The Software IPO Outlook
After years of M&A and LBO exits, the rare "software IPO" may be making a comeback in the coming year.
By Tom Taulli
Sep. 18, 2006
"I think we have reached the bottom in enterprise software... In the IPO market, I think there will be some software offerings for investors to get excited about..."
Paul Holland's words came like music to the ears of software investors. And Holland should know. As a general partner at the venture capital firm, Foundation Capital, he holds a grounded perspective on the software market. During the 1990s, he helped bring two software companies public: Kana Communications and Pure Software.
Though nothing like the action of the pre-bubble days, the software IPO market is actually picking up. A total of 14 software companies have gone public in the past 12 months - with mixed results - and new filings may be picking up as well.
The outlook for software IPOs is more positive than it has been over the past few years. As the M&A/LBO shakeout continues, there are several key trends which will guide new offerings for the coming year.
Recent Growth in M&A
Of course, when a VC invests in a software company, the goal is to achieve a high return from an "exit." Traditionally, the exit has been an IPO.
But, with the slowdown in the IPO market, software companies have been focusing on M&A as an exit.
Look at JBoss, which is a fast-growing open source company that develops middleware. Back in the 1990s, this would have been a red-hot IPO.
No more. This year, the company decided to sell out to Red Hat. Some other notable examples of M&A exits include:
There is also another trend: public software companies deciding to sell out. According to data from the tech research firm The451Group, a total of 89 public software companies have been taken out of the public markets by both strategic and private equity acquirers since 2004 (12 of the transactions had private equity buyers). The aggregate value of the transactions was about $67 billion.
Already in September, there have been two going-private transactions in the software space: Intergraph ($1.3 billion) and Embarcadero Technologies Inc. ($234 million).
The problem is that it is extremely tough to be a public software company. First of all, because of cutbacks on Wall Street, it is hard for companies to get analyst coverage. Next, there is the regulatory "tax." With Sarbanes-Oxley, the legal and accounting costs for public companies have skyrocketed. For example, if public-company costs are $3 million, then it will make it very difficult for, say, a software company with $50 million in revenues to post a profit.
Go Overseas?
With the difficulties in the IPO market, some U.S. tech companies are looking overseas. One popular spot is the London Stock Exchange's Alternative Investment Market (AIM). Its biggest selling point: there are no Sarbanes-Oxley regulations.
Yet, the AIM is a relatively new market - and has been subject to lots of volatility. According to a recent study from Innovation Advisors, there are some ominous signs:
"The increased hurdles for going public in the U.S. are not necessarily a bad thing," said said Eric Gebaide, a managing director at the tech-focused investment bank, Innovation Advisors. "The result has been better quality in the public markets. After all, institutions got burned during the dot-com bust and do not want it to happen again. While I think we will see more software IPOs, things will not return to the heyday anytime soon. So, expect the M&A to continue."
Paul Holland's words came like music to the ears of software investors. And Holland should know. As a general partner at the venture capital firm, Foundation Capital, he holds a grounded perspective on the software market. During the 1990s, he helped bring two software companies public: Kana Communications and Pure Software.
Though nothing like the action of the pre-bubble days, the software IPO market is actually picking up. A total of 14 software companies have gone public in the past 12 months - with mixed results - and new filings may be picking up as well.
The outlook for software IPOs is more positive than it has been over the past few years. As the M&A/LBO shakeout continues, there are several key trends which will guide new offerings for the coming year.
Recent Growth in M&A
Of course, when a VC invests in a software company, the goal is to achieve a high return from an "exit." Traditionally, the exit has been an IPO.
But, with the slowdown in the IPO market, software companies have been focusing on M&A as an exit.
Look at JBoss, which is a fast-growing open source company that develops middleware. Back in the 1990s, this would have been a red-hot IPO.
No more. This year, the company decided to sell out to Red Hat. Some other notable examples of M&A exits include:
- EMC's purchase of VMWare
- Symantec's purchase of Brightmail
- Kronos' purchase of Unicru
- CA's purchase of Wiley
- Sybase's purchase of Mobile 365
There is also another trend: public software companies deciding to sell out. According to data from the tech research firm The451Group, a total of 89 public software companies have been taken out of the public markets by both strategic and private equity acquirers since 2004 (12 of the transactions had private equity buyers). The aggregate value of the transactions was about $67 billion.
Already in September, there have been two going-private transactions in the software space: Intergraph ($1.3 billion) and Embarcadero Technologies Inc. ($234 million).
The problem is that it is extremely tough to be a public software company. First of all, because of cutbacks on Wall Street, it is hard for companies to get analyst coverage. Next, there is the regulatory "tax." With Sarbanes-Oxley, the legal and accounting costs for public companies have skyrocketed. For example, if public-company costs are $3 million, then it will make it very difficult for, say, a software company with $50 million in revenues to post a profit.
Go Overseas?
With the difficulties in the IPO market, some U.S. tech companies are looking overseas. One popular spot is the London Stock Exchange's Alternative Investment Market (AIM). Its biggest selling point: there are no Sarbanes-Oxley regulations.
Yet, the AIM is a relatively new market - and has been subject to lots of volatility. According to a recent study from Innovation Advisors, there are some ominous signs:
- After the third year, AIM company returns fell to -65 percent versus a -26 percent for NASDAQ.
- U.S. tech companies that went public on AIM found that their stock was worth less than half of their IPO price after two years (a loss of 57 percent for AIM companies versus a 12 percent increase for NASDAQ).
- After five years, all AIM tech IPOs traded 60 percent below their issue price, while on NASDAQ they traded 19 percent below their IPO price.
"The increased hurdles for going public in the U.S. are not necessarily a bad thing," said said Eric Gebaide, a managing director at the tech-focused investment bank, Innovation Advisors. "The result has been better quality in the public markets. After all, institutions got burned during the dot-com bust and do not want it to happen again. While I think we will see more software IPOs, things will not return to the heyday anytime soon. So, expect the M&A to continue."
