Is the time right for your company to jump on the IPO bandwagon? Here are a few factors to bear in mind when making your decision.
Anyone who has picked up a newspaper or turned on a television within the past year has taken note of the meteoric rise in the value of Internet stocks. They have become the darlings of Wall Street and have made millionaires (and in several cases, billionaires) of many of the investors and employees of these companies. Investors have apparently accepted the belief that the Internet will forever change the way we work and live and, in the process, create great opportunities for wealth.
What has received less public attention is the dramatic rise in photonic stocks during the past six months. Here, too, the Internet can take some credit. As has been reported many times in Lightwave, Internet traffic has been increasing by well over 100% per year; while some carriers have reported a tenfold annual increase in backbone traffic.
This demand has brought photonics to the attention of Wall Street, as investors have recognized that photonic technologies have become key enablers for the growth of the Internet. As of May 14, the stocks of CIENA, E-TEK Dynamics, Harmonic, JDS FITEL, SDL, and Uniphase have risen an average of 335% since November 1, 1998. During this same time period, the Nasdaq stock index rose less than 57%. With such great sector performance behind them, private photonic companies are increasingly asking themselves, "What are the potential benefits of taking my company public, and is now the right time to do it?"
Providing a means for investors and company personnel to realize significant monetary benefits from their investment and accessing another source of capital are the most often-cited motivations for taking a company public. However, there are many other issues to consider when contemplating this step, including:
- Liquidity: The market offers an environment in which company stock can be readily bought and sold. Without such an environment, it can be extremely difficult to exchange the shares, which thereby limits their value. The added liquidity makes the stock more attractive to investors, as well as current and future employees, and provides some reassurance to customers that the company is "real."
- Recruiting: In today's high-tech industries, career opportunities abound and personnel with the appropriate technical skills are in short supply. Thus, attracting and retaining skilled employees are extremely difficult. This factor, combined with the lowest jobless rate in nearly 30 years, makes recruitment more difficult than ever. The ability to offer options on a liquid stock is often used as a strategic asset to attract new employees and retain existing employees.
- Mergers and acquisitions: Improving a firm's strategic position in its market via acquisition has become a standard tactic in an environment where time to market is a key concern. By becoming a publicly owned entity, a company strengthens its ability to engage in mergers and acquisitions in two ways. First, the cash generated by a public offering becomes a form of payment whose worth is not subject to the gyrations of the stock market. Second, a public firm's stock itself also becomes a more universally accepted form of payment. While private companies are certainly free to use their stock for such purposes, the liquidity of publicly traded stock makes the use of this stock as payment less risky, and therefore more valuable, to the recipient.
- Marketing: Becoming a public company is a great way to gain access to "free" marketing. A rapidly growing public firm attracts the attention of financial research analysts, who then issue reports to investors. The perceived excitement of the photonic industry in particular has been catching the attention of major financial newspapers, magazines, and television broadcasters. Chief executives are granted interviews and quoted everywhere from the Wall Street Journal to CNBC. This attention not only increases a firm's visibility within the financial sector, but also serves to promote the company to potential customers and partners, some of whom may want to share the limelight.
While there is no set criteria for determining whether a company should go public or what will determine the success of an initial public offering (IPO), there are a number of aspects of a company that investors and analysts often look for, including:
- Experienced management: Simply stated, a company is only as good as its management. Investors would like to see a management team that has experience at both running a company and addressing the challenges facing a company undergoing rapid growth.
- Differentiated product/core competency: Investors want to see that a company is offering something that is unique within the industry. Simply offering a product or service already available but with a marginal performance improvement or price reduction is likely to generate little interest. A differentiated product or service that offers significant competitive advantages for customers is critical.
- High barriers to entry: Similarly, offering a product that can be quickly produced or offered by competitors (should the market grow large enough to attract competitors) will offer little appeal.
- Significant revenue growth: One misconception regarding profitability tends to be consistent. A company does not need to be currently profitable to have a successful IPO, and Internet stocks are a current and extreme example. While profitability is attractive and ultimately what every investor desires, investors are willing to buy into the future profitability of companies with differentiated, well-positioned products in high-growth markets. The relevant parameters are revenue and especially revenue growth rate. While there are no set rules regarding the minimum annual revenue required for a public offering, $20 million is a reasonable nominal number if the revenue growth rate is substantial.
- Rapidly growing markets: Analysts would like to see that a company's target markets have plenty of room for significant growth.
- Blue-chip customers: High-quality reference customers add a great deal of credibility to a business in the minds of investors.
- Knowledgeable, respected investors: One often-overlooked parameter is the current investors. Though not necessary, having noted venture capitalists with a successful track record listed among a company's investors offers credibility for the firm and can influence the investment decisions of portfolio managers during an offering.
- Lack of customer concentration: Ideally, a company's revenue will not be dominated by any one customer. But given the limited operating history that many IPO candidates have, there are often exceptions to this ideal. For example, at the time of CIENA's initial public offering, nearly 100% of reported revenues were derived from the sale of products to Sprint Communications. Nevertheless, a diversified customer base offers some security for future revenues from an investment standpoint and will help a company's valuation.
- Attractive sector: Being part of a hot sector is always beneficial. As the saying goes, "A rising tide raises all boats."
Entering the public markets can be a pivotal move for the growth of any company. There are many factors to consider, including the prospects of having to manage a business on a quarterly basis and the added time spent working with analysts and investors. However, the benefits of such a move are numerous and can provide an avenue for the future growth of a company.
Robert Mandra is an associate in investment banking with SoundView Technology Group (Stamford, CT). Previously, he was an optical engineer with MIT Lincoln Laboratory for nine years. He can be reached at (203) 462-7361 or rmandra@ sndv.com.
Kevin Slocum is a managing director and communications research analyst for SoundView Technology Group (Stamford, CT). He has more than 18 years of financial industry experience, including equity research, sales, and analysis. He can be reached at (203) 462-7219 or kslocum@ sndv.com.