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Stormy Seas: Why IPO?

With last week’s IPO by Chinese Internet video company Tudou (disclosure: my firm, GGV Capital is an investor) and the previous week’s IPO by Carbonite, I”ve been asked by quite a few people “Why would a company go public in such a brutal market?”

It is indeed a very rough market.  Extremely volatile.  A lot of uncertainty around the world.  Huge concerns about the US economy and a lack of any real progress on employment in the last few years.  Investors are nervous.  Nervous investors make for rough markets.  At least ten IPO’s were pulled in the last two weeks.

So why are companies still going public?  And what about the companies that went public in the last few quarters and are now riding some very choppy seas (we’ve had 11 of our portfolio companies complete public offerings since January 2010, and it’s been a rough ride for many).

Here’s the short answer: going public is another mechanism for raising growth capital for good companies.  A company puts significant growth capital on its balance sheet and is able to begin establishing a track record with public market investors.  For existing shareholders and management who aren’t selling any shares in the offering, the price of the offering is important (because they incur dilution), but not as important as where the company’s stock is trading 12-36 months later.  And, as my partner Glenn Solomon pointed out in his excellent article in VentureBeat “Why Today’s Hot IPOs Aren’t Always Tomorrow’s Stock Market Darlings,” the near term price of an IPO has little to no correlation with where the stock trades in the future.

I remember when Rackspace (NASDAQ: RAX) went public in August of 2008.  There was no IPO market to speak of at all.  Zip/zero/zilch.  In fact, not a single venture-backed company had gone public the quarter before Rackspace began trading, and Rackspace ended up being the only venture-backed IPO within the March ’09 – March ’10 twelve month period.

RAX launched its IPO on August 7th, 2008, promptly “tanked” (Fortune’s words, not mine), and kept going down from there (you may recall, we had one of the largest global financial crises in history in the Fall of 2008).  As you can see from the chart below, it traded all the way down to $4.50.

But – the company put $187M on its balance sheet for growth.  And, it was an emerging market leader with great business fundamentals.  As you can see from the chart, RAX delivered for its shareholders quarter after quarter, eventually rising approximately 10X from its lows a mere 32 months later.  That’s right – shareholders who bought RAX at the lows made an unbelievable return, and even those who bought at the IPO price of $12.50 made 3X+ on their money (if they held).  RAX has traded down a bit in the past few months, but still sports a $4B market cap and is a recognized leader in the hosting and cloud computing industries.  Its employees, management and early shareholders have been generously rewarded.

Not every IPO becomes a Rackspace.  It takes phenomenal execution as a public company to grow revenue from $300M to more than $1B, as Rackspace has.

So – to answer the question – you go public in a choppy market because your business has strong fundamentals that investors will buy into regardless, you raise important growth capital, and begin establishing a track record as a public company.  Worry about the share price down the road.  The market typically rewards companies for great performance over time, and management, employees and shareholders benefit.

(Disclosure: I have owned shares of Rackspace in my personal account for several years, and GGV is a shareholder in Tudou)

4 Responses

  1. outstanding blog! really thoughtwell and well-articulated points

    raising growth capital is important beyond words, and while valuations may fluctuate, it is essential to get good companies fuel to grow, and another point worth mentioning is that raising $ in poor conditions generally means competitors are not raising $, so companies can build their moats wider and deeper – get talented programmers, managers, operators, launch networks, build alliances, get beta testing going, improve next generation products and services, all while competitors are sitting on their hands. The initial raise matters more than the following 6-12 months of mkt fluctuation which mostly is beyond mgmnt’s control.

  2. Strong insights Jeff. For true growth cos, going public should not be an exit strategy or liquidation event, and when viewed as such by execs or investors (INSP ahem) they often fail. But “quiet” IPOs by teams with a track record for sucessful financial engineering via the public markets – these can be ones to watch.

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