Tech IPO market is frothy but not yet bubblyOctober 15, 2013: 9:20 AM ET
This year is shaping up to be the busiest for IPOs since 2007. There are some sound investments to be made in tech IPOs, the trick is separating them from the flashes in the pan.
By Kevin Kelleher, contributor
FORTUNE -- Earlier this year, I wrote that the sluggish tech IPO market in the first quarter of the year (four companies raising $221 million) presaged a bleak year for tech offerings in 2013. Boy, was I wrong about that. Others argued that economic concerns were temporarily holding back IPO candidates and that a bumper crop of them would emerge in the second half of the year, and this is indeed what has happened.
According to Renaissance Capital, 165 companies have gone public on U.S. markets, an increase of 45% over the same period in 2012. We still have 11 weeks to go in 2013, and the year is shaping up to be the busiest for IPOs since at least 2007, when 213 companies went public.
Nearly a fifth of those IPOs are tech companies -- most with software-based business models and all debuting with valuations below $3 billion. None of them are exactly household names like the upcoming Twitter IPO or past giants like Facebook (FB), Groupon (GRPN), or Zynga (ZNGA). But those better-known stocks are showing growth -- especially from their mobile business -- that are drawing interest into many of the new tech listings.
The IPO class of 2013 is largely comprised of small or mid-sized companies. The biggest among them raised relatively modest amounts. Tableau Software (DATA), a data-visualization software company, raised $254 million in May. CDW (CDW), a reseller of IT products to small businesses and others, raised $429.5 million in June. And FireEye (FEYE), a network-security company, raised $304 million last month.
Compare those to some of the biggest IPOs of the year in other industries, like Pfizer (PFE) spinoff Zoetis (ZTS) or energy company Antero Resources (AR), which raised $2.2 billion or $1.6 billion, respectively. Or Facebook's $16 billion in proceeds, the third-largest of any U.S. IPO.
The debut of Tableau seems to mark a key turning point for IPOs this year. Tableau originally filed to sell 7.2 million shares between $23 and $26 and ended up offering 8.2 million shares at $31 a share. The stock has since risen 115% over the past five months.
Before Tableau, according to Renaissance, seven tech companies had ventured out into the public market in 2013. All of them are trading below their offering price, as much as 39% down in the case of revenue-management software company Model N (MODN). The only pre-Tableau IPO to perform well in the market is Rally Software (RALY), a cloud software company that has seen it stock rise 108% since its offering.
Since Tableau, 22 tech companies have gone public. Of those, all but three have seen their stock prices rise. Another four have seen their stock prices more than double: ecommerce platform ChannelAdvisor (ECOM), project management software maker Textura (TXTR), ad-network Rocketfuel and FireEye.
There are a few reasons for that overall strong aftermarket performance. One is that Tableau, a financially healthy and growing company, showed that a mid-sized tech deal could receive a warm welcome amid the economic uncertainty that plagued the first half of the year. The other is that Facebook and other listed web companies reporting second-quarter earnings showed that software and Internet shares are entering a period of mobile-driven growth.
Another reason may be that tech IPOs have historically enjoyed a honeymoon period when their stocks rise for several weeks before sinking down slowly (12 of the 30 tech IPOs this year have debuted since early August). For example, Benefitfocus (BNFT), a cloud-based enterprise software company, went public at $26.50 a share last month, then rose as high as $55.87 a share in its first week of trading before falling as low as $37.32 last week.
Similarly, Control4 (CTRL), a maker of home-automation software, debuted at $16 a share in early August and surged to $24 in a matter of days. It has since fallen as low as $15.53 a share last week. Still others, like CDW and video-ad network Tremor Video (TRMR) are faring well in the public market but only after lowering their offering prices from the original range.
That honeymoon period can be misleading. According to the Wall Street Journal, tech IPOs as a group are seeing their strongest first-month performances this year since the dot-com days (although the first-month pops back then were much bigger than they are now). Even more worrisome from a historical perspective, two-thirds of the tech IPOs in 2013 lost money in the previous 12 months.
We are still nowhere near the regrettable and blind investing in tech IPOs that drove the dot-com bubble. The real picture is more complex. We are neither in the IPO drought that some (including me) wrongly predicted. We are seeing instead a steady flow of smaller companies with promising businesses, but too often with no profits to show. There are some sound investments to be made in tech IPOs, the trick is separating them from the flashes in the pan.
Update: An earlier version of this story said the CDW raised $395 million in its IPO. It raised $429.5 million.