Why profits don’t matter for IPOs

The Wall Street Journal has a heads-up article in Monday’s paper that says the percentage of companies going public this year that aren’t yet profitable is higher than at any time since the dot-com bubble. (The article, here, is available for free.) The paper notes that there are differences from seven years ago, primarily the number (there are fewer) and diversity (more industries are represented) of IPOs. Still, the large presence of unprofitable companies asking investors to take a chance on them is rightly seen as a warning sign.

I made a similar observation and an identical conclusion about six prominent tech IPOs a year ago. (The article, “Return of the bubble: IPOs behaving badly,” appeared last May.) All but one were unprofitable. It’s worth looking briefly at how each has performed to help explain why money-losing companies are even able to go public. The only profitable company, DivX (DIVX), went public at $16, soared over $30, and recently has fallen back to its IPO price. Vonage (VG) has been a disaster, and Clearwire (CLWR) trades well below its offering price. Only Riverbed Technology (RVBD) has been a huge success. The reason? Although unprofitable at its IPO it was, and is, growing rapidly. (GoDaddy withdrew its IPO.)

I’ve written repeatedly that I have faith in the U.S. capital markets and that companies will continue to want to go public here. The Journal’s new study and the presence of even one star from that group of six confirm the thesis. Should investors be nervous about unprofitable companies going public? Sure. They should be nervous about any untested company. That’s why the market is risky. But the companies are going public all the same. That’s good.

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