Current Trends in IPOs

Our Survey

In 2007, Mergermarket was commissioned by Nixon Peabody LLP to conduct 'IPO Executive Insights 2007,' a survey of senior corporate executives (CEOs and CFOs) of 100 companies that had undertaken an IPO in the past three years (the 'Survey'). The Survey was designed to provide insights into key IPO market trends and issues related to the process of going public in the current regulatory environment that emerged after the passage of the Sarbanes-Oxley Act of 2002 ('SOX'). Respondents in the Survey are relatively bullish about the expected number of IPOs in the next 12 months. For example, 79% of such respondents predict an increase in the number of IPOs or believe that the number will remain at the current level.

The Emergence of a Three-Legged Market

Currently, the IPO market is a 'three-legged' one, driven by the following three main sources: 1) spin-offs from major corporations (many funded by private equity); 2) companies that were previously taken private by private equity groups and have returned to the public markets; and 3) growth companies (mostly venture capital-backed). Many experts believe that these three 'legs' and the diversity among the companies going public is a sign of a healthy market. One of the key factors pushing private equity-backed companies to the public market is the size of the deals backed by private equity. Although private equity groups are acquiring companies funded by other private equity groups, the use of the public market is the only viable exit for some large deals. The healthy public market also opens opportunities for other private equity backed companies and it is having a positive impact on valuations. The growth companies coming to market are also different than in the late 1990s, when many immature companies conducted IPOs. Now, those types of companies are in the private market obtaining private money. Currently, growth companies with seasoned and proven management and stable, profitable business models are entering the public markets

Investor Perspectives Are Changing

With investors looking for high growth investments, emerging markets are receiving substantial attention. For example, emerging markets as an asset class were up 30%-40% last year as opposed to established global markets, which were up 15%-19%. Institutional investors are now much more comfortable investing in regional exchanges as opposed to just the U.S. and London exchanges. For example, in 2006, IPOs from Brazil, Russia, India and China raised U.S. $86.5 billion via 279 deals. In addition to traditional institutional investors, the enormous expansion of private equity has been one of the most far-reaching trends. With the capital markets saturated with cash and cheap debt, private equity firms have become key players in the IPO and M&A markets. Similarly, hedge funds have raised record amounts of cash in the last several years. These investors are aggressively looking to put that money to work and are searching the world for opportunities.

The Globalization of Capital

From 2001 to 2003, as the economies of emerging markets began growing rapidly, capital began migrating from developed economies to emerging markets, fueling the global rebound in IPO activity that continues in 2007. As the number of viable, flourishing economies increases, so does the number of capital markets. Capital is global today and most large investors are comfortable investing in any market in the world. In North America, Europe, Japan and elsewhere in the world, investors have greatly increased their asset allocations toward emerging markets. Dual listings are common as well as transactions in which a company will list on a foreign exchange and still access the U.S. capital markets through a Rule 144A deal (a private placement with large qualified institutional investors). In these transactions, issuers can avoid registration with the U.S. Securities and Exchange Commission ('SEC') and compliance with SOX, while still accessing the U.S. capital markets. In addition to U.S. companies engaging in Rule 144A transactions, companies from Brazil, India and China are becoming the leaders in using this mechanism. For example, the IPO of Industrial and Commercial Bank of China ('ICBC') was accompanied by a Rule 144A private placement. As trade continues to become more global, more and more investors are thinking globally as well. For instance, in the U.S., 21% of portfolios are invested outside of the country. In addition, global asset managers have relocated people, capital and resources into China and elsewhere as they manage larger, dedicated pools of capital focused on particular regions.

Increased Competition Between Stock Exchanges

In 2006, Europe's exchanges raised the most funds with 39% of the total led by many cross-border issuers listing in London. For example, the Russian energy company Rosneft raised U.S. $10.6 billion in its IPO on the London Stock Exchange ('LSE'). Asia Pacific exchanges, fueled by the Chinese 'mega-deals,' came in second with 35% of the total and North American exchanges followed in third place with 19% of the total. As for IPO activity on specific exchanges, the Hong Kong Exchange ('HKSE') led with 19% of the global capital raised (U.S. $46.1 billion), the LSE came in second with 13.5% of the total value (U.S. $33.3 billion), and the New York Stock Exchange ('NYSE') placed third with 10% of the total (U.S. $24.5 billion). At this point, the world's top exchanges must compete with each other for prime listings, especially from emerging markets. Although 75% of the top 25 IPOs did Rule 144A placements in 2006, only two of the top 25 IPOs listed on a U.S. stock exchange. The success of the ICBC offering without a U.S. or European listing was a major development and sign of the increasing liquidity around the world. Ten years ago, global companies were compelled to have a NYSE listing as part of their offerings. Now, global companies are increasingly avoiding the U.S. and the number of non- U.S. issuers listing in the U.S. has decreased. Historically, the U.S. stock exchanges had the advantages of having the best liquidity with transparency, proper disclosure, straightforward accounting rules and other positive traits. The increased liquidity of the European markets combined with the cost of SOX compliance and the litigious nature of the U.S. investor has changed this perception. The Toronto Stock Exchange was a major beneficiary of SOX as U.S. mining and energy companies opted to go public on this exchange as opposed to any of the U.S.'s exchanges.

Furthermore, the NYSE merger with Euronext is a sign of the increased competition between exchanges. The merger created the only transatlantic exchange. This competition has been taking place in the U.S. for some time as the NYSE, American Stock Exchange and NASDAQ battled for prime listings. The Survey revealed that 42% of the respondents to the Survey listed on NASDAQ and 36% listed on the NYSE. Such competition is expected to expand globally with more consolidation in sight. Like many products and services, the choice of exchange is being reduced to location, regulation, cost and convenience. At the moment, the U.S. market is still the most open, with stability of value over the long term. Over a period of time, a given sector in the U.S. will generally trade at a premium to the same sector
in the European market. As a result of this competition, all exchanges will continue to evolve and improve.

The Availability Of Capital-Raising Options

Today, companies have a wide variety of capital raising alternatives including bootstrapping, angel investors, venture capital, private equity, merger and acquisitions, reverse merger followed by a PIPE and an IPO. Rarely, if ever, have the number of viable alternatives to companies been as attractive as they are in 2007. When the equity markets are strong, the best value is often going to be realized by an IPO. However, when the equity markets are not as strong, the M&A exit is often the most attractive. From 2002 through 2005, the moribund IPO market left M&A as the main ' if not the only ' exit strategy for growth companies. Currently, 'dual-tracking' is the trend, which allows companies to pursue an IPO while at the same time leaving the company open to be acquired. This strategy is intended to maximize negotiating leverage.

Similarly, the competition between private equity groups is intense, which is creating a seller's market for quality companies. Today, in light of the strong IPO market, investment from private equity groups is often seen as a launch pad toward a future IPO. Experts predict many more IPO's as middle market companies acquired by private equity firms grow and the number of public companies taken private by private equity groups increases. The value of companies taken private in 2006 was U.S. $150 billion, a new record.

Challenges in the IPO Process Continue

Notwithstanding the strong IPO market in the U.S. and abroad, the IPO process remains challenging. Many of the executives that participated in the Survey responded that they did not have enough time to operate the business during the IPO process. One of the continuing challenges during the IPO process is for management to find the time and energy to operate the company, focus on customers and the like while trying to deal with investment bankers, auditors, attorneys, registration statement drafting sessions, due diligence, road shows and other aspects of the IPO process. Moreover, a related issue is market timing. Many of those surveyed believed that the timing was not quite right. For example, one respondent thought the IPO process would be done in approximately 4-6 months, but it took well over a year. Another continuing challenge is attracting independent board members. Although serving on the board of directors of a publicly traded company may be prestigious, many qualified people, concerned about potential legal liability shy away from such positions. Attracting independent board members has always been difficult. Moreover, the enactment of SOX has only exacerbated this challenge. For example, 73% of the respondents to the Survey deemed SOX regulation excessive and 18% view SOX compliance as the most challenging accounting issue faced during the IPO process. In that regard, approximately 20% of the respondents to the Survey identified the auditing of prior accounting periods by new auditors as a major difficulty. The difficulty arises from a variety of factors including disagreements between auditors, the additional expense and lack of incentive of the prior auditor to cooperate. Accordingly, growth companies must use care in selecting their auditors. Dealing with related-party transactions is another challenge. In the early years of a company's life, related-party transactions are common. Founders often loan money to the company, accrue salary, do business with other companies in which they or family members have an interest, issue themselves options and set their own salaries. Many of these legacy transactions must be dealt with prior to the IPO. Finally, 'cheap' stock issuances, a more recent issue to catch the attention of the SEC, plagued a number of the respondents to the Survey.

Conclusion

The globalization of capital and the impact of this overriding reality is the trend dominating the public equity markets. This globalization shows no sign of slowing. In fact, it appears to be accelerating. The good news is that the globalization of capital and evolution of the stock markets in emerging companies has created opportunity for the attainment of wealth and security by those who have previously not had access to the market. For example, take the situation in China, where the opportunity has been created for people in the new middle class to line up to invest in companies trading on the Shanghai Stock Exchange. The challenge is that risk and reward always go hand in hand and that which goes up often comes down.

Furthermore, as stated above, today's public markets and the surrounding environments are radically different than the IPO markets of the late 1990s. The standards to go public have become stricter, the quality of the newly public companies is higher, the disclosure requirements are greater and capital-raising alternatives may never have been better. As a result, it is no surprise that 82% of the respondents in the Survey believed that the current market conditions in North America are favorable for IPOs.

James C. Chapman is a partner in the Palo Alto, CA, office of Nixon Peabody LLP. He has focused on securities law, venture capital, mergers and acquisitions, and international business transactions for the past 20 years, having been involved in more than 150 mergers, acquisitions, and financing transactions. Michael Schachter is an associate with Nixon Peabody's Firms Venture Capital Emerging Growth and Technology group, where he represents a broad range of companies, from early stage to publicly traded companies.

Going public is like standing in front of an X-Ray machine forever. You are completely exposed. Everything about the business is in the public domain and in front of the competition. ' Anonymous CEO

In 2006, high investor confidence fueled a worldwide market for Initial Public Offerings ('IPO' or 'IPOs'). The amount of capital raised worldwide by companies going public rose to a record U.S. $246 billion. The number of new listings also rose sharply to 1729, which is the highest number in a calendar year since 2000. Moreover, Global IPOs in the first quarter of 2007 raised U.S. $36.5 billion through 371 IPOs. Globally, such numbers reflect that a wide diversity of companies are going public.

The United States IPO market is also robust. Notwithstanding the market's current volatility as a result of the chaos in the sub-prime credit market, a good company with strong operating and financial performance, even if it's not in the most active sectors, will find a receptive IPO market. For example, according to Dow Jones VentureOne, in the second quarter of 2007, U.S. venture-backed companies raised $2.73 billion through 22 companies going public in that period, which was more than double the aggregate amount raised in the same period last year, and the highest quarterly amount raised since the third quarter of 2000. The year 2006 was also a good one for IPOs in the U.S., with 187 deals raising U.S. $34.1 billion. One-third of all U.S. IPOs were venture backed, which underscores the key role of the U.S. venture capital industry. Furthermore, private equity had a major role as well. For example, in 2006, 34% of the IPO proceeds and 27% of IPOs were attributed to companies that engaged in private equity backed buy-outs. In the U.S., IPO activity is expected to be led by health care, e-commerce, financial services and energy companies.

Our Survey

In 2007, Mergermarket was commissioned by Nixon Peabody LLP to conduct 'IPO Executive Insights 2007,' a survey of senior corporate executives (CEOs and CFOs) of 100 companies that had undertaken an IPO in the past three years (the 'Survey'). The Survey was designed to provide insights into key IPO market trends and issues related to the process of going public in the current regulatory environment that emerged after the passage of the Sarbanes-Oxley Act of 2002 ('SOX'). Respondents in the Survey are relatively bullish about the expected number of IPOs in the next 12 months. For example, 79% of such respondents predict an increase in the number of IPOs or believe that the number will remain at the current level.

The Emergence of a Three-Legged Market

Currently, the IPO market is a 'three-legged' one, driven by the following three main sources: 1) spin-offs from major corporations (many funded by private equity); 2) companies that were previously taken private by private equity groups and have returned to the public markets; and 3) growth companies (mostly venture capital-backed). Many experts believe that these three 'legs' and the diversity among the companies going public is a sign of a healthy market. One of the key factors pushing private equity-backed companies to the public market is the size of the deals backed by private equity. Although private equity groups are acquiring companies funded by other private equity groups, the use of the public market is the only viable exit for some large deals. The healthy public market also opens opportunities for other private equity backed companies and it is having a positive impact on valuations. The growth companies coming to market are also different than in the late 1990s, when many immature companies conducted IPOs. Now, those types of companies are in the private market obtaining private money. Currently, growth companies with seasoned and proven management and stable, profitable business models are entering the public markets

Investor Perspectives Are Changing

With investors looking for high growth investments, emerging markets are receiving substantial attention. For example, emerging markets as an asset class were up 30%-40% last year as opposed to established global markets, which were up 15%-19%. Institutional investors are now much more comfortable investing in regional exchanges as opposed to just the U.S. and London exchanges. For example, in 2006, IPOs from Brazil, Russia, India and China raised U.S. $86.5 billion via 279 deals. In addition to traditional institutional investors, the enormous expansion of private equity has been one of the most far-reaching trends. With the capital markets saturated with cash and cheap debt, private equity firms have become key players in the IPO and M&A markets. Similarly, hedge funds have raised record amounts of cash in the last several years. These investors are aggressively looking to put that money to work and are searching the world for opportunities.

The Globalization of Capital

From 2001 to 2003, as the economies of emerging markets began growing rapidly, capital began migrating from developed economies to emerging markets, fueling the global rebound in IPO activity that continues in 2007. As the number of viable, flourishing economies increases, so does the number of capital markets. Capital is global today and most large investors are comfortable investing in any market in the world. In North America, Europe, Japan and elsewhere in the world, investors have greatly increased their asset allocations toward emerging markets. Dual listings are common as well as transactions in which a company will list on a foreign exchange and still access the U.S. capital markets through a Rule 144A deal (a private placement with large qualified institutional investors). In these transactions, issuers can avoid registration with the U.S. Securities and Exchange Commission ('SEC') and compliance with SOX, while still accessing the U.S. capital markets. In addition to U.S. companies engaging in Rule 144A transactions, companies from Brazil, India and China are becoming the leaders in using this mechanism. For example, the IPO of Industrial and Commercial Bank of China ('ICBC') was accompanied by a Rule 144A private placement. As trade continues to become more global, more and more investors are thinking globally as well. For instance, in the U.S., 21% of portfolios are invested outside of the country. In addition, global asset managers have relocated people, capital and resources into China and elsewhere as they manage larger, dedicated pools of capital focused on particular regions.

Increased Competition Between Stock Exchanges

In 2006, Europe's exchanges raised the most funds with 39% of the total led by many cross-border issuers listing in London. For example, the Russian energy company Rosneft raised U.S. $10.6 billion in its IPO on the London Stock Exchange ('LSE'). Asia Pacific exchanges, fueled by the Chinese 'mega-deals,' came in second with 35% of the total and North American exchanges followed in third place with 19% of the total. As for IPO activity on specific exchanges, the Hong Kong Exchange ('HKSE') led with 19% of the global capital raised (U.S. $46.1 billion), the LSE came in second with 13.5% of the total value (U.S. $33.3 billion), and the New York Stock Exchange ('NYSE') placed third with 10% of the total (U.S. $24.5 billion). At this point, the world's top exchanges must compete with each other for prime listings, especially from emerging markets. Although 75% of the top 25 IPOs did Rule 144A placements in 2006, only two of the top 25 IPOs listed on a U.S. stock exchange. The success of the ICBC offering without a U.S. or European listing was a major development and sign of the increasing liquidity around the world. Ten years ago, global companies were compelled to have a NYSE listing as part of their offerings. Now, global companies are increasingly avoiding the U.S. and the number of non- U.S. issuers listing in the U.S. has decreased. Historically, the U.S. stock exchanges had the advantages of having the best liquidity with transparency, proper disclosure, straightforward accounting rules and other positive traits. The increased liquidity of the European markets combined with the cost of SOX compliance and the litigious nature of the U.S. investor has changed this perception. The Toronto Stock Exchange was a major beneficiary of SOX as U.S. mining and energy companies opted to go public on this exchange as opposed to any of the U.S.'s exchanges.

Furthermore, the NYSE merger with Euronext is a sign of the increased competition between exchanges. The merger created the only transatlantic exchange. This competition has been taking place in the U.S. for some time as the NYSE, American Stock Exchange and NASDAQ battled for prime listings. The Survey revealed that 42% of the respondents to the Survey listed on NASDAQ and 36% listed on the NYSE. Such competition is expected to expand globally with more consolidation in sight. Like many products and services, the choice of exchange is being reduced to location, regulation, cost and convenience. At the moment, the U.S. market is still the most open, with stability of value over the long term. Over a period of time, a given sector in the U.S. will generally trade at a premium to the same sector
in the European market. As a result of this competition, all exchanges will continue to evolve and improve.

The Availability Of Capital-Raising Options

Today, companies have a wide variety of capital raising alternatives including bootstrapping, angel investors, venture capital, private equity, merger and acquisitions, reverse merger followed by a PIPE and an IPO. Rarely, if ever, have the number of viable alternatives to companies been as attractive as they are in 2007. When the equity markets are strong, the best value is often going to be realized by an IPO. However, when the equity markets are not as strong, the M&A exit is often the most attractive. From 2002 through 2005, the moribund IPO market left M&A as the main ' if not the only ' exit strategy for growth companies. Currently, 'dual-tracking' is the trend, which allows companies to pursue an IPO while at the same time leaving the company open to be acquired. This strategy is intended to maximize negotiating leverage.

Similarly, the competition between private equity groups is intense, which is creating a seller's market for quality companies. Today, in light of the strong IPO market, investment from private equity groups is often seen as a launch pad toward a future IPO. Experts predict many more IPO's as middle market companies acquired by private equity firms grow and the number of public companies taken private by private equity groups increases. The value of companies taken private in 2006 was U.S. $150 billion, a new record.

Challenges in the IPO Process Continue

Notwithstanding the strong IPO market in the U.S. and abroad, the IPO process remains challenging. Many of the executives that participated in the Survey responded that they did not have enough time to operate the business during the IPO process. One of the continuing challenges during the IPO process is for management to find the time and energy to operate the company, focus on customers and the like while trying to deal with investment bankers, auditors, attorneys, registration statement drafting sessions, due diligence, road shows and other aspects of the IPO process. Moreover, a related issue is market timing. Many of those surveyed believed that the timing was not quite right. For example, one respondent thought the IPO process would be done in approximately 4-6 months, but it took well over a year. Another continuing challenge is attracting independent board members. Although serving on the board of directors of a publicly traded company may be prestigious, many qualified people, concerned about potential legal liability shy away from such positions. Attracting independent board members has always been difficult. Moreover, the enactment of SOX has only exacerbated this challenge. For example, 73% of the respondents to the Survey deemed SOX regulation excessive and 18% view SOX compliance as the most challenging accounting issue faced during the IPO process. In that regard, approximately 20% of the respondents to the Survey identified the auditing of prior accounting periods by new auditors as a major difficulty. The difficulty arises from a variety of factors including disagreements between auditors, the additional expense and lack of incentive of the prior auditor to cooperate. Accordingly, growth companies must use care in selecting their auditors. Dealing with related-party transactions is another challenge. In the early years of a company's life, related-party transactions are common. Founders often loan money to the company, accrue salary, do business with other companies in which they or family members have an interest, issue themselves options and set their own salaries. Many of these legacy transactions must be dealt with prior to the IPO. Finally, 'cheap' stock issuances, a more recent issue to catch the attention of the SEC, plagued a number of the respondents to the Survey.

Conclusion

The globalization of capital and the impact of this overriding reality is the trend dominating the public equity markets. This globalization shows no sign of slowing. In fact, it appears to be accelerating. The good news is that the globalization of capital and evolution of the stock markets in emerging companies has created opportunity for the attainment of wealth and security by those who have previously not had access to the market. For example, take the situation in China, where the opportunity has been created for people in the new middle class to line up to invest in companies trading on the Shanghai Stock Exchange. The challenge is that risk and reward always go hand in hand and that which goes up often comes down.

Furthermore, as stated above, today's public markets and the surrounding environments are radically different than the IPO markets of the late 1990s. The standards to go public have become stricter, the quality of the newly public companies is higher, the disclosure requirements are greater and capital-raising alternatives may never have been better. As a result, it is no surprise that 82% of the respondents in the Survey believed that the current market conditions in North America are favorable for IPOs.

James C. Chapman is a partner in the Palo Alto, CA, office of Nixon Peabody LLP. He has focused on securities law, venture capital, mergers and acquisitions, and international business transactions for the past 20 years, having been involved in more than 150 mergers, acquisitions, and financing transactions. Michael Schachter is an associate with Nixon Peabody's Firms Venture Capital Emerging Growth and Technology group, where he represents a broad range of companies, from early stage to publicly traded companies.