Study: Older, Worldly Firms Make Best IPO Candidates

Bucking a trend that prevailed for much of the past decade, investment bankers are now betting big on private companies that have new ideas and business plans in addition to a more seasoned management team with well-defined global aspirations.

And while a handful of the most successful initial public offerings in the technology sector this year — VMware, BladeLogic and Netezza — have veered slightly from this new formula, all three possess most of the key characteristics that predict strong financial performance long after they’ve been assigned a ticker symbol.

Accounting and professional services firm Ernst & Young analyzed the traits and performance of 110 U.S. companies that went public from the beginning of 2006 through the first half of this year and that immediately qualified for listing in the Russell 2000, a popular index consisting of 2,000 small-cap stocks.

“When it comes to undertaking an IPO, preparation is unquestionably the key to success in both the short term and the long term,” said Maria Pinelli, Americas Director in the Strategic Growth Markets group at Ernst & Young, in the release accompanying the study results. “Part of being prepared is to understand what the market responds well to so that you can determine if you are, indeed, ready.”

The stats

Institutional investors are making fewer deals than they did during the dot-com madness, waiting instead for the fledgling companies to prove themselves before investing tens of millions of dollars at each stage of their development.

Of the 110 companies studied, only 11 percent went public in their first two years of operation, and the average company was eight to nine years old. It’s a sign of more discerning capital markets and a more cautious and circumspect attitude within the private companies.

With age comes stability and size. Of the companies that went public in the last 18 months, those founded before 1995 had average annual sales of more than $700 million. The younger ones, launched after 1995, had an average of just $190 million in annual sales.

Not surprisingly, these younger companies had a lot more volatility and risk. The worst performing of these younger companies actually lost 51.7 percent of its market capitalization within 90 days of its IPO while the worst-performing older company shed only 20.5 percent of its value within three months of going public.

As for the CEOs at these newly public companies, the news isn’t good for women. Only 2 percent of the 110 companies tracked for this study had a woman calling the shots, and that doesn’t even include VMware CEO Diane Greene who spearheaded the virtualization software firm’s sensational IPO in August.

While it may still be an Old Boys Network, it’s the young guys who are actually doing the best job.

The average age for both CEOs who either outperformed or underperformed compared to the rest of the Russell 2000 Index ranged in age from 50 to 54 years old.

Only 8 percent of the underperforming companies were headed by a CEO less than 40 compared to 20 percent for those with CEOs over 60. Among outperformers, it was pretty much a wash. Thirteen percent of CEOs under 40 and about 15 percent of CEOs over 60 outperformed the Russell 2000.

And while Microsoft CEO Bill Gates may be the world’s wealthiest man and a college dropout, this study suggests CEOs who emulate Warren Buffett (he earned a master’s degree in economics from Columbia University) are more likely to succeed — albeit slightly.

Among outperforming companies, 71 percent of those CEOs held a higher degree than a bachelor’s compared to 61 percent for underperformers.

Degree or no degree, it’s clear that venture capitalists and institutional investors care at least as much about the person leading the company as the product or service they’re selling when it comes time to close the deal.

“Our view is the best strategy is to find good people and back them,” Ravi Mhatre, general partner at Menlo Park, Calif.-based Lightspeed Venture Partners, told “The best entrepreneurs, the kind we’re looking for, are going to do everything they can to succeed. More than anything else, we invest in people.”

Based on the track record, experience and initial performance, investors should have little to fear from three of the technology industry’s most recent IPOs.

The successes

VMware shares are now trading at more than $112 a share, up almost four-fold from an opening price of $29 a share, and reported blowout sales and earnings in its first quarter as a public company earlier this week.

Greene, 51, who founded the company along with Mendel Rosenblum in 1998, has a master’s degree in naval architecture from MIT and another master’s degree in computer science from Berkeley.

BladeLogic, which makes datacenter automation software, enjoyed a successful debut in July at $17 a share and now trades at almost $30 a share.

CEO Dev Ittycheria, 38, holds a bachelor’s degree in electrical engineering from Rutgers University and, before founding BladeLogic in 2001, served as an entrepreneur-in-residence at Bessemer Venture Partners. In 2004, Ernst & Young recognized Ittycheria as an “Entrepreneur of the Year” for his early work at BladeLogic.

Data warehouse appliance firm Netezza, which also went public in July, is off to the most sluggish start of three.

Its shares, priced at $12 each, are now trading at around $12.69. CEO Jit Saxena, 60, previously founded CRM software vendor Applix and took it public in 1994. He holds a master’s degree in electrical engineering from Michigan State and a master’s of business administration from Boston University. Netezza was founded in 2000.

Perhaps more important than their respective sheepskins or the numbers on their birth certificates, all three CEOs and their companies are committed to hocking their wares in burgeoning international markets.

According to the report, 39 percent of the 110 companies studied have established global operations and offices, an impressive feat considering international outposts had long been the domain of blue-chip firms that slowly expanded their empires beyond the U.S. over the course of several generations.

Among the 43 percent of IPOs that outperformed the Russell 2000 Index through the first half of 2007, 43 percent had extensive operations outside the U.S.

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