Remember when venture capital-backed IPO volumes stood like skyscrapers against the prewar walkups that were buyout-backed offerings? Well, the contrast has now reversed itself.
Just 10 VC-backed companies began trading on U.S. exchanges in the second quarter of 2005, raising more than $714 million, according to Thomson Venture Economics (publisher of PE Week) and the National Venture Capital Association (NVCA). This is the lowest quarterly total since Q3 2003, and was disappointingly similar to the paltry $720 million raised by 10 VC-backed companies in Q1 2005.
During the same time period, however, buyout-backed offerings continued their ascension into the stratosphere (or at least the LBO version of it, which isn’t to be confused with the VC-backed dot-com boom of 1998-1999). A total of 19 buyout-backed companies began trading on U.S. exchanges last quarter, which represents a seven-year high. The overall amount they raised came in at nearly $3.5 billion, which was much lower than Q1’s $6.2 billion, but still good enough to rank second on the all-time list.
Even IPO filings favored buyout-backed companies in Q2, with 28 such filings, compared to just 17 from VC-backed companies. In fact, perhaps the only good news for VCs is that they had one less IPO withdrawal than did their LBO peers – with three VC-backed companies retreating off of the IPO launch pad, compared to four buyout-backed withdrawals. One withdrawal in each category was caused by a pending acquisition.
Tech-focused IPOs have had a run of tough luck since the good old days. Tech deals represented 45% of all IPOs (VC-backed and non-VC-backed) between 1995 and 2000, but just 14% between 2001 and the first half of 2005. Most of this is attributed to poor public market performance of tech standard-bearers such as Cisco Systems, Oracle and Sun Microsystems, although the recent drop-off also could be partially influenced by four consecutive quarters of modest growth for tech M&A.
However, public market aversion to tech is in no way a complete explanation for the recent drop in VC-backed IPOs. For example, the number of tech IPOs in the first half of 2005 is 24, whereas there were only 37 for all of 2004, according to Thomson Financial.
At the same time, there have been just 20 VC-backed IPOs – of any type – in the first half of 2005, compared to 42 during the same period last year. In other words, slightly more overall tech IPO activity in 2005 than in 2004, but drastically less VC-backed IPO activity. Also, the quarter’s largest buyout-backed offering was in the tech space, with telecom clearinghouse services provider NeuStar Inc. (NYSE: NSR) raising $605 million.
So what other factors are at play? One culprit is the biotech market, which only has debuted 16 IPOs in 2005, compared to 49 in 2004.
Another explanation is that public market investors have upped their risk aversion as the economic recovery has sputtered. As such, they are favoring larger deals with underlying financials, rather than smaller deals with underlying vision.
Chris Wand, a principal with Mobius Venture Capital, says that VC-backed IPO volume also is being depressed by the VCs and entrepreneurs themselves. “IPOs are really false liquidity in a way, because it can take months, if not years, before a VC can sell their stock,” Wand says.
China Techfaith Wireless Communication Technology Ltd. (Nasdaq: CNTF), a Beijing, China-based handset design house and mobile terminal design group, raised the second quarter’s largest VC-backed IPO, with a $141.4 million offering on May 6. Pre-IPO, the company was controlled by the family trusts of its four senior officers, but it also had received VC funding from such firms as Intel Capital and Qualcomm.
Morningstar Inc. (Nasdaq: MORN) placed a close second when it raised $140.8 million. It received VC funding from Softbank Finance Corp.
NeuStar led all buyout-backed IPOs with $605 million on June 28. The company, founded in 1996 as an operating division of Lockheed Martin Corp., was acquired three years later in a management buyout that included Warburg Pincus, MidOcean Partners and ABS Capital Partners. As part of the IPO, Warburg Pincus netted more than $500 million (in double-digit ROI excess of its original contribution), and still maintains a 35% post-IPO ownership position. Minority shareholders MidOcean and ABS also received partial liquidity via the offering.
The second-largest buyout-backed IPO was a $554.2 million offering from Warner Music Group (NYSE: WMG), which was backed by Thomas H. Lee Partners, Bain Capital, Providence Equity Partners and Edgar Bronfman’s Music Capital Partners.
In terms of aftermarket performance, the average buyout-backed IPO was trading up 12.75%, while the average Q2 VC-backed IPO was trading up about 9%, as of market close on Wednesday, June 29.