April 19, 2013 – TMT Portfolio Updates: The IPOs are Coming! The IPOs are Coming!

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The TMT IPO market has been dead since the 2008 financial crisis. Facebook was supposed to make it safe for the dozens of increasingly valuable private TMT companies to come public, but botched execution made the FB IPO an impediment rather than a catalyst. Now there are dozens of TMT companies that could come public in the next 12-18 months. We have identified 35 that have likely valuations above $500, and evaluated them on the attractiveness of both the opportunity that they address and their competitive positions. The universe includes 9 e-commerce startups, 8 enterprise SaaS providers, 4 cloud service providers, 4 social networkers, 3 each of cloud infrastructure, enterprise hardware and on-line media, and 1 internet advertising network. We are most intrigued by Alibaba, Twitter, Hulu, Square, Atlassian and Pinterest, and have the most skepticism about subscale e-commerce players and enterprise IT plays. In this light, we are adding Workday to our large cap model portfolio and Marin Software to our small cap portfolio, both of which are recent IPOs.

A 5 year IPO drought has left dozens of interesting TMT companies private. The 2008 financial crisis killed new issues for many months. Facebook’s highly anticipated 1Q12 issue was supposed to break the log jam, but instead compounded the problem with the stock still more than 25% below its offering price. Still, industry scuttlebutt and recent S1 filings suggest that many IPOs that have been in a holding pattern could look to land in 2013.

Our list of 35 potential TMT IPO candidates contains intriguing companies. We identified 35 private TMT companies that we believe would command market caps in excess of $500 million, were they to come public. Rating these companies on the size of the market that they could address and on the strength of their competitive position, we have established a rough assessment of their likely attractiveness to investors. Of course, attractiveness must be tempered by the aggressiveness of the eventual offering price, a consideration obvious to investors and bankers alike in the wake of the Facebook debacle.

Acquisitions from the list by big cap players are likely. Over the last 3 years, Google has done 62 acquisitions for an estimated $16.3B, Intel has done 19 for $9.5B, Microsoft – 12 for $10.6B, IBM – 29 for $5.6B, Oracle –26 for $8.7B, HP – 13 for $20.2B, and so on. Many of the companies our IPO candidate list have been rumored as targets in the past, and some may choose to be bought rather than to pursue a private listing. Their value to would be acquirers is largely commensurate with our ratings, although some companies would significantly improve their competitive positioning in combination with a synergistic buyer.

Our favored candidates are Alibaba, Twitter, Hulu Square and Atlassian. E-commerce companies are the largest group, but other than Alibaba and Craigslist, the companies lack for scale and barriers to competition from the likes of Amazon. SaaS Applications is the second largest category, with many opportunities for start-ups, some of which will hit while others miss. We like Atlassian best from this group. Cloud infrastructure software and social networks have fewer candidates, but carry the highest ratings – Twitter is most favored from these groups, followed by Pinterest and Tableau. Cloud services, on-line media and on-line advertising are a mixed bag, with Hulu and Square stand-out candidates. We are not optimistic about overall spending on enterprise data centers, and view enterprise hardware makers skeptically – Violin Memory is the best of a risky lot.

Our large cap model portfolio performance has been strong. The large cap portfolio outperformed the S&P500 tech components by 280bp since our last update in late December, delivering 1.2% absolute performance over that time. We are removing Akamai – which is off 19% after poor numbers and guidance in February, Nuance – which moves in sympathy with Apple, and Skyworks – which we believe to be threatened by a new RF product from Qualcomm. In their place, we are adding Workday – a SaaS ERP vendor which recently IPOd, Netflix – which has built considerable business momentum with the success of its original programming, and JDS Uniphase – which could benefit from growing wireless data in both its network test and optical components businesses.

Our small cap model portfolio performance has been weak. The small cap portfolio underperformed the tech components of the S&P600 by 200bp, dropping 2.9% in absolute terms, since it was updated on January 7. Brightcove, Fusion IO and Allot were the primary culprits, and we are removing Brightcove and Allot, along with Triquint, which, like Skyworks, we believe is threatened by Qualcomm’s innovative 40-band RF chip. In their place, we are adding Marin Software – a recent IPO which sells SaaS tools to manage on-line ad campaigns, Ixia – a network test equipment supplier that is well positioned for expected wireless data build outs, and AMCC – which has traction on ARM based server processor chips.

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

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