The financial mavens are taking notice of the tech IPO market. They’re worried, ’cause it’s gotten too hot. On Friday, two tech IPOs covered here, Rocket Fuel (FUEL) and FireEye (FEYE), nearly doubled in price just after they went public. This was after their issue price had been ratcheted up substantially from the original filing. What’s going on?
At least two people working in the financial industry mentioned to me that it was reminiscent of 1999. But this is 2013, the year after a long five-year slog back from the global financial crisis. Meanwhile, in the financial media, a number of commentators are starting to question the new frothiness.
“Are we in a bubble? That’s a very legitimate question,” said Jay Ritter, a finance professor and IPO expert at the University of Florida, in an interview with the San Jose Mercury News. Meanwhile, longtime market observer Art Cashin told CNBC the new red-hot IPO market has people questioning whether the market is becoming more fully valued.
Bipolar markets are nothing new, especially with a Federal Reserve Bank that appears willing to supply unlimited money in response to any crisis. Wall Street has frequently swung from depression to ebullience in a matter of weeks. But the problem with a red-hot IPO market in 2013 is that it presents cognitive dissonance between the winner-take-all markets in Silicon Valley and the rest of the world.
Yes, a handful of tech entrepreneurs and workers are getting rich, but the rest of the world struggles with the problems of long-term unemployment, healthcare costs, stagnant wages, and rising expenses. This is a contrast, with, say, the great tech bull market of 1995-2000, in which unemployment was extremely low and real wages were rising.
Of course, overvalued tech IPOs that become a good long-term investment are nothing new. Google was accused of being overvalued during its IPO in 2003, only to become a 10-bagger. But then again, Google’s unique auction process for the IPO at least allowed you to get in at a fair market price Both RocketFuel and FireEye priced their IPO allocations much lower than the price they debuted on the public market, giving an instant pop to those who were able to get the IPOs at the issue price.
Rocket Fuel doesn’t quite have the command of the advertising market that Google has. With a $2 billion valuation, it’s valued at about 20 times sales. Not realistic. Fireye is now weighing in at a valuation close to $4 billion with a projected annual revenue run rate of about $150 million. That’s a multiple of nearly 30 times sales. Now, there is a lot of interest in cybersecurity at the moment, but is there really that much interest?
Companies with price-to-sales multiples over 10X are almost always overvalued. It’s unsustainable. At some point their values come in. Keep in mind that both of these companies are still losing money.
If you are looking at any of these companies as a long-term investment, you’ve got to wait at least 2-3 quarters after the IPO to see how their numbers come in and what the insiders do with their stock after the lockup period ends, usually about six months after the IPO.