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Software IPO Review: 2002 (Copyright 2003, SoftwareCEO Inc.)

By Bruce Hadley, Founder, SoftwareCEO.com

For software companies struggling through the past year's stagnant economy, with frozen IT budgets and increased encroachment from starving competitors, 2002 probably didn't feel like a particularly positive year. The M&A and IPO metrics, however, point to renewed health or at least a return to normalcy, which in our book is a healthy thing.

IPOs: More activity, more realism
The resurgence of software IPOs began in the last two months of 2001, when five companies went public after a dry spell of only one IPO in 10 months. In 2002 we saw a steady stream of IPOs, with a total of 12 software and software services companies choosing the Wall Street route. May and June were the most active months, with a total of eight offerings, but 2002 IPO activity was spread pretty evenly throughout the year.

Despite the relatively small number of software IPOs in 2002 it was slow compared to 1999 and 2000, when we logged 57 and 21 software IPOs, respectively several metrics stand out that make this past year striking:

Valuations slumped to 2.4 times revenues at the median, a 36.8% drop from 2001's 3.8 multiple. While this year's number pales compared to the 26.5 and 30.2 multiples logged in 1999 and 2000, respectively, it represents a return to realism on the part of investors. And, that 2.4X is still a half-again richer return than you're going to get going the M&A route: We've got details on 191 deals from 2002, and the year's overall median M&A multiple is hovering around 1.5.

Requirements for entry got much tougher. Not many software companies are candidates for IPOs, and 2002 offered a sobering reminder that Wall Street likes a sure thing. This year's typical software IPO company had revenues $111.9 million, compared to a median of just $23.6 million in 2001. And, that's just the median: The top 25% were $329.1 million or larger. Profits were promises, for the most part: The median net income among all IPO companies this year was a $3.1 million loss, compared to a negative $0.7 million in 2001.

By way of contrast: In those nutty valuation years of 1999 and 2000, the median revenues for software companies going public were $9.4 million and $11.6 million, respectively. And, if it hadn't contributed to the $6 trillion lost in the stock market over the past three years, we'd be laughing about their net incomes: a median loss of $4.2 million in 1999 and a loss of $5.4 million in 2000. In short, lots of those 1999 and 2000 IPOs never should have happened.

A stronger market means more cash in the coffers. Interestingly, even though valuations based on IPO share price quadrupled over 2001, company market caps did not. At the time of IPO, this year's entries were worth a median $204.3 million, compared to $203 million in 2001. How could this be? Simple: In the downward spiral of 2001, initial share prices averaged just $9.50, companies gave up 25% of their shares outstanding, and raised $48.5 million in their IPOs. In the somewhat resurgent market of 2002, the average share price at IPO was $16, companies sold a 32% slice, and raised a median $66.5 million a 37% jump.

Services are sexy, software is not. More proof that that the most successful software companies will transform themselves into services firms: Seven of the 12 companies choosing the public path this year that's 58.3% of them earn the majority of their revenues from IT services rather than software licenses. Of the remainder, four are what we consider "pure" software companies, and one portal builder Plumtree Software (Nasdaq: PLUM) has centered its business around the Web.

The stats in the table above show some fascinating differences between software and services companies, and what it takes for each type to go public. Note that software companies can go public sooner (though $45.7 million is still about double what we used to figure in the "good" old days), and they're forgiven a pronounced lack of profits. When it comes to share price, however, they suffer: $10 versus $16.50 at IPO. And, the market hasn't stopped pummeling them: The software-focused companies have seen their share price increase by 24.7% while their average market cap has declined 13.2%. The services firms, on the other hand, have enjoyed a median 41.1% run-up in their stock price, and a 45.8% increase in their market cap.


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