So this year the number of companies offering an initial public offering (IPO). So far this year there have been 148 IPOs according to Renaissance Capital. This number is greater than the number of IPOs in 2008 and 2009. One thing is different about these IPOs is that they are earning money. However, the amount of money these companies are making is very little.
Linkedin which essentially is the Facebook for business people only earns an estimated $15 million. The company is now worth $9 billion. After the first day of trading Reid Hoffman became a billionaire. How is a company making so little worth so much? People believe that the company will increase profits over time. Also people might be buying the stock because they believe other people think it will be worth valuable.
Zynga is trying to get into the IPO this market this week and raise $1 billion. The company created the game social network game Farmville. The company in 2010 reported profit of $90.6 million on close to $600 million of revenue. Actually for a software company this is a very low profit margin. Considering the company doesn’t have large capital expenditures like plant, property, and equipment and just makes software you would expect them to be making 30-40 cents profit on every dollar of revenue.
I love how analysts or reports say things like “Only a small percentage of the market share has been tapped”. Market share is meaningless. A company could have 100% market share in an industry that is losing money. What investors care about is growing earnings and profits. Facebook is an example of this kind of thinking when they already have over 700 million users and people say they can keep growing by leaps and bounds. One thing I am beginning to notice is that some people are actually cancelling their Facebook account because they have things to do. What is really interesting is when people claim Facebook is worth $50-$100 billion despite the fact that no one really knows how much Facebook earns in profit. What is very confusing is how a company can be worth $50-$100 billion even though hardly anyone buys anything from Facebook. Companies like Kroger, Disney, and Best Buy are all worth less compared to Facebook yet have millions of people who fork over money to purchase something.
People forget about MySpace as this week it was sold to a group of investors (including Justin Timberlake) for $35 million even though it was bought for $580 million in 2005. I have a feeling what happened to MySpace may happen to companies like Linkedin, Facebook, Zynga, and all of these companies going public.
I see very few “established” companies going public. Recently, I saw Dunkin’ Donuts was going public and raising $400 million to do so. The company reported close to $27 million in 2010. The company has been previously owned by Bain Capital and the Carlyle Group. Companies like Bain and Carlyle buy companies like Dunkin’ Donuts and try to turn them around. The company has close to $2 billion in debt so perhaps they are trying to finance themselves by issuing shares.
For all of these companies time will tell though how well they do. Research shows that a large majority of IPOs do not do well. This is part of creative destruction as discussed by the economist Joseph Schumpeter. The only household name companies in a few years will be the ones that survive while the ones that failed will be forgotten. We have to remember companies have to survive in a profit and loss system (unless you have friends in Washington D.C).
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