NEW YORK (TheStreet) -- In ordinary times, an initial public offering for Pure Storage  (PSTG) would be a grand slam.

But when the the tech company opened for trading Wednesday morning, the stock immediately fell below its $17 offering price. That's a bad sign for tech IPOs, which haven't been having a stellar year anyway.

Pure Storage arrived on Wall Street blessed by both Goldman Sachs (GS) and Morgan Stanley (MS) , the two top technology banks out there. Its sales have shot up from $6.1 million in fiscal 2013 to $158.7 million in the first half of this year.

Its flash storage technology, which it says is cheaper and simpler than disk-based storage, is blessed by tech-analysis firm IDC, which said, "The use of flash in both servers and network-based storage is transforming how enterprise storage solutions are being built, and is an absolute requirement for organizations that are leveraging virtualization, cloud, and other [emerging] technologies and applications. "

So why has the response to Pure's IPO been been so lackluster?

Pure's shares were priced at $17, the midpoint of the pre-deal range of $16 to $18 a share, valuing the company at about $3.1 billion. That's little to no better than the $3 billion valuation that Pure -- one of the dozens of private tech companies with billion-dollar valuations that have become known as "unicorns" -- commanded in its last private financing round in 2014.

So the IPO isn't exactly the coronation the company and CEO Scott Dietzen may have been expecting. But that could create an opportunity for investors.

Golfers will understand what Pure did. Rather than try to make a tough shot for eagle, they laid up. By pricing the deal less than aggressively, Pure has given itself a clearer path to making money over time with less risk.

Pure's IPO is a clear sign of the collateral damage coming from the market's correction since July, and by extension from the troubles in Chinese stock markets that set off a global worryfest.

Normally, a deal that fits the Silicon Valley profile of an emerging, potentially great growth company as neatly as Pure does would price above the range and zoom higher when shares open. If not, it wouldn't go out. In this tougher market, Pure priced modestly.

If Pure trades moderately over the next few days, the risk-reward balance points to taking a chance on scooping up some of the money left on the table for yourself.



That the deal is a yawner isn't really Pure's fault. Only about 15 technology companies have gone public in the U.S. this year, said Kathleen Smith, president of Renaissance Capital, an IPO boutique firm in Greenwich, Conn.

"What does it take to get a tech valuation to work?" Smith asked rhetorically. "A low price.''

Financially, Pure is a pretty classic tech IPO. It is growing fast and losing money, like most big startups when they go public. (Facebook (FB) and Google (GOOGL) were prominent exceptions.) And Pure is disrupting a really large market, the $24 billion data storage business.

Pure's all-flash technology is working in some of the highest-valued segments of the storage market, said Suresh Vasudevan, CEO of rival Nimble Storage (NMBL) . The conflict with companies like Nimble boils down to what segment of that market the companies are targeting. Nimble is after the larger but slower-growing piece of the market that manages larger data sets and doesn't require such quick performance, using a combination of flash and disk-based technologies, Vasudevan said. And it has been managed to lose less money than Pure does, partly in a bow to the expectations of public investors these days, he added.

"Both of us are riding the trend that storage is being disrupted by flash," he said, at the expense of incumbents EMC (EMC)  and NetApp  (NTAP) .

Possibly in response to pressure from the market to stop losing as much money, Pure has dramatically cut its cash burn this year, its prospectus shows. Where it had $83 million in negative operating cash flow in the first half of fiscal 2015 -- Pure's fiscal year ends in January -- it burned only $44.5 million in the first half of this year. Under generally accepted accounting principles, its net loss of $113 million this year was actually bigger than the $95.2 million loss a year ago.

When times are good, investors snap up tech deals when they marry fast growth to improving gross profit margins and fast-narrowing losses -- a combination that Pure has. (In fairness, companies may wait for an IPO until they have either positive operating cash flow or earnings before interest, taxes and non-cash charges.)

Gross margins, or the percentage of each dollar of sales left over after actually making the product and/or delivering the service, rose to 59% in the first half of this year from 54% a year ago. So Pure can check off that box on the hot-deal checklist.

Pure has tapped the brakes on marketing and overhead spending that had been growing even faster than sales, containing its cash burn. Those expenses rose 58% to $135.8 million in the first half, trailing the 167% jump in revenue. The company's other big expense line, for research and development, rose 72% to $69.9 million.

The likely outcome? Pure keeps growing, the curve crosses into cash-flow profitability by early 2016, and net profits emerge fairly quickly after that.

To justify the $3 billion valuation -- Smith said it could be about $4 billion if you assume that all outstanding stock options are exercised soon -- Pure would need to make about $100 million a year. It could take less than that, considering the high valuation the market has assigned to other companies selling cloud-based network services, including Salesforce.com (CRM) and Athenahealth (ATHN) .



Barring something unforeseen, the growth of flash-based storage should deliver those profits and more, and reasonably soon.

In ordinary times, the hardest decision for potential Pure investors would be whether to buy shares after they rise sharply on the first day of trading. But in a market notably less tolerant of the risk an unprofitable startup poses, that first-day pop may not happen, and at least it's likely not to be as pronounced as it would be when investors are more optimistic.

Investors may also be wary based on Nimble's experience. Its shares have dropped to about $24 from a 2014 peak near $53, as early venture investors cashed out and the market became less receptive to money-losing growth companies, Vasudevan said. That happened even though Nimble has had narrower losses than analysts projected for each of the last four quarters.

Whether the IPO pops or not, Pure is a fast-growing company that is beginning to harvest the benefits of scale, which will grow predictably as Pure adds revenue. It is also spending money on the right things, as the big R&D budget suggests.

This is what a classically strong tech IPO looks like. And if a skittish market insists on valuing Pure's stock at a sale price, investors should snag some.

 

This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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