IPO Lessons From Pandora

NEW YORK (TheStreet) -- Internet radio hot spot Pandora Media is going public.

The Oakland, Calif.-based company filed an S-1 registration Friday with the Securities and Exchange Commission letting regulators and investors know it is looking to do an initial common stock offering to raise around $100 million. Pandora's revenue from advertising sales and partnership subscriptions is solid, but the company has posted a net loss for the past three years, according to the filing. (Its fiscal year ends Jan. 31.)

That may work out for Pandora, but experts say that for small and emerging firms eyeing the public markets, doing an IPO generally requires much more than a need for capital.

"Pandora is still losing money," says Rich Brenner, founder of the Brenner Group, a professional services firm providing financial and management services mainly for tech firms in Silicon Valley. "That is a concern for me."

Firms choosing to go public should "have a history of revenue and profit," Brenner says. "The cost of being a public company, the exposure on the public company and the pressure is so great that a company that hasn't made it on its own -- thinking they can be a successful public company is a big question mark if they're not ready."

That being said, experts say that Pandora's IPO will likely do well. It's in a hot sector, and the buzz is significant

"Investors will recognize the name and likely make a decision based on emotion rather than financial facts," Brenner says. "But is the company really ready to go public, when they're losing the amount of money they are? Is it the right time, or should they be raising a mezzanine round first?"

Brenner is concerned that more not-yet-profitable companies that have tasted a bit of success will follow the example and want to go public.

Small businesses should be able to meet certain thresholds before even considering going public, experts say.

"You don't want to be doing an IPO with a market cap below $100 million. The operating costs are just too high," says Joe Duran, CEO of United Capital Financial Partners, a wealth management firm in Newport Beach, Calif. He led the 2001 sale of Centurion Capital Management to GE Financial, a division of General Electric ( GE). It later became GE Private Asset Management.

Small companies may go public for several reasons. Some may have shareholders who want to monetize their interests, such as founding partners who want to cash in on a portion or all of their stakes, and some may want to raise money for growth.

Notwithstanding the past few years, and depending on the specific business, small-business owners typically can get a higher value for their company in the public markets than in the private markets, Duran says.

Experts say a company considering the public markets should be sure to have:
  • A minimum of $500 million to $1.5 billion in annual revenue.
  • Two to three quarters of profitability.
  • A compelling growth story, and a compelling reason for investors to buy the firm's stock.
  • A specific reason to want the money and a clear reason on how the money will be used.
  • A IPO deal seeking at least $50 million to $100 million.
  • A seasoned management team, including a chief financial officer experienced at public offerings, and strong board of directors.
  • Underwriters experienced in a firm's specific industry.

Beyond that a company should have "enough investor interest to create interest in the stock," Duran says.

"You need to be large enough and have a sustainable enough revenue stream to take this money to invest in future growth rather than just sustain the business you have. If the business is losing money and has no track for growth, no one will invest," Duran says.

Duran says businesses should not go public if:
  • It is too reliant on any one person.
  • The owner doesn't have a clear understanding of how the money will be invested.
  • There is no clear plan for growth.
  • The owner doesn't understand the increased regulatory environment and is not comfortable having a much more demanding shareholder.
  • The owner doesn't need the money.

Small firms should be prepared for 12 to 18 months of preparation "getting your house in order" before the actual IPO, Duran says, because what might be acceptable as a private company may not be good as a public company.

As far as picking an exchange, for the most part domestic companies should list their stock on a U.S. exchange, despite the fact that non-U.S. exchanges are less regulated.

There's a perception involved: Unless a company does significant business outside the U.S., by listing elsewhere, including on a Canadian exchange or one of the penny exchanges, "what you're saying is that were not good enough to be listed in America," Brenner says.

Picking between NYSE Euronext's ( NYX), the New York Stock Exchange or the Nasdaq Stock Market ( NDAQ) depends on how much the company is willing to pay for the listing and where competitors are listed.

As the markets return to pre-recession levels, the IPO market is also slowly returning. The IPO market had virtually shut down for a half-year ending in March 2009, and then only large, stable companies were able to successfully take their company public.

Investors are still fairly leery of small companies going public.

These days investors are looking to companies that have an eye on the future -- those pioneering in digital media, mobile technology, clean tech and alternative energy, says Kathleen Smith, principal of IPO investment and research firm Renaissance Capital.

"But the market still needs track records," Smith says. Unlike what happened in the dot-com bubble, when Internet companies were barely making revenue, let alone profit, the key is to have positive revenue and earnings.

"The only ones that have managed to get through that do have losses are the biotech firms," Smith says. "They really are a different category. Investors are willing to look at that, but many of these IPOs come at great discounts of what the companies are hoping to raise primarily because some venture capitalists who invest in biotech firms are very impatient and want liquidity fast."

Of the 24 U.S. IPOs that have priced this year, the average return has been 10.5%, according to Renaissance Capital's website. Seven were in the health care sector, primarily biotech.

Excluding biotech, small firms with deals over $50 million are outperforming the larger IPOs this year, Smith says.

Smith notes that of the five companies already trading below their IPO prices, four underwent IPOs of less than $50 million and three are biotech firms.
  • Of the five companies, Tornier (TRNX), an Amsterdam-based orthopedic device specialist, was the largest deal at $166 million. Still, the stock closed Tuesday at $18.45 -- below the $19 IPO price it announced Feb. 2.
  • AcelRx Pharmaceuticals (ACRX), which debuted Friday, priced 8 million shares at $5 per share -- well below its expected trading range. The IPO raised gross proceeds of about $40 million. The stock closed Tuesday at $4.31.
  • Trunkbow International Holdings (TBOW), a Beijing-based mobile application provider that began trading Feb. 3, also priced its stock below the previously expected trading range at $5 per share. The IPO raised gross proceeds of $20 million. The stock closed Tuesday at $4.62.
  • Pacira Pharmaceuticals (PCRX) priced its $32 million IPO at $7 a share Feb. 3. The stock closed on Tuesday at $6.91.
  • Kips Bay Medical (KIPS) of Minneapolis priced shares at $8, raising gross proceeds of about $16.5 million. The stock closed Tuesday at $7.93.

-- Written by Laurie Kulikowski in New York.

To contact the writer of this article, click here: Laurie Kulikowski.

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