Pandora Media (NYSE:P), a top Internet radio platform, was expected to have a blowout IPO last week. While the company was able to boost its offering price and raise a cool $235 million, the stock quickly fell apart. By the end of the week, investors had sustained big losses.
Does this mean that the IPO boom is over? Perhaps, but I think it’s too early to tell. The fact is that there haven’t been many IPOs this year – at least for emerging tech operators. Besides, other hot IPOs, such as LinkedIn (NYSE:LNKD) and Yandex (Nasdaq:YNDX), are still well above their offering prices.
Despite all this, there are still some interesting trends emerging:
Profits Matter: Sounds obvious, right? The 1990s were most likely an aberration. After all, investors want to invest in companies that are either highly profitable or on the path to profitability. This has always been a driver for breakout companies. Just look at some of the top IPOs of the last 10 years, such as Google (Nasdaq:GOOG) and Salesforce.com (NYSE:CRM).
As for Pandora, the company has never made a profit. In fact, according to its prospectus, it expects losses to continue until the end of 2012.
Consider that the company has to pay roughly half its revenue to the recording industry — and these fees will increase over the years. In other words, there is no operating leverage in the model.
Thus, if investors are focused on profitability, this does not bode well for IPOs like Groupon. This company, which had $117 million in operating losses in first quarter, makes Pandora’s losses look like rounding errors.
However, profitable companies – such as Facebook and Zynga – should do quite well.
Flipping: Keep in mind that it’s mostly hedge funds, mutual funds and institutions that get most of the allocated shares of IPOs. Basically, Wall Street underwriters hope that they will hold onto the shares for the long-haul.
But again, the Pandora deal shows that IPO investors are really interested in flipping shares for a quick profit. On its first day of trading, the volume was more than 40 million shares. The number of shares issued was only 14.6 million.
So to effectively launch IPOs, underwriters will likely need to greatly underprice the deals and keep the share count low.
Volatility: Tech IPOs should be nice investments for day traders. If they are nimble, it will be possible to make nice gains with quick trades.
However, IPOs can punish individual investors. In a few hours, it’s easy to lose 20% of your investment.
Thus, as I’ve indicated many times in my InvestorPlace columns, the best strategy is to wait a couple quarters until buying hot tech IPOs. Often, you’ll be able to get better valuations.
Tom Taulli’s latest book is “All About Short Selling” and he has an upcoming book called “All About Commodities.” You can find him at Twitter account @ttaulli. He does not own a position in any of the stocks named here.
