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Dot-Com Daze: Why the U.S. IPO Market Isn't Ready to Soar

Facebook! Groupon! Zynga! Hot companies are lining up to go public, with LinkedIn the latest to join the IPO queue. Is dot-com fever back?

Don't dust off those stock options just yet. True, the number of U.S. IPOs surged in 2010, with 154 startups going out, compared with 63 in 2009 and 31 the previous year. The amount of money raised also rebounded, while investor returns also rose after bottoming out at a dreadful -33 percent in 2008.

Yet by some measures, fewer companies are going public than might be expected three years after the bottom fell out of the market. More important, the IPO sector is fundamentally different than it was during those days of irrational exuberance.

And unlike during the Internet boom, when U.S. startups drew the lion's share of venture capital, domestic IPO activity is largely driven by investor demand for companies in emerging markets. Chinese startups constituted more than a third of the VC-backed IPOs last year, for instance. Notes Renaissance Capital analyst Paul Bard:

Excluding the Chinese venture-backed IPOs, the domestic VC activity was solid, but not quite back to normal. The 40 US-based venture-backed IPOs fell short of the 50-70 deal levels seen in the 2004-2007 period.
Emerging-market IPOs also proved a good bet for investors, highlighting the growing importance of overseas markets for startups thinking of going public. The country seeing the greatest bang for the buck? Brazil, with average returns of 40 percent. IPOs in Latin America led the way in performance, delivering returns of 28.4 percent. That topped the 28 percent return for IPOs in North America, 27 percent in Asia-Pacific and a relatively meager 18 percent in Europe, according to Renaissance.

Here's how much the global center of gravity has changed for IPOs. North American companies accounted for only 16 percent of total proceeds in 2010, which Bard notes is the lowest ever (click on adjoining chart at right to expand).

Another difference is who's bringing the biggest deals to market. While VCs chalked up the biggest hits (and misses) during the boom, private equity firms recently have accounted for the biggest IPOs. Buyout shops accounted for seven of 10 largest IPO in 2010, including GM, the third-largest offering in U.S. history.

The focus on giant IPOs is also somewhat deceptive. Goldman Sachs's (GS) investment in Facebook shows that top startups can raise vast sums without going public. As venture capitalist Robert Ackerman, founder and managing director of Allegis Capital, noted last year in citing two other highly publicized startups expected to launch IPOs:

Companies such as Facebook and Twitter Inc. will likely go public at some point at enormous valuations and create a big stir, but they, like Tesla, are clearly the exceptions. There have been more IPOs this year than last, but that's obviously not saying much, and there is no reason to think the number will rise much, if at all, in 2011.
As for LinkedIn, there's at least one obvious reason why its IPO is likely to come sooner rather than later: Facebook. Technology players, particularly in the consumer sector, will seek to avoid going public around the same time as the social-networking titan for the same reason new movie releases dodge a new Harry Potter flick. As my colleague Erik Sherman puts it:
Facebook has become a company so potentially powerful -- and, more importantly, is also perceived as such -- that many people want a piece of it and the expected privileges that stock ownership brings. That's why Goldman Sachs and others will trip over themselves to do whatever the company wants. They all badly want to friend Facebook. And as solid as LinkedIn's prospects seem to be, it is not in the same category.
A final difference between then and now when it comes to IPOs is, well, then and now. Two financial bubbles have burst since the days when the likes of Webvan and were blowing money on Super Bowl ads. VCs and investors remain, properly, cautious. Companies must show healthy revenue streams, rather than simply a "path to profitability," to get a look-in from analysts. Meanwhile, attractive tech, healthcare and financial firms seeking to cash out focus more on getting acquired than going public.

Expect the IPO market to continue crawling out of the mud this year. But exuberance will, at least for now, remain more or less rational.

Image from Wikimedia Commons, CC 2.0

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