Bullish investors are pushing technology firms to launch initial public offerings but, says Dan Barnes, they need to pick their market carefully.

Following a record year for initial public offerings (IPOs), technology firms are looking at the equity markets in 2014 with confidence. "People have made money in the asset class, and investors and issuers will be encouraged by that momentum,” says Richard Cormack, co-head of equity capital markets for Europe, the Middle East and Africa (EMEA) at Goldman Sachs.

“Therefore, the pipeline across the street is pretty strong as we move into the March/April period and I would expect to see a fairly heavy backlog executed at that time. Assuming that the market holds out, then I think the momentum in IPOs will follow through for the balance of the year.

“If you look at the last US tech IPOs, they generated 20% of the calendar by proceeds raised, Twitter being a good part of that. The mean performance of the last 20 tech companies to IPO in the US is up by 80%. That speaks to a pretty robust environment.”

Raising capital

Deciding how and where to raise capital is still a challenge. US exchange Nasdaq has about 20% of the world’s technology stocks, according to Bloomberg. However, London has ramped up its ability to support the growth trajectory of technology firms, while Hong Kong is increasingly being considered by Chinese companies.

Once listed, technology and intellectual property firms are valued for their growth potential relative to other stocks. "The capital intensity of growth in those firms is low compared with, say, a hardware device manufacturer or a telecommunications network," says Nick Train, joint founder of Lindsell Train, a buy-side firm that holds stocks in about 15 businesses that fall into the media content and software bracket. "Inherently the returns to capital are higher in those pure [intellectual property] businesses."

In a note published in December last year, Tobias Mueller, an analyst at fund manager T Rowe Price, highlighted two areas in the UK – ‘Silicon Fen’ in Cambridge and ‘Tech City’ in London – as ones to watch for up-and-coming companies, particularly those with protected intellectual property. “These are very capital-light business models, which means the cash generated in the business can either be reinvested in innovation or returned to shareholders as dividends,” he said. “Investors also benefit from the subscription models these businesses deploy with customers, which provides good visibility on future revenues.”

Confidence in the market

Concern about a second dot-com bubble is still an undertone in the markets, say analysts, but it has been diminished following a string of successful IPOs in the past couple of years. The cost of launching a technology firm has been reduced by innovations such as cloud computing, which gives access to huge amounts of computing power without the need to own a costly datacentre and lowers the barriers to technology product development.

“Creative and technology firms mine a completely free resource, which is ideas,” says Erik van der Kleij, head of Level39, which advises technology companies focused on providing financial services. “The tools required to develop them have changed dramatically. When I started a tech firm 15 years ago, we had to raise $40m to do what I could do with $5m today. Once a product is developed, it takes on the characteristics of traditional software. You build it once and then you sell it to many millions of people without significantly increasing the cost of distribution.”

Where firms in 1999 were going public without revenues or business models, bringing a product to market is now a much more mature process and technology firms are more measured and strategic. “Companies are taking longer to mature in the private space, which is a good thing,” says Nelson Griggs, senior vice-president of new listings and capital markets in the US and Asia for Nasdaq OMX. “When a window does open up, companies are lining up to go public, but data indicates they are taking longer to prepare for the process. That maturity leads to a market that can withstand more ups and downs.”

Magic number

Huddle, a London-based enterprise collaboration service, raised its first round of institutional capital in 2007 with UK-based venture capital firm Eden Ventures. Second and third rounds were completed in 2010 and 2012, both mainly with capital from the west coast of the US. In total it has raised about $38m and is still a few years away from looking at a public offering.

"For technology companies there is a magic number of revenue that you want to hit to get the upside from an IPO, floating at a valuation of $1bn, which typically reflects past revenues of $100m,” says Andy McLoughlin, co-founder of Huddle.

A greater issue for investors now stems from the price volatility seen around IPOs such as Facebook in the US, which has left investors more cautious about valuation. “There are lingering concerns around overvaluation,” says Markus Boser, co-head of technology, media and telecommunications banking for EMEA at JPMorgan. “For example, some companies in the US are including a [mergers and acquisitions] premium already.”

Getting buy-in

Encouraging investors to support start-ups has become a political issue, as Western countries try to drive economic growth, while bank lending to small businesses is suppressed. Marcus Stuttard, head of UK primary markets at the London Stock Exchange, says that a series of regulatory and legislative changes have improved the UK market for small firms, such as the Seed Enterprise Investment Scheme (SEIS), which is designed to help small, early-stage companies raise equity by offering tax relief to individual investors buying shares in those firms.

“What we do well in the UK is supporting start-ups and young businesses,” says Mr Stuttard. "There’s been the introduction of SEIS to bridge that early-stage funding gap, while last year the government made changes to the savings account rules so that AIM [Alternative Investment Market]-listed firms are eligible for ISAs [the UK’s tax-efficient individual savings accounts]. And from April 28, 2014, stamp duty on the trading of AIM shares will be abolished. All of these factors are aimed at diversifying the investor base.”

In the US, the Jumpstart Our Business Start-ups (JOBS) Act allows firms with less than $1bn of revenues to have relief from some regulatory and disclosure requirements when they go public, and for another five years, notably from obligations imposed by Section 404 of the Sarbanes-Oxley Act, which calls for all firms to verify their financial reporting.

“I wouldn’t underestimate the power and the value of the JOBS Act,” says Mr Griggs. “The ability to test their story and file confidentially is a big driver for a lot of industries, but it really helps tech companies. The macro-environment is looking better and the stock market is balancing.”

There is a growing interest from traditional, cautious investors in tech firms that have more balanced risk profiles than the start-up firms. “More mainstream investors who want to get exposure to technology are looking at sectors that are more stable with manageable product lifecycles,” says Philippe Cerf, co-head of the EMEA technology, media and telecommunications group and vice-chairman of the mergers and acquisitions EMEA group at Credit Suisse. “A good example would be the payments space, where technology continues to drive growth but within a relatively stable market structure due to high requirements in areas such as security standards and consumer protection.”
 

Having issues

For issuers, getting the right investor audience is crucial. An understanding of the business and its prospects requires a knowledgeable base of buy-side firms. Globally, exchanges are reporting that 2013 was a strong year for technology. “There were 36 technology companies who raised about £1bn [$1.6bn] last year,” says Mr Stuttard. “Given the strong performance of tech firms last year, not just in raising capital but in after-market performance, along with those that came to the market in 2012, it augurs well for the pipeline.”

Hong Kong Exchange and Clearing (HKEx), operator of the Hong Kong Stock Exchange, reported 12 technology IPOs out of a total of 120 IPOs in 2012 (10%), up from five tech IPOs out of a total of 64 (7.8%) in 2011. HKEx’s decision in 2013 not to allow the $60bn IPO of Alibaba, the Chinese e-commerce giant, on the grounds of corporate governance – the firm’s partnership structure demanded that it select its own board members – may not prevent the Chinese firm from revisiting negotiations with HKEx. However, it appears that a US listing is now more likely.

“Most Asian firms have come to the US,” says one US broker based in London. “There was the public debate around Alibaba and it was genuinely thinking about Hong Kong. The only reason it didn’t go is that Hong Kong’s listing rules are so similar to London’s.”

US appeal

The US market certainly has appeal, as Nasdaq’s global dominance of the tech sector verifies. The appetite for Chinese tech firms in the US may have been dampened following a series of governance scandals in 2011, but the final quarter of 2013 saw a spate of US listings for Chinese internet firms, including the launch of classified ad site 58.com via the New York Stock Exchange on November 1 and, on the same day, travel website Qunar via Nasdaq. Both saw excellent take up, surging by 42% and 133%, respectively, on their debuts. London and Hong Kong are keen to replicate the strong growth prospects that US markets see.

The Growth Enterprise Market (GEM), launched in 1999 by HKEx, had 58 listed companies from the IT sector at the end of 2013, which the exchange says comprised more than 30% of all GEM companies, accounted for more than 31% of GEM market cap and generated more than 35% of GEM turnover value. 

“Regarding IT companies, some have seen great share price growth since listing in Hong Kong,” says a spokesman for HKEx. “For example, shares of Tencent, which were listed at HKEx in 2004 with an offer price of HK$3.70 ($0.48), closed on January 17 this year at HK$529. [Our] securities market attracts investors from around the world, including leading institutional investors from the major markets of Europe, North America and Asia. The market also has an active local retail investor base, which gives it a good mix. About half of the investors are based overseas and about half are based in Hong Kong.”

The London Stock Exchange launched its High Growth Segment (HGS) in March 2013 in an effort to deliver the same sort of funding trajectory that firms listed in the US have seen. It is yet to see a listing but has attracted interest. “Somebody has to be the first to [use the HGS] and I know that there are some companies looking at it at the moment,” says Mr Cormack of Goldman.

Pulling together

The HGS needs to bring focused buy-side investors into contact with businesses that expect to IPO on the main market in the future, but are currently at the stage of raising capital. It only admits firms that can demonstrate growth in audited consolidated revenue of at least 20% on a compound annual growth rate basis over the previous three years, with at least 10% of the securities to be admitted held in public hands at a value of £30m.

Alastair Lukies, chief executive of mobile banking firm Monitise, which launched its IPO on the AIM market in 2007, believes UK start-ups are increasingly well catered for, with a variety of seed funding options. “One challenge for the UK to address is the provision of true risk/growth funding and the whole ecosystem that goes with it,” he says.

“In other markets, such as Silicon Valley it is common practice for a business that has delivered its proof of concept and perhaps some initial contracts then to raise $10m to $20m to help turn concepts into scaleable ventures. Given the UK’s history of creative enterprise and financing innovation amid a robust regulatory framework, we certainly have all the right ingredients in place to make a success of this. We just need to see more 'growth investors' if we are going to create some real global game-changers,” adds Mr Lukies.

Mr Cerf notes that there are not only differences in the US investor base but also in the approach on the US issuer side – such as issuing small amounts of equity – that offer lessons for firms wishing to list in Europe. “It is a very valid option to consider listing in Europe. There is occasionally a perception by issuers that a value arbitrage may favour the US in particular for companies with new and disruptive technologies. The question in those instances centres on whether there is a deep enough pool of European tech-savvy investors who will invest the time to understand a relatively new market segment,” he says.

Mr Stuttard believes that the concerns about firms wishing to issue smaller amounts of public offerings are addressed by the London Stock Exchange’s new HGS segment. “The playing field in the UK wasn't level with other markets until we launched the HGS,” he says. “By allowing companies to float on the market with a lower free float, it enables some of the companies, particularly the venture capital businesses where their backers want to continue to stay in for future growth, to float on the main market.”

Other options

Raising capital via the public market is not the only way for a firm to grow. Not only are businesses able to take advantage of incubators, such as Euclid Opportunities, the ICAP-majority-owned broker (see Tech Vision, page 78), but private equity companies are also bringing some serious money for the right goods.

“There is a lot of firepower in some of the private equity portfolios,” says Goldman’s Mr Cormack. “Last year the public market became as competitive as the private equity market across sectors and in some instances significantly more so. Compared with 2011 and 2012, when things were often more likely to go to private equity, when a firm embarks on a dual-track process to assess [private equity] and IPO interest now, in most cases the balance of expectation is that it will end up in IPO.”

Mr Lukies says there are a number of different approaches that businesses can take, depending on where they are in their growth and funding cycle. “Joint ventures can be particularly attractive,” he says. “Corporate venturing has a bad name but can be very effective and worthwhile. The power of partnerships – strategic, commercial or advisory – should never be underestimated.”

Nevertheless, for a public offering Europe still has issues says Mr Boser. “High-quality tech firms in Europe trade at the same value or even a premium to US tech firms. The challenge lies in getting to a decent growth valuation at the point of listing or going public.”

Mr McLoughlin at Huddle adds: “For tech companies such as ours, when looking at where to IPO, the signs seem to point to the US. Investor appetite is slightly better attuned to the kind of business we are building and its long-term prospects.”

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