What do public market investors look for in an IPO?
Jeremy Abelson Contributor
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What do public market investors want to see when investing in an IPO?
We rounded up a group of the 50 highest-profile software IPOs (excluding outliers like Zoom during COVID) since 2012. We also studied — but didn’t include — direct-to-consumer, internet, and fast-casual. We are happy to provide such data upon request.
The group presented here is a very strong representation of the last decade of technology IPOs. We looked for themes, trends, and averages that would tell us what was working and sketched profiles of successful software companies in the past.
To do so, we examined execution, performance, size, scale, margin, Rule of 40, and transaction size (notional and %), which uncovered a lot of interesting conclusive data.
If a company is willing to accept the valuation that the market considers public, the time is ripe. Jeremy Abelson
Key takeaway: Execution vs forecasting
The most significant finding was the impact of the company’s execution versus their estimates, also known as their “beat and raise”.
Our data shows a surprising correlation between better performing stocks and the magnitude of the “underperformance gain” versus the company’s guidance at the time of the IPO. To show this, we’ve broken down the company group into three different performance groups:
Group 1: Wunderkind Never miss a forecast (GAAP revenue, GM%, OM%) and beat the peer average of every metric every quarter. Group 2: Very solid Never missed a quarter vs. estimates (GAAP rev, GM%, OM%) Group 3: Less than perfect Missed at least one metric, one quarter
As you can see in the chart below, the impact is significant. Group 1 outperformed Group 3 by a factor of ~7x (382% average vs. 53%) over a two-and-a-half year period. (Please see red box for median and average.)
Note: This chart contains only 36 names, as we removed all names without three years of data (for example, IPO 2021), as well as all direct listings.
% better performance vs. IGV since IPO. Image Credit: Investor Irving
The data should be relevant to the management team currently considering establishing an underwriter’s estimate, leading to the IPO pricing and projected fair value of the company/share.
Raw data
This chart includes the 50 relevant software IPOs we studied and how each company performed over three years versus the projections they were given at the time of their IPO across four critical metrics (our favorite is the Rule of 40).
An important place to focus is on the quantum. The average beat in the top row is 35% in year three!
Frankly, it is not uncommon for us to see ordinary private companies “behind” versus projections. Companies learn quickly that private markets are forgiving of mistakes while public investors are highly punitive of mistakes, especially in the first post-issuance quarter (and reward beats).
For reference: FY+0 correlates with the year prior to a company’s IPO, which was the most recent year of all actual quarterly results; FY+1 is the year of the IPO and also the first year with an underwriter estimate; and FY+2 is the year following the IPO and the first full year of quarterly estimates.
