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Big IPOs Had Good Q1, But VC-Backed Growth Plays Lagged

Although the equity markets boomed in the first quarter of 2013, IPO investors played it safe with a modest number of deals heavy on dividend-paying stocks. But analysts say things should get more interesting as the year goes on.

A total of 31 IPOs came out in the quarter, down from 42 in the first quarter of last year, according to IPO investment firm Renaissance Capital. Proceeds rose 29% to $7.6 billion, however, largely due to Pfizer's (PFE) $2.2 billion spinoff of its veterinary unit Zoetis (ZTS).

Zoetis was also one of the better-performing IPOs in the aftermarket. As of Monday, it was up about 27% from its Jan. 31 pricing at 26, despite the fact that it came to market without a whole lot of revenue growth. It was a similar story for two other large companies that debuted in the quarter, Norwegian Cruise Line (NCLH) (up 57%) and Bright Horizons Family Solutions (BFAM) (up 52%). Both companies were not only large and slow-growing, but backed by private-equity firms who'd acquired them through leveraged buyouts. Those sorts of deals usually aren't that popular among IPO investors because they come with a debt load.

Underpricing IPOs

James Krapfel, IPO analyst at Morningstar, thinks investors saw them as bargains.

"There was arguably not as much excitement about the IPOs at the time, but that probably led to some underpricing, resulting in strong performance (in the aftermarket)," Krapfel told IBD. "These companies that may be not as appealing from a growth-investor standpoint have been better received by the market.

Still, the top return came from a classic venture-capital-backed growth IPO, ExOne (XONE), now up more than 80% from its Feb. 6 IPO price of 18. ExOne is a nascent player in the red-hot 3D printing industry, and debuted as its peers 3D Systems (DDD) and Stratasys (SSYS) were riding high on media attention. Another VC-backed stock, online money-transfer service Xoom (XOOM), is also doing well with a 35% return so far.

Yet those two deals didn't have a lot of company. In fact, according to research released Monday by the National Venture Capital Association, the number of VC-backed deals hit a three-year low in Q1 with just eight deals raising a total of $672 million. Research by Ernst & Young notes that the downtrend has been going on for a few years, despite the fact that the JOBS Act, which marks its one-year anniversary on Friday, was supposed to help bring more emerging companies to market.

Jackie Kelley, Americas IPO Leader at Ernst & Young, believes that the equity markets are still a bit volatile for smaller companies' comfort.

"There's a lot of challenges in getting out in this market," Kelley told IBD. "If there's any sort of global macroeconomic issue, it impacts our U.S. capital markets. If we have hurricanes or natural disasters, it seems to impact our markets, along with tax issues, fiscal cliffs and all that. The market can get on a roll and then it takes a halt.


However, Krapfel notes that one possible effect of the JOBS Act may be seen in how early some of these companies chose to go public. ExOne came out with just $29 million in revenue in all of 2012 and no profits, though it did report a profit in Q1 last week. Xoom and enterprise software firm Model N (MODN), which also has done well in the aftermarket, reported 2012 sales of around $80 million but were unprofitable when they came out. Between these and the large private-equity deals, practically no IPOs in the quarter met IBD's CAN SLIM criteria of being both profitable and fast-growing.

Technology Sector

Analysts agree that one cause of this was the relative lack of IPOs from the technology sector, which usually leads the way in growth offerings. Instead, the really hot plays were finance and real estate, playing on the strength of the financial markets and the housing recovery. A total of six REITs came out in the quarter, and excitement about construction also probably drove the 54% return on building-products maker Boise Cascade Company (BCC), despite the fact that it was both unprofitable and leveraged.

Health care, led by the Zoetis juggernaut, also brought some strong deals to the table. Enanta Pharmaceuticals (ENTA), which is collaborating with some leading pharmas to create hepatitis C drugs, has racked up a 45% return just since it priced on March 20. Model N drew interest partly from the fact that most of its customers are in the life-sciences industry, and the top-returning REIT, Aviv (AVIV), specializes in nursing homes.

Average Return

The average return for all the IPOs in the quarter was a strong 18%, leading observers to expect that the deal pace will pick up as the year goes on.

The pipeline isn't entirely visible at this point, as Kelley notes that one aspect of the JOBS Act that her clients have embraced is the ability of smaller companies to file confidentially until they set their IPO terms.

Companies with more than $1 billion in annual revenue still go through the usual process, however, and those in the pipeline include some prominent names. Among them are contact-lens giant Bausch & Lomb, amusement-park chain Sea World, clinical research organization Quintiles, perfume maker Coty and Empire State Realty, owner of the Empire State Building.

On Monday, major homebuilder Taylor Morrison Homes filed to go public, which Krapfel expects to do well given the excitement about real estate.

"There seem to be more high-profile companies in the backlog," Krapfel said. "Activity should pick up the rest of the year."