Initial Public Momentum?

Throughout Silicon Valley, all eyes are on Google Inc. and its chief

executive, Eric Schmidt. The privately held technology highflier is expected to

launch an initial public offering early next year. With the market for tech IPOs

starting to heat up, cubicle dwellers everywhere are excitedly speculating that

the Google offering, as well as the one from Salesforce.com Inc., could provide

the spark needed to really rekindle the market.

That would mark a major turnaround. After soaring in the late ’90s–more

than 2,300 companies went public from 1996 to 1999–initial public offerings

virtually dried up when the technology sector and the broader stock market

collapsed. Fewer than 100 companies went public in each of the past two years,

while just 10 companies came out in the first six months of 2003 – the lowest

half-year total since the mid-’70s.

CEO SCHMIDT: "Google's IPO could jazz up the market

Now, however, the appetite for IPOs is returning among investors and upstart

companies alike. With the economy picking up and the stock market rallying, 38

companies went public from July through October. An additional 35 have

registered to go public in the next few months. And with plenty of others

scoping out potential underwriters, investment bank Thomas Weisel Partners

expects 150—200 tech and non-tech companies to go public next year. Says Blake

Jorgensen, director of investment banking at Thomas Weisel: "We’re

starting to see a pipeline



develop."

So far, performance has been mixed. Overall, the few dozen companies that

have gone public this year have averaged a 32% return on investment–well below

the 45% climb the Nasdaq index has posted. In part, that’s because several

recent biotech IPOs have failed to live up to expectations and are now trading

below their offer prices. And others, such as money-losing e-tailer RedEnvelope

Inc., have barely held their own. Shares in the online gift site, which went

public on September 25 at $14 a share, closed on November 5 at $13.89.

Back to Basics



Some newly listed companies are going gangbusters, however. The best

technology performer, semiconductor outfit FormFactor Inc., is up 91% since

going public in June, thanks to a hot market for the flash-memory chips it

makes. Meanwhile, shares in Digital Theatre Systems Inc., a provider of digital

entertainment products and services, have jumped 84% since its July offering.

As the IPO market warms up, the emerging rules of engagement look markedly

different from the frothy boom years. For starters, companies need to prove

their financial chops before taking the plunge. According to Thomas Weisel, the

tech companies that have gone public this year have averaged about $40 million

in quarterly revenues. Moreover, prior to going public, on average, they project

27% annual revenue growth.

That’s one reason Sequence Design Inc., a promising chip-design software

company in Santa Clara, Calif., is holding off for now. Chief executive Vic

Kulkarni doesn’t expect to become profitable until May, so he’s aiming for a

late 2004 offering. "You go sailing only if there’s wind behind

you," he says.

In addition, there’s a whole new definition for a ‘successful’ IPO.

During the bubble, companies often defined success by the size of their

first-day pop, and the ensuing marketing buzz it earned. Indeed, in 1999, the

average first-day return on IPOs was 71%. Trouble is, companies were leaving

billions of dollars on the table that could have gone into corporate coffers.

Now, say bankers, investors, and private firms, the focus is on the basics:

getting the needed capital at the best possible price for the company. And most

companies today frown on the 1990s practice of doling out ‘friends and family’

stock to pals, associates, and customers. That makes for less incentive to

lowball a company’s asking price. All told, first-day pops now average 12%.

The more sober environment is bringing long-term institutional investors back

to the table–the kind who often hold equity stakes for several years rather

than look for short-term trading profits. "You actually have time to do

your work, meet with management, and accumulate a substantial position in a

company," says Allison Thacker, a portfolio manager with RS Investments.

Where will the IPO market go from here? Analysts say tech will continue to

provide most of the opportunities–and that Internet companies are winning

renewed favor. Even a handful of profitable e-tailers, among them BizRate.com

and Shopping.com Inc., are considering listing. The IPO market has come back

from the dead–but for now, it’s walking, not running.

By Ben Elgin, with Robert D Hof, in San Mateo, Calif., and

Emily Thornton in

New York in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc

WINNERS: The Gold in Google’s IPO Goes to…

If Google Inc. goes public in early 2004 as planned; the Internet search

kingpin easily could set a record for initial public offerings. Analysts say

Google could fetch  a valuation of $20 billion. That would make it the most

richly valued Internet company ever to go public, according to Thomson Financial–far

exceeding the $9 billion valuation garnered by online broker TD Waterhouse Group

Inc. in 1999 or the $1.9 billion price tag fetched by Internet hosting outfit

Genuity Inc. in 2000.

Although Google, its execs, and its investors decline to discuss their equity

stakes, BusinessWeek culled venture data and interviewed sources close to Google

and its investors to piece together the stakes of several key players.

Even if estimates that Google will pull in $100 million in net profits on $1

billion in sales this year are conservative, as some analysts argue, $20 billion

is still a lofty valuation. However, Google believers say it could be reasonable

given the supercharged growth of Google’s revenues and profits and its

dominance of the lucrative search business: Google now handles nearly 40% of

global Internet searches, up from 1% in 2000.

When Google does go public, the biggest winners, of course, would be Google’s

cofounders, Larry E Page and Sergey Brin, who dropped out of Stanford University’s

computer science graduate program to found Google in 1998. Today, each still

owns over 15% of the company, according to a source close to Google. So a $20

billion valuation would peg each founder’s stake at well above $3 billion.

Google also could represent one of the biggest venture-capital payoffs this

decade. Its two most prominent backers, Kleiner Perkins Caufield & Byers and

Sequoia Capital, ponied up a little more than $10 million each in the summer of

1999, according to venture data and people familiar with Google’s financing.

Through these investments, each firm today owns an estimated 10% of the search

giant, they say. That means they could pocket $2 billion a piece–a staggering

20,000% return on investment.

Ironically, Yahoo itself stands to clean up. It invested $10 million in

Google in 2000–back when the companies were on friendlier terms. That stake

now represents slightly less than 2% of Google, according to sources–which

should work out to a cool $300 million. That would handily top Yahoo’s

expected 2003 net profit of $230 million.

For sheer return on investment, some of the best returns could go to Google’s

earliest individual investors. Among them: Stanford professor David R Cheriton

and Cisco Systems Inc. executive Andreas Bechtolsheim, who contributed $100,000

to $200,000 apiece to Google’s initial financing round in 1998. Bechtolsheim,

in fact, interrupted Page and Brin partway through their presentation to fetch

his checkbook. Today, each owns over 1% of the company–a stake worth at least

$200 million, according to a source close to Google.

Cheriton, who still drives a 1993 Honda, isn’t exactly obsessed with the

financial payout.

"At some point," he says, "Money is a bigger problem than a

solution." Easy for him to say.

By Linda Himelstein and Ben Elgin in San Mateo, Calif. in BusinessWeek. Copyright 2003 by The McGraw-Hill Companies, Inc