April 15, 2014 – TMT: Don’t Rain on My IPO

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TMT: Don’t Rain on My IPO

2013 was the biggest year for TMT IPOs since 2007, with 54 companies hitting the market, led by TWTR, but otherwise dominated by enterprise cloud software. 2014 began with a big backlog of 590 venture funded companies in the pipeline, up from 426 a year ago, representative of years of public market angst. 19 IPOs have issued YTD, with several high profile acquisitions as well. This year, the mix includes more consumer names, including 50%+of the IPOs YTD, and with Chinese e-commerce giant Alibaba expected to top FB’s 2012 offering as the biggest debut in history. For investors, we see 2014’s likely IPOs as a mixed bag. To date, intriguing plays like GRUB and OPWR have had strong launches, while riskier issues like KING have foundered. Looking ahead, we are more optimistic for enterprise cloud application plays like Palantir, New Relic and AppDynamics, than for the sub-scale infrastructure plays like Box and platform vulnerable consumer businesses like Dropbox and Evernote. Overall, we are bullish that paradigm shifts in advertising, retail, enterprise IT, entertainment, and telecom are opening huge new addressable markets to new paradigm TMT players, and that most valuations remain reasonable given this growth potential. Given this, strong cash flows and balance sheet liquidity, we believe talk of a new tech bubble is misplaced. On a side note, the IPO market may raise prices and slow the pace of sector M&A. We are adjusting our model portfolio – over the past 4 months, the large cap underperformed by 3200bp, driven by the recent pull back, while the small cap outperformed by 4600bp. FB and DATA are joining the large cap list, replacing CRM and CTXS, while OPWR and GRUB are added to the small cap portfolio, replacing GTAT and TYPE.

The window is open. Years of public market weakness had stacked up promising TMT companies in the private market. FB’s botched 2012 IPO held back the growing tide, but 2013 finally saw the window open for new issues. TWTR was the marquee name, but the large majority of 2013 IPOs were well positioned, high growth enterprise cloud software names, such as strong performers DATA and MKTO. However, the 45 TMT IPOs in 2013 did little to alleviate the backlog, with the total pipeline growing from 472 companies at the start of 2013 to 590 a year later. Nearly 2 dozen of these companies carried presumed valuations in excess of $1B, including high profile acquisitions like WhatsApp, Nest and Oculus, and recent new issues KING and GRUB.

The calendar of future IPOs is intriguing. The line-up for the remainder of 2014 is could include well-known consumer internet names like Dropbox, AirBnB, Evernote, Gilt, and Pinterest, enterprise application players like Palantir, New Relic, and AppDynamics, IT cloud infrastructure plays Box and MongoDB, and Chinese e-commerce giant Alibaba, which appears poised to break FB’s record for the largest IPO valuation in history. While prospectives and pricing will ultimately determine the attractiveness of each issue, we see the SaaS names as the most promising but are skeptical that many of the consumer and infrastructure companies can cope with looming rivalry from scale players.

No evidence of a bubble. Many have suggested that the high multiples being paid for high growth TMT stocks, IPOs and acquisitions constitute a bubble, analogous to the frothy internet bull market of 1999-2000. We believe that the comparisons are cosmetic at best. At its heart, the 2000 bubble was driven by capital investment that was largely unsupported by cash flows. When telecom carriers could no longer secure financing for speculative network build-outs, equipment deals were canceled and dot com dreams of ubiquitous broadband were dashed. Combined with the end of enterprise spending on Year 2000 upgrades, growth and profitability assumptions across TMT proved wildly optimistic. This time, the growth expectations are fueled by paradigm shifts in advertising campaigns, consumer retail spending, enterprise IT budgets, and infotainment habits – these are enormous global addressable markets, with plenty of runway left. Capital investment in pursuit of these opportunities is fueled by prodigious cash flows, with most balance sheets blissfully unlevered. Valuations are also reasonable, particularly compared with the 2000 peak and in light of the visibility into future growth and the strength of the sectors cash position. While there are certainly individual issues where hype exceed reality, we do not see evidence of comprehensive overvaluation.

Adding FB and recent IPO DATA to the large cap model portfolio. Our large cap model portfolio performance slid during the past month, with returns since our last update in December off 3200bp vs. the tech components of the S&P. The biggest culprits were TWTR and AMZN, both of which traded off sharply on poorly received 4Q results that we believe will prove anomalous. We are removing CRM, which we fear will face new competition fueled by plummeting cloud hosting prices, and CTXS, which does not seem to getting the traction that we had hoped in device virtualization and which faces aggressive consensus expectations. In their place, we are adding FB, of which we recently wrote a detailed report (http://live.ssrllc.com/2014/03/march-26-2014-facebook-dream-until-your-dreams-come-true/), and DATA, which rides the SaaS/IaaS wave described in our recent piece (http://live.ssrllc.com/2014/03/mach-2-2014-saas-after-the-levee-breaks-competition-in-software/).

Adding new IPOs OPWR and GRUB to the small cap model portfolio. The small cap portfolio outgrew the tech components of the S&P600 by 4600bp, led by GTAT, which more than doubled on news that it would supply sapphire crystal display technology to AAPL for its anticipated iPhone6. We are inclined to sell on the hype, and are removing it from the portfolio, along with type font licensor TYPE. We are adding two IPOs from a week ago, OPWR, which offers SaaS software to the electric utility industry, and GRUB, which has clear leadership handling on-line restaurant delivery orders after merging with its main rival, Seamless, several months ago.  We note that the pace and quality of new IPOs will make the TMT small cap space far more interesting than it has been over the past few years.

For our full research notes, please visit our published research site.

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