The Good and the Unlucky

How much has the world changed in six months? Just look at two initial public offerings profiled here in February, days before the companies made grossly divergent stock debuts. The two, Varsity Group (VSTY Quote) (formerly VarsityBooks.com) and webMethods (WEBM Quote), tell nearly all the relevant tales of the crazed market for tech stocks over the past three years: devil-may-care investing by venture capitalists, a cavalier willingness by investment bankers to foist ill-prepared companies on the public markets, and momentum-trading scenarios where it's tough for average investors to make money even on shares of promising companies, to name just a few.

VarsityBooks and webMethods made for an odd couple of IPOs for reasons beyond the proximity of their offerings. Both were funded by prestigious Silicon Valley venture firm Mayfield Fund as well as the venture arm of investment brokerage Friedman Billings Ramsey. Both are headquartered in the Washington, D.C., area. And both embraced one of the Web's biggest buzzwords. Unfortunately for VarsityBooks, its buzzwords were business-to-consumer e-commerce, the twist being a focus on the college textbook market. Fortunately for webMethods, its buzzword was business-to-business, or B2B, which in its case means selling software to businesses for use in tying corporate Web sites to other sites.

Even though both companies have more or less stuck with their game plans, the results couldn't be more different. VarsityBooks.com delayed its IPO by a few days, lowered its offering price to 10 (from 12 to 14) and then went public on Feb. 15. The stock never went anywhere -- except down -- and rests today at one buck per share. webMethods, on the other hand, rode an IPO rocket ship. It was priced at 35, far above its planned range of 11 to 13, soared to 336 1/4 shortly after the IPO and rests today at a hair below 96.

The bottom line is that Varsity is a company that no banker would have the audacity to take public today. And even webMethods is a company that investors in the aftermarket would think twice about before buying its inflated post-IPO shares.

The renamed Varsity Group is useful to illustrate the fast boom-to-bust cycle of the dot-com craze. It had single-digit gross margins when it went public and onerous marketing payments to America Online's ICQ unit. Profitability was far into the future. Not surprisingly, the company shifted its focus after the stock cratered; it no longer stresses its campus bookselling program and instead focuses on marketing services, whereby it can connect major marketers like AT&T Wireless with a college audience.

"The long-term goal of the company always was to be a marketing services channel to college kids," says Allen Morgan, a partner with Mayfield and a Varsity Group board member, who adds that books were only a "hook" to attract customers who could then be sold all sorts of stuff.

"Since Nasdaq made clear that everybody had a shorter runway that we thought," Varsity has had to focus more on capitalizing on its expertise, he says. Morgan contends that as Varsity is heading into the crucial back-to-school season, the next few months will determine if the company is to be successful.

Wall Street hasn't been impressed. Even Lauren Cooks Levitan, an analyst with Varsity's lead underwriter, Robertson Stephens, downgraded the company's shares to market performer from long-term accumulate following Varsity's earnings release last week.

For its part, Varsity predicts it will be profitable by the second half of next year, and it has fired employees and cut back on marketing spending to help achieve the goal. Oh, and it plans to raise an additional $10 million to $12 million to pad its $23 million cash horde, undoubtedly the best reason to have gone public. The prospect of raising more money, at least, should keep the investment-banking community's interest.

The story at webMethods has been completely different. The company has been growing revenue quickly. It recorded revenue for the quarter ended June 30 of $15.6 million, up about fivefold from the year-earlier period. Tuesday its shareholders approved the $1.3 billion acquisition of Active Software (ASWX Quote), another B2B software concern.

Despite its success, webMethods hardly has been a home run for investors. Those privileged enough to get its IPO shares made a killing, of course. But plenty lost out as the stock skidded to 44 1/2, and it has bounced around with the volatility of a stock that trades more on whims than on fundamentals. Not taking into account the Active purchase, webMethods sports a $3 billion valuation. And yet the company faces new competition from the likes of Tibco Software (TIBX Quote) and Vitria Technology (VITR Quote).

I predicted back in February that even if IPOs like Varsity cratered, it wouldn't mean an end to the IPO party. Plenty of mutual funds remain ready to snap up shares in the many venture-backed firms that still want to go public. But the growth must be huge, and investors can't hear often enough that "success" is relative.

Don't confuse the success of institutional investors with yours.