Is it time to play "pop goes the IPO" again?
It's been six years since a technology IPO popped up like network-storage play
did last Friday. The offering listed at $13 a share, but after being oversubscribed because of big money managers lining up to get in on the money-losing company, it surged to $22.85 that day. That's a 76% gain on Isilon's
The last time a stock rose that much on its first day was
back in November 2000. Transmeta rose to $46 on its first day of trading, above the offering price of $19. It's now trading at $1.11.
Yet after a weekend to think over its exuberance, Wall Street decided that Isilon's gain was perfectly reasonable. The stock didn't lose any ground but has added a few more points to its gains, and was trading at $25.77 Friday.
So it's looking like 1999 all over again, right? A money-losing company surges on going public? Not exactly. It's a little more complex than that. First of all, Isilon may be the best-performing technology IPO of 2006, but it's not the best performing IPO -- or even the second-best.
Those distinctions belong, respectively, to financial exchange
and McDonald's spinoff
Chipotle Mexican Grill
Second, Isilon was oversubscribed and remains in demand despite its first-day pop in part because money managers genuinely like the company. Isilon is a storage story with a twist. Storage, of course, has been reliably growing industry for some time, dominated by companies such as
Research firm IDG estimates that the storage industry will grow from $17.4 billion last year to $22.1 billion in 2010. But Isilon's corner of the industry -- digital storage -- will grow much faster.
Another research firm, Enterprise Strategy Group, says that demand for disk-based digital archiving, an area Isilon is focusing on, will grow 96% during the same period.
Much of that demand for digital content will be coming from media companies, whether they be
with its customers' digital photos or
with streaming movies. But digital storage will also serve other industries' needs, such as seismic images for oil companies, DNA sequencing at bioscience companies and even satellite images for the federal government.
And Seattle-based Isilon is signing up new customers -- 184 over the past year and 63 alone in the quarter ended Oct. 1:
sprawling MySpace unit is using Isilon's technology for MP3 and video streaming; and Movielink, a movie-download joint venture involving the top five film studios, is relying on Isilon's clustered-storage systems, as is Cedars-Sinai Medical Center.
Isilon's systems' edge is that they are remarkably easy to scale up. When customers have a surge in demand for their digital content, Isilon's technology can let them add to a storage cluster with a minimum of cost, IT staff time and negative impact on performance.
That's a big reason why the company is winning rave reviews as well as clients. Isilon has "the easiest storage system out of the gate and over its life cycle," Tony Asaro wrote on
"Isilon ushers in a next-generation storage system that uses commodity hardware and focuses heavily on its software capability and architecture. They can potentially reinvent the way storage is done," he wrote.
And from a financial perspective, Isilon looks, if not perfect, then promising. A shrewd investor never likes to buy into an IPO of a company in the red. But in its favor, Isilon's margins, while negative, have been edging closer to positive territory in each passing year.
Research and development expenses fell to 28% of revenue in the first nine months of this year, down from 72% a year before. Marketing expenses fell to 41% of revenue in the period from 59% a year before, and sales and administrative fell to 12% from 21%.
The risk in buying a newly public company that has lost money to date is, of course, that in spending the capital it has raised, the company drops further into the red as its expenses mount faster than revenue.
Only a small fraction of the $105 million Isilon raised is going to pay down existing debt; the rest will finance future growth.
But here, too, Isilon offers some comfort. Revenue has been skyrocketing much faster than the company has been spending money -- tripling in 2005 and rising 236% in the first nine months of 2006.
That speaks to strong demand for its storage systems that's unlikely to abate even as the company hires new sales and R&D staff.
And while 27% of Isilon's revenue currently come from two customers -- Comcast and Kodak -- the company has been steadily diversifying its revenue base. Some 20% of revenue comes from overseas, up from 14% last year and 3% two years ago. Similarly, revenue through channel partners (as opposed to direct sales) increased from 6% in 2004 to 27% in 2005 and 41% in the first nine months of 2006.
Though Isilon seems to be at a rarefied level by some metrics (it's trading at 28 times its trailing 12-month sales) the stock may be appealing as a long-term holding in an era where digital-storage demand is ever-growing.
At first blush, Isilon's first-day pop may not as scary as it looks. But if less-promising IPOs start to see similar pops, we may be in trouble.