Twitter's secret IPO temptation

Could Twitter and Dropbox be the latest in a string of small tech companies to file for a 'secret' IPO?
That's what the speculation coming out of the US is hinting at as the controversial Jumpstart Our Business Startups (JOBS) Act appears to be hitting its mark.

Analysis from Ernst and Young and market intelligence company Ipreo shows the Act, controversially signed into law in April last year, is changing the appearance of the IPO pipeline in the US although perhaps not the quantity.

It's old news that Twitter is expected to file for an initial public offering sometime in 2013 or 2014 while Dropbox is said to be already meeting with bankers in preparation for a late 2013 listing.

An article by Quartz.com suggests Twitter might use the new rules that allow it to keep a lid on news that it's planning an IPO for up to 21 days before it starts the 'roadshow' IPO marketing process.

The JOBS Act was intended to help small companies create jobs and stem the decline in IPOs. It lets private companies with annual revenue of $1 billion or less, termed emerging growth companies, keep their company filings confidential until they are ready to market shares to investors instead of undergoing months of public analysis of their books.

Twitter earned $350 million in revenue in 2012 and isn't expected to hit the $1 billion mark until 2014, and Dropbox would be eligible as it's estimated to have made between $100 million and $240 million in revenue in 2011.

Twitter wasn't prepared to comment on "speculation" and Dropbox did not respond to enquiries.

Under the Act, emerging companies can also run the offer by large investors in private to gauge the market reaction to a potential IPO. They can also report two years of financial statements to the market instead of the usual five, don't need to conduct an outside audit on their internal controls for five years, and needn't register with the Securities and Exchange Commission until they have 2000 shareholders instead of the customary 500.

The Act was severely criticised last year for lowering the bar on investor protection – making it easier to conduct fraudulent activity and essentially allowing companies to be lazier in their market reporting.

Harvard Law School professor John Coates and Harvard Business School senior lecturer Robert Pozen wrote at the time in The Washington Post that, "the loosened regulations would make it easier for future Bernie Madoffs to create, say, 50 fake firms, steal $50 million from unsuspecting investors and retire to a tropical island".

However, despite the handy advantages – especially for technology companies seeking money from investors who still have the hype-to-horror of Facebook's IPO ringing in their ears – emerging growth company candidates are so far being selective about how much of the Act they use in order to gain investor confidence.

Business software company Eloqua, which listed in August, insisted on hiring an outside auditor straight away, and propylene producer Petrologistics said in its prospectus last May that it wouldn't take advantage of the more lax regulations. Software-simulator maker Exa Corp has forgone the external audit, however, because it will save the company $500,000 a year.

Ernst and Young data shows only 31 per cent of the emerging growth company IPOs it analysed opted to provide only the minimum two years of financial data. Sequoia Capital partner Roelof Botha told the Wall Street Journal that this preference for greater transparency would probably continue.

"If you have five years or so of financial history and you aren’t showing them all, the question becomes, why aren't you?” Botha says.

The Act also loosened the rules on crowdfunding by allowing companies to raise up to $1 million a year from unsophisticated investors without needing an IPO, provided they use SEC-accredited portals, and ended the prohibition on the general advertisement of private offerings.

But one of the biggest effects it's having is that the pipeline for IPOs looks much smaller than it has in the past.

"In contrast with a high level of activity in primary markets year-to-date, a bleak pipeline of only 28 IPOs provides little confidence in future deal volumes,” Ipreo said. The company pointed out that in the week to February 15, the value of public filings was $5 billion – the lowest amount since mid-2009.

Ernst and Young says this is down to companies taking advantage of the JOBS Act and keeping mum about their IPO plans; it expects the number of US IPOs in 2013 to equal that of last year in terms of size and sector.

In keeping with that view, separate data from Ipreo shows 61 of the 91 companies that went public between April and end-January did so under the new rules. In other words, investors wouldn't have known about 67 per cent of those IPOs until, at most, three weeks before the company began advertising the offer.

But the Act may yet prove ineffective in reinvigorating small company IPOs, according to Florida University professor Jay Ritter. In research released in December he said the number of listings fell between 2001 and 2011. This is because it's more profitable for small companies to sell themselves to larger ones, and small IPOs tend not to be very profitable. He says it's likely these conditions will continue to suppress small company IPOs.

Moreover for technology companies such as Dropbox and Twitter, they must take into account the trend over the past year of enterprise businesses being the ones setting the IPO sector on fire and not consumer-oriented companies – just look at the performance of online game maker Zynga and Facebook (losses of 67 per cent and 24 per cent respectively, from the public offer to Wednesday's opening price), compared to that of security software business Palo Alto Networks and management software company Workday (rises of 32 per cent and 84 per cent respectively).

Then again, Ipreo's data indicates that companies listing under the emerging growth tag performed better than those that didn't, with an average share rise of 28.9 per cent on the offer price compared to a 13.1 per cent rise. This is, however, likely because most of those companies were from high growth industries such as biotech, oil and gas, and technology.

If small companies are holding themselves to a higher standard than the JOBS Act rules allow, it may be a mistake for high profile companies such as a Twitter or Dropbox to take the more relaxed route to market as it would put a question marks over their credentials and suggest they have something to hide.

But although businesses may be eschewing some of the new rules in fear of undermining investor confidence, there's no doubt they're taking advantage of the lighter regulatory hand.

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