I just read a great piece by Mark Cuban about the broader woes of the lack luster returns for IPO's and what it means for business in general. Essentially, he is arguing that recent failures of IPO's have soured the market, causing lower returns which in turns does a number of bad things to the broader economy. Over looking the fact that they are failing to generate the necessary capital and returns for their investors which is bad in and of itself there are some other serious ramifications.
One issue is that competing companies can buy up technology startups at a bargain with a couple possible outcomes expanding their product portfolio or burying the technology. The latter has the very serious side effect of stymieing the development of viable competitors, limiting our choices as consumers and forcing us to pay more for inferior products. I will not name names but I believe that a large provider of office software products is an example of this. They have integrated a number of disparate products and nearly 20 years later haven't improved on them much nor, have they resolved the continuing integration issues but they have consistently raised their prices.
Another issue is that venture capital funds are feeling the pressure. The returns have slowed and investors have been reluctant to invest. I just spoke with a friend who works for a great VC firm who was lamenting that it took several years to close their recent fun and he was exhausted. He went on to say in the heyday it was possible to close a fund in 12 -18 months without a lot of difficulty. Today, it takes twice as long and more than twice the effort. Investors are far more skeptical.
There are some who say that the last really successful IPO was Google and that was nearly 10 years ago. In the 1990's there were a continuing stream of wildly successful IPO's but despite vast improvements in technology it has been nearly a decade since we have seen have seen a home run of an IPO. Why is that? I would argue that the telecom and internet bubble busts at the turn of this century was part of a trend where people became more skeptical of startups and IPO's. A lot of wealth was lost in a very short amount of time and the aura of IPO's being a ticket to sure fire wealth was lost with it. Used to be that IPO's were seen as such a lucrative offering that only institutional and high wealth clients had a real shot of buying at the introduction price. Not so today.
The fact that investors have become more skeptical is a good thing. What has not changed with these times are the exuberance of the firms that underwrite these IPOs and the stock analysts that establish their valuations. Facebook is a great case in point. During the roadshow leading to the offering, analysts were falling all over themselves to establish valuations between $18 and $68 above the offering price. All this despite the company had a CEO that had no experience in public markets and demonstrated some real maturity issues in the business world. Further, Facebook had not demonstrated how to monetize their access to people and their data. Yet, the drum beat of wild enthusiasm continued on up to 48 hours when a major advertiser announced they were cancelling their contract for advertising because they were not seeing the promised benefits. The analysts soldered on trying to brush off the bad news but on the first day of trading Facebook finished substantially below its offering price and continued to drop for many months eventually losing about 50% of its value before turning around. I give Facebook and Mark Zuckerberg a lot of credit for taking the wake up call and working very hard to build a solid business plan and fundamentals.
The other story is Solyndra. They road the tidal wave of enthusiasm for solar to an IPO. Analysts were wildly optimistic about their future. To be sure they had sexy technology and state of the art technology but that was as far as it went. They had lousy fundamentals. Their product could never compete on price. They had better conversion efficiency but a fundamentally expensive and non-competitive technology. Yet, analysts overlooked this fatal flaw and continued to hype the stock and billions were lost. The failure of Solyndra and the fallout from it was seen as the beginning of demise of the investments made in solar. I was told by a prominent VC that today it doesn't matter how promising the idea you have might be, there is no serious money going into solar. I can personally vouch for this statement based on my recent experience trying to raise a 3rd round for a company in that space.
Investors have been burned and they have learned to be cautious. Companies need to do a better job at building fundamentally good businesses and demonstrating good performance. The other part of the story is that the underwriters of IPO's and the stock analysts need to do a better job evaluating the business fundamentals. The need to look beyond the hype and sexiness of the technology and answer the basic questions. Will people or businesses buy it? Will they pay more than it costs to deliver it? Can they make money and are the conditions to make money sustainable? Is the leadership sound and trustworthy? Until the investment community addresses these issues we are likely to see continued skepticism from investors. Further, if we fail to restore this confidence we may lose one of the major growth engines in our economy.
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