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In mid-February, when ONI Systems, a San Jose (Calif.) manufacturer of optical networking equipment, was considering whether to file for an initial public offering, the decision was a no-brainer. The Nasdaq, up about 13% from Jan. 1, seemed locked in a never-ending upward trajectory. So, on Friday, Mar. 10, ONI filed for the option of doing an IPO. But back in the office the following Monday, CEO Hugh Martin and his team watched with queasy stomachs as the market plummeted in what was to be the first of several severe corrections. They began reconsidering their IPO plan.
In the end, encouraged by their investment bankers, Goldman Sachs, ONI's management decided to go ahead. "Goldman was very strong in its belief that we could get the deal done because of the quality of the company and the market we were addressing," says Martin. Goldman proved to be quite right. ONI's initial filing included a price range of $14 to $16 a share. After Goldman did some market research, this was revised upward to $21 to $23. The issue finally came public at $25 per share on June 1, in the midst of one of the more tepid IPO markets of the last year and a half. But it was worth the effort: The stock (ONIS) has soared to $117 3/16 since then.
The message of ONI's deal is that the IPO market continues to be surprisingly strong, despite volatile markets. Jeff Hirschkorn, senior market analyst at IPO.com expects the total value of U.S. IPOs this year to hit $54 billion, vs. $51.2 billion last year. But cancellations are becoming far more common than earlier in the year: 83 IPOs have been pulled this year, 51 of them in the last two months. And IPO.com projects that the total number of deals will drop from 527 last year to 400 in 2000, reflecting a trend toward much larger deals as dot-coms have fallen out of favor and infrastructure companies have stepped into the limelight.
NO RUSH?
The ONI deal also reaffirms the power of a good investment bank. But for the companies going public, this may be a two-edged sword. As they agonize over the decision of whether or not to go ahead, they rely on the advice of investment bankers -- whose business is pumping out product to feed their institutional sales forces. In volatile markets, the temptation can be great to push ahead even with companies whose prospects are far weaker than ONI's.
Bankers pooh-pooh criticism that they're rushing clients to market against their interests. Says one investment banker among the top four IPO advisory firms: "Look at the performance of our deals, and you'll see it's not true." Indeed, the top IPO dealmakers have excellent records when it comes to the post-IPO performance of their deals, according to statistics from IPO.com. Of the deals Credit Suisse First Boston brought to market over the last 18 months, 90% are up more than 100% above their IPO price. Of Goldman-led deals during the same period, 82% are trading 100% or more above their IPO price. Merrill Lynch can boast 45% to 46% of its deals up over 100%.
But the IPO market is clearly getting a lot pickier. Only companies with very strong business models can still raise money easily. As Chase H&Q's co-head of investment banking Christina Morgan puts it: "We are not in a market where anybody can get financing, but we are not in a market that is completely shut down." Investors are still willing to entertain companies that are not making money yet, but now they demand a clear path to profitability. "Investors want companies with a scaleable business model," Hirschkorn says. "They're not demanding profits yet, but they love them."
HEAVY PRESSURE.
Market watchers say the strongest trend right now is sectoral favoritism. For instance, foreign companies listing in the U.S. are in favor, with gigantic flotations by China Unicom ($5 billion) and Germany's Infineon Technology (also $5 billion). Among U.S. companies, those in the fiber optics, wireless communications, and semiconductors are enjoying almost unabated interest from investors.
Still, despite their defensive statements, bankers and venture capitalists often put on heavy pressure on companies to go public. Because of ONI's experienced management team, Martin and crew made the decision to go ahead themselves, he says. But he acknowledges that other companies may not find themselves so fortunate. He recently advised the CEO of a small company contemplating a subordinated debt issue not to accept $20 million from a top investment bank, even though it would guarantee the company top-notch advice on the eventual IPO. "It's a huge risk. They might invest in you and decide not to take you [public]," says Martin. "That changes your negotiating leverage. Why take on that kind of liability for an upside you may never realize?"
More often than not, companies contemplating an IPO are eager to proceed, too -- even under iffy market conditions. "There aren't many companies that lightheartedly wait for market conditions to improve to do their IPOs," says Mark Tercek, Goldman's co-head of global equity capital markets. "For one thing, the market can always get worse. For another, they usually need the capital. Third, there are morale issues involved in waiting. But we wouldn't hesitate to tell a client to wait if that's what we thought they should do." In fact, ONI's Martin says Goldman was "very balanced in its discussions with us."
REMEMBER '87.
Experienced executives know it can be dangerous to wait. A case in point is Rich Mora, vice-president for operations and CFO of Numerical Technologies (NMTC), a San Jose (Calif.) manufacturer of semiconductor software, who has taken four companies public as CFO. Numerical filed for its IPO at an estimated price of $15 in January and actually came to market Apr. 6, for $14. This is higher than the revised $11 to $13 range it put on the offer immediately before coming to market, but less than the company might have gotten a few months earlier.
Mora says the drop in the market price barely gave him pause. That's because he recalled his first IPO, when he was CFO of a company called HHB Systems. It was back in mid-October of 1987, and the market was showing signs of weakness. One of the VCs wanted to hold up the deal because the price was a dollar lower than the company had originally planned on. Mora and others convinced the board to go ahead. "Our check cleared on Oct. 19, 1987," he chuckles -- just before the 1987 market crash. "We'd already held up the closing one day because we didn't like the price. Imagine if we had waited one more day."
Mora admits to having had some "tough one-on-ones" with portfolio managers in the last week of Numerical's road show, but he is pleased with his decision to forge ahead with the IPO. He had the advantage of having a good business in a wobbly market, "Ninety-six percent of the people we spoke to participated in our IPO," he says. The stock, which is now trading at $48 5/8, is way up. Employee morale is good, too, as workers' stock options now have more value. His investors are happy. His company has enough money to do what it needs. And having delivered strong returns to the IPO investors, his company is in a good position to come into the market again at a later date.
"There are three rules I've learned in a startup," says Mora. "First is: This is a marathon, not a sprint. Second is: Take the money. Third is: Take the money." That's a credo a lot of savvy share issuers are following these days.
Margaret Popper covers the markets for BW Online EDITED BY THANE PETERSON
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