Facebook's Initial Public Offering - An IPO Case Study
How to Launch a Successful IPO and Maintain That Success in the Future
Initial public offerings (IPOs) are making a comeback in the middle market. In 2018, there were 30 IPOs of US technology companies with deal sizes of $100 million to $500 million, and so far in 2019, 15 IPOs in the same deal size range.
“In my area of specialty—software as a service—valuation multiples are near all-time highs, so it’s an attractive time for an issuer,” says David Spitz, Managing Director, KeyBanc Capital Markets Technology Group.
Terry Schallich, Head of KeyBanc Capital Markets Technology Group, notes other developments propelling the interest in IPOs.
For example, the Jumpstart Our Business Startups Act, or JOBS Act, permits prospective issuers to keep the initial filings of their draft registration statements with the SEC confidential, as well as conduct test-the-waters discussions with institutional investors in a confidential manner in order to further gauge overall interest and likely valuation of their company.
“We’re really starting to see that impact the flow of tech IPOs,” he says.
An IPO has many benefits—it can enlarge and diversify the equity base, provide cheaper access to capital and give a company more prominence in the eye of the public. However, an IPO must be approached carefully, ensuring the process provides maximum value while protecting the company’s future prospects and giving the management team the control it needs to continue to succeed following the IPO.
Developing a Strong Story
Spitz, who has been involved in more than 75 IPOs over the past 20 years, begins building a relationship with a company three to five years before it goes public.
“Getting to the IPO is just a step along the way as we’ve been spending years helping companies think about it,” he says.
While there are no hard-and-fast benchmarks for when a company is ready to go public, Spitz says they generally have a minimum market cap of $400 million to $500 million. Occasionally smaller companies go public, but they have a much smaller base of investors to sell to. For technology IPOs in particular, demonstrating strong growth is critical to valuation.
“Often these companies are growing in excess of 20, 30 or 40 percent annually,” he says.
In addition to a strong growth profile, a company that launches a successful IPO also needs a strong “story.” This means communicating the vision and future of the company to institutional investors, using the most powerful metrics that are true to its business model.
“In tech, we’re often defining entirely new markets,” Schallich says.
“Part of the banker’s role is to understand how to articulate the total addressable market in a way that’s sensible.
For example, to attract the interest of investors, an issuer will likely need to emphasize different elements of their story than those they use to sell to new customers.”
While metrics may seem to be a cut-and-dried affair, choosing the correct metrics to showcase in an IPO is an exacting task, especially in the technology industry where new business models are emerging.
Consider software as a service, or SaaS, the fast-growing niche where companies provide software on an as-needed basis through a subscription service.
In addition to typical accounting statement measures like GAAP revenues and net income, SaaS firms that go public usually provide investors with additional information particularly relevant to their industry, such as customer churn rate.
At a simple level, churn is how much of the customer base is lost each year.
However, as companies and investors become more sophisticated about a rapidly evolving technology area, they seek metrics that provide deeper insight into its operations.
In the case of SaaS, companies often choose to disclose net dollar retention, which factors in not just how many customers are lost, but also how companies can expand their existing customer base through upselling.
“We can find the best metrics to tell a company’s story to educate the public market investors.” Spitz says.
“Even though churn, or net dollar retention, seem like fairly simple metrics, there are literally hundreds of ways to describe them.”
Choosing the best metric isn’t simply about showcasing the company for the IPO, but understanding how the business will develop in the future. “If you stop disclosing a metric and don’t replace it with something else, you’re going to get a lot of questions, and people are just going to assume the worst,” Spitz says.
“One of the mistakes companies make in selecting the metrics for their IPO is to not be thoughtful about how they will evolve in the coming years.”
Choosing Your Investors
The success of an IPO often depends on a well-done road show, where the company management or underwriters travel around the country, making presentations to analysts, fund managers and potential investors to generate excitement.
“If you’ve had a successful road show, the demand is going to absolutely dwarf the amount of shares that you can sell,” Spitz says.
“Typically, these deals can be 10 to 20 times oversubscribed, at least on paper.”
Schallich says it’s critical for the issuer to find the right set of foundational investors that will make a sizeable, long-term investment among those that want to take part.
This often means identifying investors that have a sophisticated understanding of a narrow industry niche, such as unified communications as a service (UCaaS), which is a slice of the overall SaaS market.
He says this type of IPO matchmaking has become even more important in an era of algorithmic trading, which is not driven by the underlying fundamentals of the operation of the company, but by stock price performance and volatility.
“We look at the IPO as an opportunity for issuers to pick their investors,” Schallich says.
“By selecting the best group of foundational shareholders, an issuer’s executive team and board can better allow their execution of the fundamental business model to determine stock price as opposed to have it affected by street rumors and whispers.”
To launch a successful IPO, a middle-market company must develop a strong story, with metrics true to its business model, The combination of a strong metrics-driven story, and targeting of the right investors will position the business for a successful roadshow, a successful IPO and, ultimately, success long after the IPO is concluded.
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This article is for general information purposes only and does not consider the specific investment objectives, financial situation, and particular needs of any individual person or entity.
KeyBanc Capital Markets is a trade name under which corporate and investment banking products and services of KeyCorp and its subsidiaries, KeyBanc Capital Markets Inc., Member FINRA/SIPC, and KeyBank National Association (“KeyBank N.A.”), are marketed.