The corporate venturing-backed flotation of internet browser provider Netscape Communications in 1995 sparked a regrettable trend for badly overpriced flotations – potentially including recent deals, such as RenRen and Youku, that have damaged the stock market and capital allocation efficiency and limited the exit route for a broader range of private companies by setting a high bar of expectations.
Netscape, which had raised $18m from software provider Adobe Systems and five media companies as a private company, effectively sparked the dot.com boom and demand for its initial public offering was so strong the issue price was doubled 24 hours before listing to $28 per share at launch. The first day pop, or price rise, went as high as $75 per share before closing the day at $58 each on August 9, 1995.
The $28 per share, which gave an enterprise value of $1bn to Netscape, was justified a number of ways with a crucial expectation that the company would grow revenues by more than 50% per year for the next decade. By 2005, and after competing with Microsoft’s Internet Explorer, Netscape’s Navigator browser was effectively dead and rolled into the non-profit, open source Mozilla Foundation’s Firefox product.
Shareholders had made out okay with internet firm AOL buying Netscape in March 1999 for $4bn in stock (the deal was worth $10bn by the time it closed) – provided they subsequently sold AOL stock after its merger with Time Warner in what is regarded by some as the greatest value-destroying deal of all time.
So what has this history to do with today? One of the biggest complaints by venture investors is the relative dearth of flotations in the US and other developed markets. (See lobbying and reports by trade bodies, such as the US’s National Venture Capital Association.) China now makes up more than half of the past three years’ numbers by volume and value.
To bolster their case, savvy investors such as Eric Jackson and Ben Horowitz in their blogs ("Will you shut up about this being another internet bubble already" and "Bubble trouble I don’t think so" respectively), decry there to be an internet bubble.
As Jackson refers to Horowitz’s analysis that: "His most compelling argument in that post was the comparison of the enterprise value-to-revenues multiples of all the big tech companies back then compared to now:
Cisco (CSCO): 27.4x then, 1.8x now;
eBay (EBAY): 125.2x then, 3.9x now;
Akamai (AKAM): 7,369.2x then, 6.0x now; [and]
Amazon (AMZN): 25.5x then, 2.0x now.
End of discussion."
Not quite. The obvious point is companies’ growth rates tend to flatten over time and multiples on mature businesses fall. A better comparison is more recent valuations on newer businesses. Social media network provider Facebook, backed by corporate venture-backed internet investor Digital Sky Technologies, is reportedly valued at 25 to 50 times its estimated revenues of $2bn last year even before its potential IPO, while its Chinese peer RenRen, which is backed by Japan-based media group Softbank, saw its first-day closing price of $18.01 during the past week’s flotation.
Based on the closing price, which was 28.6% higher than issue price of $14 per share, RenRen has a $7bn market capitalization and the company is worth about 67 times revenues at issuance, according to news provider Business Insider. This, however, is still 50% less than China-based online video provider Youku’s 100 times market value to revenues at its flotation.
These are historically high multiples (see table below). Even during the dot.com frenzy during the late 1990s the average market value to sales multiple was 4.2 times at IPO, according to US-based academics Annette Poulsen and Mike Stegemoller in their paper, Transitions: from private to public ownership.
Venture-backed companies floated at significantly higher multiples than other private businesses, they added. Between 1995 and 1999, the average venture-backed company listed at 6.6 times sales, compared to 2.8 times for non-venture capital backed businesses.
Luke Taylor, a Wharton finance professor in a post at Wharton@Knowledge via news site Motley Fool suggested valuations for discount coupon provider Groupon and a handful of social media companies that investors can’t get enough of these days — Facebook, Twitter, Zynga, LinkedIn, and Foursquare — were aggressive and perhaps overly optimistic. Groupon turned down a reported $6bn takeover offer in December from Google in favour of a private placement and potential flotation at a reported $15-25bn valuation.
Taylor said companies listed on the S&P 500 trade at "zero to four times revenue" but "does Twitter deserve a [market value to revenue] multiple 25 times larger than any company in the S&P 500"?
Obviously, there are successful businesses that can not only effectively create and grow a new market and reap the rewards but also defend their position in it over a longer period of time. But as Netscape showed, the number is relatively small, limited to those such as Microsoft with defensible, monopolistic positions in must-have product areas.
However, for salesmen looking out for the short term, this needs be little constraint. Stock market investing is about perceived net present value and shorter-term expectations of share price movements rather than longer-term judgments about the business. Given past market cycles there is another three to five years of frenzy to come but the super liquidity caused by super low interest rates and public funding means the temperature is already unduly high.
This hot-house atmosphere for a few great businesses and others clinging on means its harder for patient, longer-term capital to be efficiently invested in businesses for the overall health of the economy. In such conditions, insiders and intermediaries reap the benefits.
Valuation Multiples of IPOs and Sell-outs from 1995 to 1999
|
|
Sell-outs |
IPOs |
|
Panel A: All firms |
||
|
MV / book value of assets |
2.9*** |
6.1 |
|
MV / earnings |
14.5 |
10.0 |
|
MV / EBITDA |
9.2 |
6.9 |
|
MV / sales |
2.4*** |
4.2 |
|
Panel B: By venture backing |
||
|
VC backed |
||
|
MV / book value of assets |
5.1*** |
9.2a |
|
MV / earnings |
-13.0*** |
-15.9a |
|
MV / EBITDA |
4.0*** |
-11.3a |
|
MV / sales |
4.7***,b |
6.6a |
|
Non-VC backed |
||
|
MV / book value of assets |
2.7*** |
4.1 |
|
MV / earnings |
20.4 |
20.0 |
|
MV / EBITDA |
10.3 |
10.5 |
|
MV / sales |
1.8*** |
2.8 |
*** Sell-out/IPO different at 1% level a VC/non-VC different at 1% level
** Sell-out/IPO different at 5% level b VC/non-VC different at 5% level
* Sell-out/IPO different at 10% level c VC/non-VC different at 10% level
Source: Transitions: from private to public ownership*
Annette Poulsena, ** and Mike Stegemollerb
aTerry College of Business, University of Georgia, Athens, GA 30602, USA
bKelley School of Business, 801 W. Michigan St., Indianapolis, IN 46202, USA