January 12, 2007

Do we need more IPOs?

(c) copyright, View From Silicon Valley, 2007.  All rights reserved.



There is a fresh graph floating around claiming there is a "shortage" of equities available to buy.  It implies share buy-backs and LBOs are significantly reducing the pool of stocks available.  Supposedly big pension funds and so forth need more stocks to be made available.

Let's ignore, for the moment, studies showing buy-backs are mainly used to "fund" employee options.  A large percentage of buy-backs do not actually reduce the float but rather reduce the pace of dilution caused when employees exercise options.

The scope of today's point limits our ability to detail the fat fees LBO firms pocket on the alleged basis they "help" companies whose shares weren't going up at the desired pace.  Hopefully, someday somebody will document the public company managements' conflicts of interest in some of these deals...

Today's point isn't focused on the "shortage" argument.  Suffice it to say this argument was last heard during the latter stages of the dot-com boom during late-1999 and into 2000.

The preferred "solution" to this so-called "shortage" is, of course, more IPOs.  The local paper, news radio and even Business Week are speculating 2007 will see a bumper crop of IPOs, especially tech IPOs.

Let's talk about IPOs.

Make no mistake.  We have no problem with a lot of money getting pumped into the Silicon Valley economy --even when none of it is going directly into our pockets.

Today's point (yes, yes, you hoped there would eventually be a point) is two-fold.  Let's discuss:

1) Are more IPOs be a sign we have a lot of growing companies? Would IPO money be used to help these companies grow faster?  (And add jobs?)
 
2) Most importantly to those of us on the outside of these deals, are IPOs a good investment?

Since we still don't own Tahiti, it must still be true that nobody can predict the future.  Lacking this skill, let's instead examine recent IPOs.

Conveniently, the local paper recently published a table with actual facts on this exact topic.  (Someday they may learn to quit giving us ammunition):

Company           Date     Price   Raised  Change
Smart Modular   02/03/06   $9.00   $184M    +58%
Cardica         02/03/06  $10.00    $35M    -54%
Alexza Pharm.   03/08/06   $8.00    $44M    +34%
Nextest Sys.    03/22/06  $14.00    $76M    -34%
CPI Int'l.      04/28/06  $18.00   $127M    -17%
Techwell        06/21/06   $9.00    $50M    +84%
Shutterfly      09/29/06  $15.00    $87M     -7%
eHealth         10/13/06  $14.00    $70M    -12%
Globalstar      11/02/06  $17.00   $128M    -21%
Hansen Med.     11/15/06  $12.00    $75M     -5%
Affymax         12/15/06  $25.00    $93M     +0.5%


So let's see... 11 IPOs with four winners and seven losers.  One of the "winners" was only up 0.5% while all the losers were down at least ten times that amount (i.e., -5.0%).

Smart Modular was the biggest IPO in dollars and in terms of dollars gained after the IPO.  Interestingly, a large portion of the funds raised in SMART's IPO was used to cash out insiders instead of being put to use towards growing the company.

According to the local paper(*), in addition to collecting $6M in "transaction fees" and a $1M per year "advisory fee," the investors sold 9M of the ~20M shares and collected an extra $9M, "for terminating their annual advisory agreement."

SMART Modular itself collected only ~$76M of the $184M raised (41%). Nearly 60% of the money went to the "players."  Their $76M was apparently not enough since SMART plans to soon dilute current shareholders with another 12.5M shares, as the investors dump more of their stock.

Looking at SMART's actual company results:

Fiscal-Q Sales     Gross Profit  GAP Earnings
1FQ06   $158M       $30.6M     --not reported--
2FQ06   $164M       $29.7M        $0.01
3FQ06   $189M       $32.7M        $0.07
4FQ06   $197M       $33.5M        $0.19  <---??
FY06    $707M      $127.0M        $0.55  <---??

Wouldn't you like to understand, without spending hours in their financials, how three public quarters yielded $0.27 but the "missing" quarter (when Smart was still private) magically accounted for $0.28 in GAAP earnings?  Or how a profit gain between the 2nd and 3rd quarters of only $800K yielded a $0.12 earnings increase? (BTW, $0.12/share times 59M shares outstanding implies a $7.1M profit gain, nearly 9x the reported $800K profit gain.)

Proving once again we know nothing about investing, the stock is up 58% since the IPO.

Smart is probably not the only IPO where chunks of the funds went to the managers instead of into operations.  Unfortunately, free newsletters like ours don't have the bandwidth to ferret out all the gory details.

Undaunted, let's slice the IPO data another way:

Company          Date    Raised  Change  Value-Change
Smart Modular  02/03/06  $184M    +58%     $106.7M
Cardica        02/03/06   $35M    -54%     -$18.9M
Alexza Pharm.  03/08/06   $44M    +34%     +$15.0M
Nextest Sys.   03/22/06   $76M    -34%     -$25.8M
CPI Int'l.     04/28/06  $127M    -17%     -$21.6M
Techwell       06/21/06   $50M    +84%      +42.0M
Shutterfly     09/29/06   $87M     -7%      -$6.1M
eHealth        10/13/06   $70M    -12%      -$8.4M
Globalstar     11/02/06  $128M    -21%     -$26.9M
Hansen Med.    11/15/06   $75M     -5%      -$3.8M
Affymax        12/15/06   $93M     +0.5%     +0.5M

The IPOs cumulatively raised $969M but the net gain was only $52.4M, or +5.4%.  That's a better yield than a CD or T-bill, but not by much.

If you had bought $10K of each IPO (assuming us peons are now able to buy IPOs at the open), your $110K would be up only $2,650, or 2.4%.

If you waited until mid-year and are trying to ride these repeated "all time highs" in the DOW, you would only have participated in the last five of 11 IPOs.  Those five IPOs would have you down -$4,450, or -8.9%? In the face of all these new highs?!??

Maybe now it's clear why managements are busy dumping their own stock?

Conclusion:
Don't buy into the "spin."  There is NO shortage of stocks.  The "market" doesn't need more IPOs.

Insiders are taking such large chunks of funds being raised for themselves that you have to ask if the companies really "need" all the money being raised.

Results from 2006 Silicon Valley-based IPOs show investors aren't making much money.  (Unless, or course, you're an insider.)

If there is a gusher tech IPOs coming out in 2007, they will hit the market without any of our hard-earned money.