Rackspace alone doesn’t douse IPO drought

It’s not a stretch to say that it has been a bad year for IPOs. But how bad may be surprising.

In the first two quarters of 2008, only six VC-backed companies have gone public, raising more than $280 million in proceeds, with none in the second quarter. The slowdown comes as 86 VC-backed companies went public in 2007, raising $10.3 billion.

However, the lack of IPOs in 2008 is made more notable by what could have been. Two dozen venture-backed companies have taken their public offerings off the table this year, according to data compiled by PE Week. The withdrawn offerings represent more than $2.2 billion worth of shares that were never sold.

Whether some of those companies that withdrew offerings intend to re-submit IPO plans is uncertain, but the IPO drought broke on Aug. 8 when Rackspace Hosting Inc. (NYSE: RAX), became the first venture capital-backed IPO since March 19.

Rackspace’s backers—principally Norwest Venture Partners and Sequoia Capital—did fairly well in the offering. As a group, the venture investors hold shares worth nearly $400 million, which means they’ve seen a 10x return, at least.

Rackspace may have seen the offering as a do-or-die event. The company had already pulled an IPO off the table once before, withdrawing in March 2001, at a time when the Nasdaq had lost more than 60% of its value since the dot-com peak. After pricing its IPO at $12.50 a share (the lower end of an estimated range of $12 to $16), Rackspace opened trading at just $10, off 20 percent. Two days later it was still trading below $11 a share.

Skittish investors have been parsimonious lately, sending valuations down even for good companies, says Paul Bard, an analyst with Greenwich, Connecticut-based IPO research firm Renaissance Capital. “With nine of the last 10 IPOs trading below their initial price, companies see this and are willing to wait it out,” he says.

And there’s reason to suspect that they’re optimistic about the timing of an economic turnaround. A total of 30 companies registered for IPOs in the second quarter, up from 23 in the first quarter and 24 in the fourth quarter of last year, according to Ernst & Young.

Among the recent VC-backed companies to register for a public offering was A123 Systems, a maker of lithium-ion batteries for Black & Decker power tools and other manufacturers. The Watertown, Mass.-based company, which hopes to raise $175 million through an IPO, has raised more than $230 million in venture funding to date.

IPOs vs. M&A

But sometimes filing to go public is little more than an invitation for acquisition. Three of the 24 companies that said “no” to public markets this year later said “yes” to strategic acquirers.

For example, storage company EqualLogic had planned on launching a $125 million IPO, but the company changed course after receiving a $1.4 billion buyout offer from Dell. Mobile phone software company Danger had planned a $100 million IPO, but took it off the table after a $500 million buyout offer from Microsoft. And Vision correction company Eyeonics was intending to raise $86.3 million in its IPO, but went with an undisclosed buyout offer from Bausch & Lomb instead.

Window dressing may certainly account for some companies filing IPOs. A survey released earlier this month by Ernst & Young found companies wait six months between filing to go public and debuting, which is double the amount of time last year. It’s a statistic that suggests that companies in the pipeline may be looking for something other than just an improvement in market conditions.

That’s no surprise to National Venture Capital Association President Mark Heesen. He says that many tech companies now seem to want from the outset to be acquired instead of becoming giants in their own right.

“We’re seeing entrepreneurs more than willing to go the acquisition route rather than go public,” he says.

It can be a lot faster to go with an acquisition offer, too. The time to liquidity for VCs in an IPO scenario has reached 8.6 years, Heesen says.

Venture capitalists can find at least some hope in ArcSight Inc. (Nasdaq: ARST). After pricing at $9 a share on Feb. 14, the maker of security software for the enterprise has seen its stock price gradually move past $11 per share. Sure, it’s no Google, but it’s nothing to cry about in a down market.

Lawrence Aragon and Reuters reporter Phil Wahba contributed to this story.