even on the shelf are the broadband infrastructure firms,” Quain said.
One of those is Flashcom Inc., a Huntington Beach provider of high-speed Internet service bucking the trend by filing for a $125 million IPO, even after losing $32.8 million on sales of $8.4 million last year. Officials with the company say they expect market conditions to improve by the time shares begin trading.
And last week Irvine-based Lantronix Inc., which makes small devices that manufacturers can use to make their products Internet-ready, filed for a $115 million IPO. Unlike Flashcom, Lantronix is profitable, earning $2.8 million on sales of $33 million last year. The company plans to use the money for research and development and possible acquisitions.
Even if the immediate outlook improves, the longer-term effects of a cooled IPO environment could be more consequential.
The go-go environment of the late ’90s allowed many startups to lure workers with stock options and the tacit promise that the company’s eventual public offering would bring instant riches.
“Some of the people most who might be most seriously affected are the employees who were granted stock options at IPO prices and are finding that lock-up provisions are basically giving them worthless options,” said Jerry Kalman, founder and chief executive of ocstox.com, a Web site that focuses on Orange County firms. “Employees are definitely looking at opportunities outside of those companies, so you’re going to see a brain drain.”
Other Roads to Take
Though Kalman said there always will be companies lining up to go public, the process won’t be as inevitable as it has been for Internet-related firms.
Historically, IPOs have risen in the range of 10% to 20% in initial trading. As the Internet sector’s abnormally spectacular returns and corresponding valuations fall back to earth, observers expect fewer companies to see an IPO as their best option.
Companies that can’t muster an IPO usually have several options: they may pursue adiitonal rounds of financing, undergo a so-called reverse merger (which involves buying an already-public company and trading under those shares), being acquired, or buying out another company that is flush with cash but has few business prospects of its own.
While a muffled IPO environment might come as a disappointment to some, it’s a sign of a more rational market, according to Fred Poska, partner in charge of Deloitte & Touche’s Orange County high-technology group. Instead of frantically investing in any and all dot-coms to avoid being left behind by the Internet revolution, investors now are showing better judgment, Poska said.
“A lot of the Internet companies that have gone public have very little revenues and big losses. Traditionally, you couldn’t get companies public with that kind of profile,” he said. And like other maturing industries, he said, the tech market will continue to forge ahead after the frenzied parade of IPOs has passed.
Mike Dewey, founder and chief executive of Web site design firm eBuilt Inc., said fewer IPOs could level the playing field for growing companies like his that do not plan to go public. Though Dewey has not taken on outside funding yet, he isn’t ruling it out and concedes that stifled valuations could make it harder to assemble an attractive deal.
“There are a lot of ways to create shareholder value, and only one of those is an IPO,” he said. “That expectation is created by executive management, and anyone who told their employees or shareholders it would absolutely happen is taking a credibility hit right now. I’m one of the few who actually likes what’s going on in the market right now.”
Still, that could be cold comfort to the investment banks, accountants, lawyers and other service providers that have profited handsomely from a bustling IPO market.
Poska predicted that old-line businesses, which largely have sat out the dot-com party, will begin scooping up the younger dot-coms to acquire their technology and web savvy.
“The fundamentals of the market are still pretty healthy, and there’s a lot of good technology being developed,” he said.
Kalman, of ocstox.com, agrees.
“I suspect that companies with good roll-up strategies are out there licking their chops,” he said. “They’re waiting out there in the bushes, taking a second and third look at some of these fallen angels and seeing excellent opportunities for creating a new business out of the rubble.” n
