Can Loudcloud set the IPO tone?

The foggy technology IPO picture will clear up this week, thanks to Loudcloud Inc. On Thursday, the Internet infrastructure services company is expected to price its US$150 million offering for Friday. That is, unless lead underwriters Goldman Sachs and Morgan Stanley postpone the deal due to questionable market conditions - or the bad weather on the East Coast.

Loudcloud, led by former Netscape Communications Corp. execs Marc Andreessen, Tim Howes and Ben Horowitz, is a critical cog in judging the sluggish 2001 technology IPO market. The company could be the last of a breed - an Internet-related IPO that falls flat in spite of big promise. Or, six months from now, it could be marked as the rebound point.

Already the signs are shaky. According to a federal filing Thursday, Loudcloud bumped up the number of shares it will sell to 25 million but lowered the price to $6 each, which would raise $150 million for the Sunnyvale, Calif.-based firm. Previously, Loudcloud said it was going to sell 20 million shares for $8 to $10 each, which would have raised $200 million at the top of the range.

Investment banks will be watching how Loudcloud prices, and it's subsequent valuation. Venture capitalists want to see whether the public markets will support risky tech offerings. They're hoping, perhaps blindly, that the market can bounce back to pre-correction conditions.

According to Venture One, 333 venture-backed IPOs - 143 of which were tech companies - priced in 1996 and 1997. Those companies raised more than $6 billion. From 1999 to 2000, 437 venture backed deals priced, of which 280 were tech companies, raising more than $24.5 billion.

Of course, the drive of both public and private investment into technology companies turned into what's now commonly referred to as the tech stock bubble. And the IPO market is the victim. In the first nine weeks of 2000, 176 companies had filed for IPOs. This year, that number is 20. Even the valley of 1998 had 52 issues filed at this time.

The bursting of the bubble has made both VCs and bankers alike rethink their roles in the downturn and how they may prosper in this new environment. Still, the business of venture capital continues. And still, bankers keep their eyes on the markets because there are plenty of companies that still need cash infusions. A year after the downturn, however, all are eager to admit that the mania that swept the capital markets in the past couple of years was out of control.

"As good as the market was for IPOs last February, there needs to be a counter cycle. It was just too unhealthy," said Wade Massad, senior managing director of syndicate at Dain Rauscher Wessels.

"You had to be dumb or unlucky in this business not to fund a company that would see a 300 percent pop on an IPO," said Cliff Higgerson, a general partner at ComVentures.

That world doesn't exist anymore. IPO registrations have been consistently pulled or postponed for the past few months, with only the most daring or healthy deals making it through. Besides Loudcloud, the notable offerings so far in 2001 are or will be corporate spinouts, such as KPMG Consulting Inc. (KCIN) and Agere Systems Inc. (out of Lucent Technologies Inc.); more traditional companies, such as Peet's Coffee & Tea Inc. (PEET) and AFC Enterprises Inc. (AFCE) ; and from two sectors - biotech and energy, which are less averse to overall market sentiment in their search for cash.

Why are there so few IPOs out there when there are obviously private companies that might be able to succeed in the public markets? One reason is banks and public investors are finding it difficult to value a new company if the market caps of its top public rivals continue to be heavily discounted.

"Valuations remain in question. And they help determine what truly is the potential for new companies," said Mo Cheston, head of equity capital markets at Thomas Weisel Partners.

Cheston said the valuation confusion means metrics are back for good. Though each company strives for top- and bottom-line growth at minimal cost, positive cash flow is back in the spotlight. If a company can't generate cash on its own, given the proceeds of an IPO, investors are quicker these days to dismiss it.

Mitch Whiteford, head of equity capital markets at Robertson Stephens, said the money is out there. "Liquidity is on the sidelines," Whiteford said, as cash or cash-like positions in major mutual funds have grown.

To persuade these cash-heavy investors to re-enter the market, the banks will have to base valuations on trailing results versus expectations because investors, Whiteford said, are looking at rate-of-return instead of valuation when choosing where to put their money.

In the meantime, bankers are licking their chops to offer startups other products and services.

"Many of the customers we'd be talking to about public equity have now been shifted to our private equity group," said Dain Rauscher Corp.'s Massad.

Banks' ability and speed at which they can place private equity should improve because of SEC rule 155, which went into effect Wednesday. The rule lessens the amount of time a company has to wait from withdrawing its IPO registration to receiving more private financing.

Conversely, Weisel's Cheston mentioned that he's seen a growing number of PIPEs, private investing in public equities. If private investors see potential in a company, and a secondary offering by that company is out of the picture, they'll ask a bank to help them purchase a significant amount of shares. However, all banks seem to be looking for M&A activity to pick up - perhaps to deal with companies stuck in registration or that have postponed or withdrawn their offerings.

That the IPO window closed so abruptly has taken some by surprise, but this isn't the first time there's been a dramatic shift in the IPO market. And many VCs are using this historical sense of bubble markets and downturns to help them slog through tough times ahead.

"Right now a market recovery is based on hope. It'll take more time than people think for the excesses in the market to work off," said ComVentures' Higgerson. Higgerson knows what he's talking about. In the business since the bear market of1974 at Hambrecht & Quist, he has watched speculative bubbles and made some smart bets on companies that would pull through. The first analyst on the Street to cover Nortel Networks Corp. (NT) , Higgerson directed venture money into America Online Inc., MCI, Tellabs (TLAB) , Ciena Corp. and Broadcom Corp. (BRCM) , among others.

"The peak in Nasdaq-type stocks came in 1972. The market didn't come back to those levels until 1980," Higgerson said, predicting that it'll take two or three years for these markets to make any type of similar comeback. He likens what happened in the past few years with Internet and tech startups to the phenomenon surrounding biotech ventures in the early '90s. That same phenomenon occurred during the past few years with optical startups.

Dick Kramlich of NEA Ventures said the hard landing in tech will not have a severe long-term effect on the massive infrastructure build-out undertaken in the past few years when capital was flowing freely. Kramlich has invested in companies such as 3Com Corp. (COMS) , UUNet Technologies Inc., Ascend, Silicon Graphics Inc. and Immunex Corp. (IMNX) .

"This bear market isn't like 1974. There was political chaos, double-digit inflation, high interest rates and high unemployment. I don't think this is anything similar," Kramlich said. According to Thomson Financial Securities Data, there were only eight IPOs in 1974.

In this market, Kramlich feels that companies are forced to be more creative in terms of public financing. He notes that many VCs may be analyzing reverse public offerings for their portfolio companies.

"If there are sound business reasons for two companies to get together, now is a time to look for back-door offerings," Kramlich said. A back-door offering is a rarely used vehicle in which a private company merges with a public company for its status on the capital markets.

The venture capitalists are, of course, looking for new opportunities. Many VCs, like Kramlich, are now eyeing life-sciences companies and health care information services plays - essentially biotech firms that are taking advantage of genomic and technological innovations.

And there are still opportunities in companies that take advantage of increased speed. Jon Feiber, a partner at Mohr Davidow for 10 years since leaving Sun Microsystems Inc. (SUNW) , said he has his eye on companies and technologies that will be able to capitalize on the growing number of broadband homes and a new generation of digital content consumers being spawned in connected universities and colleges.

"We have a generation of graduates who are now used to getting their content from a PC," Feiber said. Content holders are now battling for consumers, but Feiber thinks the investment opportunity lies in the enabling technologies that will provide the billing, management and in-home storage for the digital consumer.

Of course, new technologies are great, but all of the VCs said what separates an average company from a truly compelling startup is a strong management team. That, perhaps most of all, is what makes the Loudcloud IPO even possible in such a bad market.

"It's an unproven product in a tough market," said Melanie Hase, analyst with the IPO Plus Fund. "Their team is the reason this deal gets done."

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