September 16, 2015 Volume XLI, Issue VII & VIII

Introduction

Introduction: Exploring the Current IPO Market in Historical Context

As we explored potential topics for this summer’s issue, we were drawn to the market for several reasons. For one, IPO activity has historically served as a reasonably good proxy for overall investor sentiment. At times of particular frenzied IPO activity, this has also served as a useful warning light,flashing caution to alert investors that danger lurks ahead. We are not sure whether the light is turning red or just flashing yellow at this point, but as detailed later in this report there are at least pockets of concern. As illustrated below, IPO volume exceeded $74 billion in 2014 or 72% above levels reached during the last stock market peak in 2007. In fact, last year’s IPO dollar volume has only been breached in one prior periodand 2000 during the peak of the technology bubble. For some per2000 or 45% above 2014 levels—and even greater in real dollars or as a percentage of GDP. year’s total was inflated by Alibaba’s recordmarkedly in 2015 to date (volume down by 45% through midcompanies waiting in the IPO wings if market conditions settle etc.) that could boost 2015 totals, the recent market correction remain muted in the coming quarters.

U.S. IPO Count and Volume, 1996

Source: SEC filings via WilmerHale

While this suggests we are not necessarily in the midst of anotunique dynamics behind the recent activity that could portend trouble in the years ahead. In particular, venture capital funding (up 61% in 2014 and another 27% in 1H 2015) has continued to grow at seemingly unsustainably high rates. Previously unseen megavaluations reaching as high as $50 billion, have seized the ground once ruled by the IPO market. Presumably, at some point these companies will have to come public,the stock market (to provide liquidity and support private valuations) or require large writeinvestors. This could test the recently dominant VC philosophy that seems to have placedprofitability at any cost.

We also believe this is a potentially instructive topic given the changing dynamics in terms of sector concentration. Technology/Internet companies

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Introduction – Initial Public Offerings

Introduction: Exploring the Current IPO Market in Historical Context

As we explored potential topics for this summer’s issue, we were drawn to the initial public offering (IPO) market for several reasons. For one, IPO activity has historically served as a reasonably good proxy for overall investor sentiment. At times of particular frenzied IPO activity, this has also served as a useful warning light,flashing caution to alert investors that danger lurks ahead. We are not sure whether the light is turning red or just flashing yellow at this point, but as detailed later in this report there are at least pockets of concern. As

me exceeded $74 billion in 2014 or 72% above levels reached during the last stock market peak in 2007. In fact, last year’s IPO dollar volume has only been breached in one prior periodand 2000 during the peak of the technology bubble. For some perspective, IPO volume reached $108 billion in

and even greater in real dollars or as a percentage of GDP. year’s total was inflated by Alibaba’s record-setting $21.7 billion IPO in September and IPO activity h

down by 45% through mid-September). Although there are several large if market conditions settle (potentially including First Data,

the recent market correction has dulled investor optimism

U.S. IPO Count and Volume, 1996-2014

While this suggests we are not necessarily in the midst of another bubble formation, there are also unique dynamics behind the recent activity that could portend trouble in the years ahead. In particular, venture capital funding (up 61% in 2014 and another 27% in 1H 2015) has continued to grow at seemingly

ly high rates. Previously unseen mega-funding rounds totaling $500 million or greater, with valuations reaching as high as $50 billion, have seized the ground once ruled by the IPO market. Presumably, at some point these companies will have to come public, which likely will demand either valuation expansion in the stock market (to provide liquidity and support private valuations) or require large writeinvestors. This could test the recently dominant VC philosophy that seems to have placed

We also believe this is a potentially instructive topic given the changing dynamics in terms of sector companies are no longer the leading participants in the IPO market, with

initial public offering (IPO) market for several reasons. For one, IPO activity has historically served as a reasonably good proxy for overall investor sentiment. At times of particular frenzied IPO activity, this has also served as a useful warning light, flashing caution to alert investors that danger lurks ahead. We are not sure whether the light is turning red or just flashing yellow at this point, but as detailed later in this report there are at least pockets of concern. As

me exceeded $74 billion in 2014 or 72% above levels reached during the last stock market peak in 2007. In fact, last year’s IPO dollar volume has only been breached in one prior period—in 1999

spective, IPO volume reached $108 billion in and even greater in real dollars or as a percentage of GDP. Furthermore, last

IPO activity has cooled Although there are several large

otentially including First Data, Ferrari, Petco, investor optimism and activity may

her bubble formation, there are also unique dynamics behind the recent activity that could portend trouble in the years ahead. In particular, venture capital funding (up 61% in 2014 and another 27% in 1H 2015) has continued to grow at seemingly

funding rounds totaling $500 million or greater, with valuations reaching as high as $50 billion, have seized the ground once ruled by the IPO market. Presumably,

which likely will demand either valuation expansion in the stock market (to provide liquidity and support private valuations) or require large write-downs for private investors. This could test the recently dominant VC philosophy that seems to have placed revenue growth over

We also believe this is a potentially instructive topic given the changing dynamics in terms of sector are no longer the leading participants in the IPO market, with

To receive a complimentary report of a company featured in this issue please email Jonathan Boyar at

jboyar@boyarvaluegroup.com.

Introduction

biotech, consumer (notably including many restaurants in the new breed of “fast casual” chains), and energy taking on larger roles. The number of health care (principally pharma/biotech) IPOs tripled from 34 in 2005 to 102 in 2014, according to research from Renaaverage first day return of 18.6%. Biotech investors, beware. These dynamics also seem to further confirm the looming presence of highly-valued private, venturemarket in the coming years.

IPO Industry Breakdown (

Industry Number of

Deals

Health Care

Financial

Technology

Consumer

Energy

Capital Goods & Services

Business Services

Materials

Transportation

Communications

Source: Renaissance Capital

How are we to build a constructive investment around a topic that raises such concern? Not only are the

current conditions fairly unattractive, but as we detail, academic research supports consistent underperformance of new stock issues looking over a multripe for shorting, unfortunately we are principally a longinflated IPOs to stay that way for an extended period in overheated marketcosts (with annual rates currently exceeding 100% for some of the biggest name IPOs a difficult business. However, the high volatility of IPOs suggests discerning stock pickers can do well byavoiding “hot” sectors or stocks and identifying overlooked, high quality issues. In particular, we believe high quality companies that have been unfairly punished due to temporary or nonan attractive source of undervalued investment ideas in an otherwise challenging market climate. Additionally, academic research does suggest some categories of new stock listings do tend to outperform, such as reof companies previously taken private and post

Notably, while we entered the summer seeing extremely strong IPO performance and an overabundance of highly valued IPOs, the recent market correction has stung IPOs particularly badly. While our summer theme often tends to be early in calling market turns,of a trend. Since the start of 2015, the Bloomberg IPO Index has already declined 20% versus 5% for the S&P 500—signaling bear market conditions for IPOs. The number of broken IPOs (IPOs trading below theprice) has swelled drastically; according to (minimum IPO offer amount of $50 million) since the start of 2012 are under their IPO price including 25 of 63 IPOs (40%) from 2015. We estimate an even greater S&P 500 since issuance. The median underperformance from these “dogs”? Fortyannualized). In the appendix to this report, we have provided a list of all IPOs smarket cap of $500 million) as well as two sorts that may be of interest: “broken” IPOs and those with the highest short interest. On one hand, the recent poor performance from IPOs has provided greater opportunity for bargain hunters. On the other hand, considering a majority of IPOs underperform over the long term, we wonder whether the worst is yet to come.

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, consumer (notably including many restaurants in the new breed of “fast casual” chains), and energy taking on larger roles. The number of health care (principally pharma/biotech) IPOs tripled from 34 in 2005 to 102 in 2014, according to research from Renaissance. There were 58 health care IPOs in 2015 to date with an average first day return of 18.6%. Biotech investors, beware. These dynamics also seem to further confirm the

valued private, venture-backed Internet/tech companies that could pressure the IPO

IPO Industry Breakdown (YTD Sep. 15, 2015)

Number of Deals

Total Proceeds

Average First Day Return Total Return

58 $5.1 bil 18.6%

17 $2.2 bil 6.2%

15 $2.6 bil 21.6%

13 $3.1 bil 31.4%

12 $5.5 bil 2.9%

6 $0.9 bil 16.8%

3 $1.3 bil 11.2%

3 $0.9 bil 4.6%

3 $0.7 bil -3.4%

1 $0.1 bil -15.8%

How are we to build a constructive investment around a topic that raises such concern? Not only are the current conditions fairly unattractive, but as we detail, academic research supports consistent underperformance of new stock issues looking over a multi-decade timeframe. While we believe the recent IPO market has been ripe for shorting, unfortunately we are principally a long-only research publication. Further, the propensity for inflated IPOs to stay that way for an extended period in overheated markets combined with often high borrowing costs (with annual rates currently exceeding 100% for some of the biggest name recent IPOs) makes shorting IPOs a difficult business. However, the high volatility of IPOs suggests discerning stock pickers can do well byavoiding “hot” sectors or stocks and identifying overlooked, high quality issues. In particular, we believe high quality companies that have been unfairly punished due to temporary or non-fundamental issues could present

d investment ideas in an otherwise challenging market climate. Additionally, academic research does suggest some categories of new stock listings do tend to outperform, such as reof companies previously taken private and post-bankruptcy relistings.

Notably, while we entered the summer seeing extremely strong IPO performance and an overabundance of highly valued IPOs, the recent market correction has stung IPOs particularly badly. While our summer theme often tends to be early in calling market turns, this year we may even be slightly behind the start of a trend. Since the start of 2015, the Bloomberg IPO Index has already declined 20% versus 5% for the S&P

signaling bear market conditions for IPOs. The number of broken IPOs (IPOs trading below theprice) has swelled drastically; according to AAF estimates, a staggering 260 of 578 (45%) currently traded IPOs (minimum IPO offer amount of $50 million) since the start of 2012 are under their IPO price including 25 of 63

We estimate an even greater 49% of IPOs (2012-present) have underperformed the The median underperformance from these “dogs”? Forty

In the appendix to this report, we have provided a list of all IPOs since 2012 (minimum current market cap of $500 million) as well as two sorts that may be of interest: “broken” IPOs and those with the highest short interest. On one hand, the recent poor performance from IPOs has provided greater opportunity

unters. On the other hand, considering a majority of IPOs underperform over the long term, we wonder whether the worst is yet to come.

, consumer (notably including many restaurants in the new breed of “fast casual” chains), and energy taking on larger roles. The number of health care (principally pharma/biotech) IPOs tripled from 34 in 2005 to

issance. There were 58 health care IPOs in 2015 to date with an average first day return of 18.6%. Biotech investors, beware. These dynamics also seem to further confirm the

that could pressure the IPO

Average Total Return

8.9%

7.0%

-2.1%

17.7%

-10.6%

12.5%

29.2%

-10.2%

-7.4%

-33.8%

How are we to build a constructive investment around a topic that raises such concern? Not only are the current conditions fairly unattractive, but as we detail, academic research supports consistent underperformance

decade timeframe. While we believe the recent IPO market has been only research publication. Further, the propensity for

s combined with often high borrowing IPOs) makes shorting

IPOs a difficult business. However, the high volatility of IPOs suggests discerning stock pickers can do well by avoiding “hot” sectors or stocks and identifying overlooked, high quality issues. In particular, we believe high

fundamental issues could present d investment ideas in an otherwise challenging market climate. Additionally,

academic research does suggest some categories of new stock listings do tend to outperform, such as re-IPOs

Notably, while we entered the summer seeing extremely strong IPO performance and an overabundance of highly valued IPOs, the recent market correction has stung IPOs particularly badly. While our

this year we may even be slightly behind the start of a trend. Since the start of 2015, the Bloomberg IPO Index has already declined 20% versus 5% for the S&P

signaling bear market conditions for IPOs. The number of broken IPOs (IPOs trading below their offering estimates, a staggering 260 of 578 (45%) currently traded IPOs

(minimum IPO offer amount of $50 million) since the start of 2012 are under their IPO price including 25 of 63 present) have underperformed the

The median underperformance from these “dogs”? Forty-one percent (not ince 2012 (minimum current

market cap of $500 million) as well as two sorts that may be of interest: “broken” IPOs and those with the highest short interest. On one hand, the recent poor performance from IPOs has provided greater opportunity

unters. On the other hand, considering a majority of IPOs underperform over the long term, we

Introduction

Bloomberg IPO Index 5 Year Performance

Source: Bloomberg

Finally, we cannot conclude this introduction without mentioning that this is a topic has actually visited before: some 21 years ago, IPO R.I.P.? We promise it is just a coincidence that we are currently celebrating our 40covering the same theme. Interestingly enough, last time around in the summer of 1994 the Federal Reserve’s recent reversal into a phase of monetary tightening was responsibalso punished recent IPOs without discrimination and we noted there could be many neglected small cap IPOs trading below intrinsic value. At that time, we narrowed the list of investment candidates by screeningquality companies that had gone public during the previous 3 years and declined 25% or more from their listing price. While we are not quite in the same scenario today, we do wonder whether a similar set of events will be in store if and when the Fed finally raises rates.

Two of the companies profiled in this issue also fit the criteria of our past stock screen (SeaWorld and MRC Global are both more than 30% below their IPO prices), while another of the profiled companies (Kodak) technically is not an IPO but only reemerged from neglected stock. Our fourth profiled company, Oaktree Capital, does not directly fit the beatenas shares are up 18% from their IPO price, but they have partnership shares to the public in 2012. Oaktree’s contrarian philosophy and expertise in investing in distressed scenarios position the company to capitalize on any possible market dislocation in the comin

Venture Capital Trends and Impact on IPO market

Venture capital funding has been experiencing similar growth as the IPO market in recent years, and in fact is shaping many of the trends that characterize this IPO environment. Overall, venture capinvested $65 billion in 2014, the highest since 2000 according to PitchBook data. VC financing in 2015 through June ($36.8 billion) was ahead of last year’s figures and is on pace to set another postVenture funding has been particularly concentrated in the technology and software industries. Software garnered 41% of VC funding in 2014 according to data from the National Venture Capital Association (NVCA) and Thomson Reuters. According to the same sources, software funding 30% Q/Q and the highest level on record looking back to 1995.

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Bloomberg IPO Index 5 Year Performance

Finally, we cannot conclude this introduction without mentioning that this is a topic has actually visited before: some 21 years ago, AAF celebrated its 20th anniversary with a summer issue titled

just a coincidence that we are currently celebrating our 40th

covering the same theme. Interestingly enough, last time around in the summer of 1994 the Federal Reserve’s recent reversal into a phase of monetary tightening was responsible for routing the bond market. Investors had also punished recent IPOs without discrimination and we noted there could be many neglected small cap IPOs trading below intrinsic value. At that time, we narrowed the list of investment candidates by screeningquality companies that had gone public during the previous 3 years and declined 25% or more from their listing price. While we are not quite in the same scenario today, we do wonder whether a similar set of events will be in

Fed finally raises rates.

Two of the companies profiled in this issue also fit the criteria of our past stock screen (SeaWorld and MRC Global are both more than 30% below their IPO prices), while another of the profiled companies (Kodak)

t an IPO but only reemerged from Chapter 11 two years ago and fits the description of a neglected stock. Our fourth profiled company, Oaktree Capital, does not directly fit the beatenas shares are up 18% from their IPO price, but they have underperformed the market since offering limited partnership shares to the public in 2012. Oaktree’s contrarian philosophy and expertise in investing in distressed scenarios position the company to capitalize on any possible market dislocation in the comin

Venture Capital Trends and Impact on IPO market

Venture capital funding has been experiencing similar growth as the IPO market in recent years, and in fact is shaping many of the trends that characterize this IPO environment. Overall, venture capinvested $65 billion in 2014, the highest since 2000 according to PitchBook data. VC financing in 2015 through June ($36.8 billion) was ahead of last year’s figures and is on pace to set another post-dot com bubble record.

en particularly concentrated in the technology and software industries. Software garnered 41% of VC funding in 2014 according to data from the National Venture Capital Association (NVCA) and Thomson Reuters. According to the same sources, software funding reached $7.3 billion in 2Q 2015, up 30% Q/Q and the highest level on record looking back to 1995.

Finally, we cannot conclude this introduction without mentioning that this is a topic Asset Analysis Focus celebrated its 20th anniversary with a summer issue titled

th anniversary and are

covering the same theme. Interestingly enough, last time around in the summer of 1994 the Federal Reserve’s le for routing the bond market. Investors had

also punished recent IPOs without discrimination and we noted there could be many neglected small cap IPOs trading below intrinsic value. At that time, we narrowed the list of investment candidates by screening for high quality companies that had gone public during the previous 3 years and declined 25% or more from their listing price. While we are not quite in the same scenario today, we do wonder whether a similar set of events will be in

Two of the companies profiled in this issue also fit the criteria of our past stock screen (SeaWorld and MRC Global are both more than 30% below their IPO prices), while another of the profiled companies (Kodak)

11 two years ago and fits the description of a neglected stock. Our fourth profiled company, Oaktree Capital, does not directly fit the beaten-down IPO theme

underperformed the market since offering limited partnership shares to the public in 2012. Oaktree’s contrarian philosophy and expertise in investing in distressed scenarios position the company to capitalize on any possible market dislocation in the coming years.

Venture capital funding has been experiencing similar growth as the IPO market in recent years, and in fact is shaping many of the trends that characterize this IPO environment. Overall, venture capital funds invested $65 billion in 2014, the highest since 2000 according to PitchBook data. VC financing in 2015 through

dot com bubble record. en particularly concentrated in the technology and software industries. Software

garnered 41% of VC funding in 2014 according to data from the National Venture Capital Association (NVCA) reached $7.3 billion in 2Q 2015, up

– 4000

–3500

–3000

–2912.26 –2500

–2000

Introduction

Venture Financing, Quarterly, 1Q95

Source: PwC/NVCA MoneyTree Report; Thomson Reuters

Perhaps the most notable recent example of a starte-commerce company Jet.com. Jet.com is reportedly looking to raise new funding at a $2 billion to $3 billion valuation despite just launching the site to the 12 months, nearly double the previous high set by infamous bubbleJones VentureSource.

1,

2 Jet.com founder Marc Lore, who previously sold his company Quidsi (the parent of

Diapers.com) to Amazon for $545 million (or a comparatively meager 1.2x sales), has predicted profitability will not arrive until Jet.com reaches $20 billion in GMV, which is targeted for 2020. By contrast, Amazon raised less than $10 million prior to its 1997 IPO which raised $55 millio

Equity Raised by e

Company Founding

Year

Jet.com 2014

Pets.com 1999

OurHouse.com 1999

Eziba.com 1999

DrugStore.com 1998

PetSmart.com 1999

Miadora.com 1999

WineShopper.com 1998

Living.com 1998

Petopia.com 1998

Source:wsj.com

This begs the line of questioning, is VC funding reaching “bubble” territory, and how will it impact the IPO market and public markets more generally? Despite some of the headlines like the Jet.com story, the overall picture is less clear. The preponderanc

1 http://www.wsj.com/articles/frenzy-around

2 http://blogs.wsj.com/digits/2015/07/20/behind

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Venture Financing, Quarterly, 1Q95 – 2Q15

Source: PwC/NVCA MoneyTree Report; Thomson Reuters

Perhaps the most notable recent example of a start-up receiving startling levels of funding is new commerce company Jet.com. Jet.com is reportedly looking to raise new funding at a $2 billion to $3 billion

valuation despite just launching the site to the public this July. Jet.com already raised $195 millionmonths, nearly double the previous high set by infamous bubble-era startup Pets.com according to Dow

Jet.com founder Marc Lore, who previously sold his company Quidsi (the parent of million (or a comparatively meager 1.2x sales), has predicted profitability will

not arrive until Jet.com reaches $20 billion in GMV, which is targeted for 2020. By contrast, Amazon raised less than $10 million prior to its 1997 IPO which raised $55 million and valued the company at ~$400 million.

Equity Raised by e-Commerce Startups in Year One ($ millions)

Founding Equity Raised First Year ($MM) Status

$194 Private

$111 IPO in 2000, then shut down

$88 Shut down in 2000

$71 Sold to Overstock.com in 2005

$61 IPO in 1999; bought by Walgreens in 2011

$59 Acquired by PetSmart in 2002

$52 Shut down in 2000

$46 Merged with Wine.com in 2000

$42 Shut down in 2000

$40 Sold assets to Petcom in 2000

This begs the line of questioning, is VC funding reaching “bubble” territory, and how will it impact the IPO market and public markets more generally? Despite some of the headlines like the Jet.com story, the overall picture is less clear. The preponderance of money and sky-high valuations being thrown at pre

around-shopping-site-jet-com-harks-back-to-dot-com-boom-1437359430

http://blogs.wsj.com/digits/2015/07/20/behind-the-numbers-of-jet-coms-audacious-plan-to-attack-amazon/

receiving startling levels of funding is new commerce company Jet.com. Jet.com is reportedly looking to raise new funding at a $2 billion to $3 billion

this July. Jet.com already raised $195 million in its first era startup Pets.com according to Dow

Jet.com founder Marc Lore, who previously sold his company Quidsi (the parent of million (or a comparatively meager 1.2x sales), has predicted profitability will

not arrive until Jet.com reaches $20 billion in GMV, which is targeted for 2020. By contrast, Amazon raised less n and valued the company at ~$400 million.

IPO in 2000, then shut down

Sold to Overstock.com in 2005

IPO in 1999; bought by Walgreens in 2011

Acquired by PetSmart in 2002

Merged with Wine.com in 2000

Sold assets to Petcom in 2000

This begs the line of questioning, is VC funding reaching “bubble” territory, and how will it impact the IPO market and public markets more generally? Despite some of the headlines like the Jet.com story, the

high valuations being thrown at pre-revenue

1437359430

amazon/

Introduction

companies in the late-90s tech bubble has yet to reach comparable scale today. As already illustrated, overall venture investment levels are still nearly 40% below the recordadjusting for inflation. Nonetheless, growth has accelerated beginning in 2013 and in particular, higher risk seed or early stage funding is showing what could be early signs of unsustainable exponential growth that is characteristic of bubble formation. As illustrated in the following chart, seed and early stage funding increased 59% sequentially and 45% Y/Y to just shy of $6 billion in 2Q 2015. The average seed stage prehas nearly doubled the past 2 years to $3.9 million in 2Q 2015. As angel investor Jeffrey Carter recently put it, “When people from the coast tell me that the new prechoke.” Software companies are again garnering the biggest share of biotechnology funding has exploded more markedly in recent years and now accounts for close to one quarter of seed/early stage funding.

Seed and Early Stage Venture Financing, Quarterly, 1Q95

Source: PwC/NVCA MoneyTree Report; Thomson Reuters

It has also been widely reported in the media that startups/venture

delaying or forgoing going public. This narrative is usually supported by referencing the recent private financing rounds at eye popping valuations from a few high profile companies such as Uber, Airbnb, Snapchat, and SpaceX—each of which raised upwards of one billion dollars in equity in its latest private funding round at individual valuations ranging from $12 billion tocompanies are delaying their IPOs. According to Goldman Sachs, the median tech IPO was 11 years old in 2014 versus a median of just 5 years in 2000. Similarly, Wilmerventure-backed companies averaged just under 7 years in recent quarters, or nearly 3x the average during the tech bubble. And according to CB Insights, during 1H 2015, ventureaggregate $11.7 billion in private funding rounds of $100 millioncontrast, in 2007 VC-backed IPOs raised $7.3 billion versus $7.9 billion in private financing rounds of $40 million or more.

The trend appears to be accelerating. As of Septeventure-backed companies valued at $1 billion or higher according to Dow Jones Venture Source, more than double the total one year ago. It is worth noting that approximately 20 companies have exited the list measures such as an IPO (e.g. Box) or an acquisition in the case of Beats Electronics, which was acquired by Apple. By some predictions, the rank of chart lists the highest all-time valuations ascribed to companies in venture funding rounds. Notably, all have occurred since the start of 2014.

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90s tech bubble has yet to reach comparable scale today. As already illustrated, overall venture investment levels are still nearly 40% below the record-setting $28 billion in 2Q 2000, and this is before adjusting for inflation. Nonetheless, growth has accelerated beginning in 2013 and in particular, higher risk seed or early stage funding is showing what could be early signs of unsustainable exponential growth that is

acteristic of bubble formation. As illustrated in the following chart, seed and early stage funding increased 59% sequentially and 45% Y/Y to just shy of $6 billion in 2Q 2015. The average seed stage pre

to $3.9 million in 2Q 2015. As angel investor Jeffrey Carter recently put it, “When people from the coast tell me that the new pre-money valuation for seed rounds is $6M plus, it makes me

Software companies are again garnering the biggest share of this funding at close to 41%, but biotechnology funding has exploded more markedly in recent years and now accounts for close to one quarter

Seed and Early Stage Venture Financing, Quarterly, 1Q95 – 2Q15

MoneyTree Report; Thomson Reuters

It has also been widely reported in the media that startups/venture-backed companies are increasingly delaying or forgoing going public. This narrative is usually supported by referencing the recent private financing

ds at eye popping valuations from a few high profile companies such as Uber, Airbnb, Snapchat, and each of which raised upwards of one billion dollars in equity in its latest private funding round at

individual valuations ranging from $12 billion to as high as $50 billion. A deeper look confirms the trend that companies are delaying their IPOs. According to Goldman Sachs, the median tech IPO was 11 years old in 2014 versus a median of just 5 years in 2000. Similarly, Wilmer-Hale reports the median ti

backed companies averaged just under 7 years in recent quarters, or nearly 3x the average during the tech bubble. And according to CB Insights, during 1H 2015, venture-backed tech companies raised an

te funding rounds of $100 million-plus versus just $1.7 billion through IPOs. By backed IPOs raised $7.3 billion versus $7.9 billion in private financing rounds of $40 million

The trend appears to be accelerating. As of September 2015 there were 118 “unicorns” or private, backed companies valued at $1 billion or higher according to Dow Jones Venture Source, more than

double the total one year ago. It is worth noting that approximately 20 companies have exited the list measures such as an IPO (e.g. Box) or an acquisition in the case of Beats Electronics, which was acquired by Apple. By some predictions, the rank of unicorns could swell to 150-plus before the end of 2015. The following

valuations ascribed to companies in venture funding rounds. Notably, all have

90s tech bubble has yet to reach comparable scale today. As already illustrated, overall n in 2Q 2000, and this is before

adjusting for inflation. Nonetheless, growth has accelerated beginning in 2013 and in particular, higher risk seed or early stage funding is showing what could be early signs of unsustainable exponential growth that is

acteristic of bubble formation. As illustrated in the following chart, seed and early stage funding increased 59% sequentially and 45% Y/Y to just shy of $6 billion in 2Q 2015. The average seed stage pre-money valuation

to $3.9 million in 2Q 2015. As angel investor Jeffrey Carter recently put it, money valuation for seed rounds is $6M plus, it makes me

this funding at close to 41%, but biotechnology funding has exploded more markedly in recent years and now accounts for close to one quarter

2Q15

backed companies are increasingly delaying or forgoing going public. This narrative is usually supported by referencing the recent private financing

ds at eye popping valuations from a few high profile companies such as Uber, Airbnb, Snapchat, and each of which raised upwards of one billion dollars in equity in its latest private funding round at

as high as $50 billion. A deeper look confirms the trend that companies are delaying their IPOs. According to Goldman Sachs, the median tech IPO was 11 years old in

reports the median time to IPO among backed companies averaged just under 7 years in recent quarters, or nearly 3x the average during the

backed tech companies raised an plus versus just $1.7 billion through IPOs. By

backed IPOs raised $7.3 billion versus $7.9 billion in private financing rounds of $40 million

mber 2015 there were 118 “unicorns” or private, backed companies valued at $1 billion or higher according to Dow Jones Venture Source, more than

double the total one year ago. It is worth noting that approximately 20 companies have exited the list via measures such as an IPO (e.g. Box) or an acquisition in the case of Beats Electronics, which was acquired by

plus before the end of 2015. The following valuations ascribed to companies in venture funding rounds. Notably, all have

Introduction

Highest Valuation Venture Financing Rounds

Company Latest Valuation

Uber $

Xiaomi $46.0

Airbnb $25.5

Palantir $20.0

Snapchat $16.0

Flipkart $15.0

Didi Kuaidi $15.0

SpaceX $12.0

Pinterest $11.0

Dropbox $10.0

WeWork $10.0

Lufax

Theranos

Spotify

DJI

Zhong An Online

Source: wsj.com

Despite the more extended timeframe to

ramped up notably in recent years. According to National Venture Capital Association (NVCA) and Thomson Reuters, 116 venture-backed companies completed IPOs in 2014, raising $15.4 billion. Both fignearly 40% growth from 2013 levels. The current explosion in lateIPO exit in a reasonable timeframe, suggests the supply pressure on the IPO pipeline could expand even more rapidly in the coming quarters/years. This should give IPO investors pausebuying shares from insiders who hold significant informational advantages and have delayed an IPO as long as possible. Further, with an unsettled longparticipating only for the expected shorthigh volatility and are often amongst the hardest hit in a market downturn. Heavy insiofferings after lock up arrangements expire can add to the pressure. Case in point, during the recent market correction between late May and August 24, 2015, the Renaissance IPO ETF (composed of IPOs less than two years old) fell nearly 16% from peak to trough versus 11% for the S&P 500. Many of the more recent issues were hit even harder.

While we detail the risks of overvaluation in the current IPO market in the following section, at this stage it appears the venture capital industry faces far greater risk. Insofar as a greater portion of higher risk venture investments are currently being funded by private capital, this means less of the risk is being borne by the public/stock markets. If there is a more sustained downturn in theskepticism toward IPOs, exit opportunitiesinvestors in the next 2-3 years. Even the recent market correction led many market participants to speculatethe IPO pipeline will be delayed by at least a month or two for all but the highest demand companies. The VC-backed investment pool is still dwarfed in size by the $20 trillion domestic stock market, and risk is more concentrated among large institutions and accredited investors, so the impact of a VC funding bubble on the stock market or the broader economy should be proportionally smaller than a full

Finally, M&A is another increasingly popular exit strategy for ventureCambridge Associates, there were 479 deals for venturetransaction size of publicly disclosed deals (which is certainly well above the overall average) was $345 million, up 94% from 2013. The recent declines in the IPO market could also lead to public companies rescuing more

- 6 -

Highest Valuation Venture Financing Rounds ($ Billions)

Latest Valuation ($B) Total Equity Funding ($B) Last Valuation

$51.1 $5.6 Jul

$46.0 $1.4 Dec

$25.5 $2.3 Jun

$20.0 $1.5 Jul

$16.0 $1.2 May

$15.0 $3.0 Apr

$15.0 $3.0 Jul

$12.0 $1.1 Jan

$11.0 $1.3 Feb

$10.0 $0.6 Jan

$10.0 $1.0 Jun

$9.6 $0.5 Mar

$9.0 $0.4 Jun

$8.5 $1.0 Apr

$8.0 $0.1 May

$8.0 $0.9 Jun

Despite the more extended timeframe to reaching an IPO, venture capital exits via IPOs have still ramped up notably in recent years. According to National Venture Capital Association (NVCA) and Thomson

backed companies completed IPOs in 2014, raising $15.4 billion. Both fignearly 40% growth from 2013 levels. The current explosion in late-stage venture funding, often premised on an IPO exit in a reasonable timeframe, suggests the supply pressure on the IPO pipeline could expand even more

quarters/years. This should give IPO investors pause—knowing that by and large, they are buying shares from insiders who hold significant informational advantages and have delayed an IPO as long as possible. Further, with an unsettled long-term investor base, often a limited initial float, and many IPO buyers participating only for the expected short-term ‘pop’ following the IPO, post-IPO shares tend to exhibit extremely high volatility and are often amongst the hardest hit in a market downturn. Heavy insider selling via secondary offerings after lock up arrangements expire can add to the pressure. Case in point, during the recent market correction between late May and August 24, 2015, the Renaissance IPO ETF (composed of IPOs less than two

nearly 16% from peak to trough versus 11% for the S&P 500. Many of the more recent issues

While we detail the risks of overvaluation in the current IPO market in the following section, at this stage stry faces far greater risk. Insofar as a greater portion of higher risk venture

investments are currently being funded by private capital, this means less of the risk is being borne by the public/stock markets. If there is a more sustained downturn in the public markets or increased investor

opportunities could quickly dissolve, potentially wreaking havoc for startups/VC 3 years. Even the recent market correction led many market participants to speculate

the IPO pipeline will be delayed by at least a month or two for all but the highest demand companies. The backed investment pool is still dwarfed in size by the $20 trillion domestic stock market, and risk is more

ions and accredited investors, so the impact of a VC funding bubble on the stock market or the broader economy should be proportionally smaller than a full-blown stock market bubble.

Finally, M&A is another increasingly popular exit strategy for venture-backed companies. According to Cambridge Associates, there were 479 deals for venture-based companies in 2014, up 86% Y/Y. The average transaction size of publicly disclosed deals (which is certainly well above the overall average) was $345 million,

from 2013. The recent declines in the IPO market could also lead to public companies rescuing more

Last Valuation

Jul-15

Dec-14

Jun-15

Jul-15

May-15

Apr-15

Jul-15

Jan-15

Feb-15

Jan-14

Jun-15

Mar-15

Jun-14

Apr-15

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Jun-15

reaching an IPO, venture capital exits via IPOs have still ramped up notably in recent years. According to National Venture Capital Association (NVCA) and Thomson

backed companies completed IPOs in 2014, raising $15.4 billion. Both figures represented stage venture funding, often premised on an

IPO exit in a reasonable timeframe, suggests the supply pressure on the IPO pipeline could expand even more knowing that by and large, they are

buying shares from insiders who hold significant informational advantages and have delayed an IPO as long as ase, often a limited initial float, and many IPO buyers

IPO shares tend to exhibit extremely der selling via secondary

offerings after lock up arrangements expire can add to the pressure. Case in point, during the recent market correction between late May and August 24, 2015, the Renaissance IPO ETF (composed of IPOs less than two

nearly 16% from peak to trough versus 11% for the S&P 500. Many of the more recent issues

While we detail the risks of overvaluation in the current IPO market in the following section, at this stage stry faces far greater risk. Insofar as a greater portion of higher risk venture

investments are currently being funded by private capital, this means less of the risk is being borne by the public markets or increased investor

could quickly dissolve, potentially wreaking havoc for startups/VC 3 years. Even the recent market correction led many market participants to speculate that

the IPO pipeline will be delayed by at least a month or two for all but the highest demand companies. The backed investment pool is still dwarfed in size by the $20 trillion domestic stock market, and risk is more

ions and accredited investors, so the impact of a VC funding bubble on the blown stock market bubble.

cked companies. According to based companies in 2014, up 86% Y/Y. The average

transaction size of publicly disclosed deals (which is certainly well above the overall average) was $345 million, from 2013. The recent declines in the IPO market could also lead to public companies rescuing more

Introduction

“stranded” VC-backed firms as well as broken IPOs with insiders desperate for liquidity. In fact, we have already seen early signs of this activity heating uacquire smaller e-commerce peer Zulilly for $18.75/share, below its $22/share IPO in November 2013 and well below the over $70 a share Zulily commanded in early 2014. While not a takemoney exchange platform Xoom Corp. was recently rescued from the list of broken IPOs by an acquisition offer from AAF-profiled company eBay.

The implications for increased M&A eoverlooked. Technology companies in particular have long relied on acquisitions to position, with M&A often serving as an R&D substitute of sorts. Thus we would caution thmargins of tech companies in many cases, especially based on adjusted EBITDA (which excludes depreciation expense and amortization of acquired intangibles) and even free cash flow (which does not factor in the recurring cost of acquisitions that some companies require to maintain their competitive positions), may not reflect true, sustainable underlying profitability. Outsourced R&D via M&A is also gaining popularity in other industries like pharma—perhaps best exemplified by the rollmanagement’s acumen for creating long term value is essential in estimating the value for M&Acompanies, and further heating up of M&A volume/pricing could create the risk of long

This Time It’s Different. Sort of …

As we noted previously, there has been an increase in both the number and dollar value of IPOs in recent years. The IPO resurgence has prompted comparisons with the last IPO boom that was responsible for driving valuations of IPOs, tech stocks and many sectors of the market to unsustainable levels. While IPO activity has increased markedly recently, the widespread overvaluations in the public markets that ensued following the late 1990s/early 2000s are largely absentthat the IPO activity has cooled off during 2015 following a strong 2014, which saw the largest IPO in history (Alibaba). As discussed, one factor that helps explain the slowdown within the public conditions within private markets. As illustrated in the following graphic, the number one cited reason for weaker IPO activity in 1H 2015 according to a survey of capital markets executives conducted by BDO is the availability of capital on attractive terms.

Source: 2015 BDO IPO Halftime Report, BDO.com

While IPO activity has slowed down in 2015, there are signs in the current environment worth monitoring. There has been a trend toward smaller companies (based on revenues) coming public with the median average revenue of IPO companies falling to $68.2 milyear that the metric has declined. It is worth noting that the JOBS act (Jumpstart Our Business Startups), which was passed by Congress in 2012, has made it easier for companies with revenues under $1 billion partially contributing to the decline. As part of the JOBS Act, there are reduced disclosure requirements

- 7 -

backed firms as well as broken IPOs with insiders desperate for liquidity. In fact, we have already seen early signs of this activity heating up. Asset Analysis Focus’ favorite, QVC Group

commerce peer Zulilly for $18.75/share, below its $22/share IPO in November 2013 and well commanded in early 2014. While not a take-under in this case, Internet

money exchange platform Xoom Corp. was recently rescued from the list of broken IPOs by an acquisition offer

The implications for increased M&A exits for VC-backed companies and recent IPOs should not be overlooked. Technology companies in particular have long relied on acquisitions to bolsterposition, with M&A often serving as an R&D substitute of sorts. Thus we would caution thmargins of tech companies in many cases, especially based on adjusted EBITDA (which excludes depreciation expense and amortization of acquired intangibles) and even free cash flow (which does not factor in the

ons that some companies require to maintain their competitive positions), may not reflect true, sustainable underlying profitability. Outsourced R&D via M&A is also gaining popularity in other

perhaps best exemplified by the roll-up and R&D-slashing model at Valeant. Assessing management’s acumen for creating long term value is essential in estimating the value for M&Acompanies, and further heating up of M&A volume/pricing could create the risk of long-term value destruction.

As we noted previously, there has been an increase in both the number and dollar value of IPOs in recent years. The IPO resurgence has prompted comparisons with the last IPO boom that was responsible for

uations of IPOs, tech stocks and many sectors of the market to unsustainable levels. While IPO activity has increased markedly recently, the widespread overvaluations in the public markets that ensued following the late 1990s/early 2000s are largely absent from today’s public markets. It is also worth reiterating that the IPO activity has cooled off during 2015 following a strong 2014, which saw the largest IPO in history (Alibaba). As discussed, one factor that helps explain the slowdown within the public markets is the robust conditions within private markets. As illustrated in the following graphic, the number one cited reason for weaker IPO activity in 1H 2015 according to a survey of capital markets executives conducted by BDO is the availability

Source: 2015 BDO IPO Halftime Report, BDO.com

While IPO activity has slowed down in 2015, there are signs in the current environment worth monitoring. There has been a trend toward smaller companies (based on revenues) coming public with the median average revenue of IPO companies falling to $68.2 million in 2014, representing the second straight year that the metric has declined. It is worth noting that the JOBS act (Jumpstart Our Business Startups), which was passed by Congress in 2012, has made it easier for companies with revenues under $1 billion partially contributing to the decline. As part of the JOBS Act, there are reduced disclosure requirements

backed firms as well as broken IPOs with insiders desperate for liquidity. In fact, we have already QVC Group, recently agreed to

commerce peer Zulilly for $18.75/share, below its $22/share IPO in November 2013 and well under in this case, Internet-based

money exchange platform Xoom Corp. was recently rescued from the list of broken IPOs by an acquisition offer

backed companies and recent IPOs should not be bolster their competitive

position, with M&A often serving as an R&D substitute of sorts. Thus we would caution that the high profit margins of tech companies in many cases, especially based on adjusted EBITDA (which excludes depreciation expense and amortization of acquired intangibles) and even free cash flow (which does not factor in the

ons that some companies require to maintain their competitive positions), may not reflect true, sustainable underlying profitability. Outsourced R&D via M&A is also gaining popularity in other

slashing model at Valeant. Assessing management’s acumen for creating long term value is essential in estimating the value for M&A-reliant

term value destruction.

As we noted previously, there has been an increase in both the number and dollar value of IPOs in recent years. The IPO resurgence has prompted comparisons with the last IPO boom that was responsible for

uations of IPOs, tech stocks and many sectors of the market to unsustainable levels. While IPO activity has increased markedly recently, the widespread overvaluations in the public markets that ensued

from today’s public markets. It is also worth reiterating that the IPO activity has cooled off during 2015 following a strong 2014, which saw the largest IPO in history

markets is the robust conditions within private markets. As illustrated in the following graphic, the number one cited reason for weaker IPO activity in 1H 2015 according to a survey of capital markets executives conducted by BDO is the availability

While IPO activity has slowed down in 2015, there are signs in the current environment worth monitoring. There has been a trend toward smaller companies (based on revenues) coming public with the

lion in 2014, representing the second straight year that the metric has declined. It is worth noting that the JOBS act (Jumpstart Our Business Startups), which was passed by Congress in 2012, has made it easier for companies with revenues under $1 billion to go public partially contributing to the decline. As part of the JOBS Act, there are reduced disclosure requirements

Introduction

available for companies that fall under the cut off including the ability to submit IPO documents confidentially and more limited compensation and financial statement reporting disclosures. According to a 2014 report by Ernst & Young, ~80% of emerging-growth companies chose the provision to file confidentially, with 90% utilizing the ability to disclose limited compensation information andstatements compared with the standard 3 year reporting history.

Median Annual Revenue of IPO Companies

Source: SEC filings and IPO Vital Signs via WilmerHale 2015 IPO Report

Although the so-called unicorns and VC markets have received a disproportionate amount of the press surrounding elevated company valuations, there has been some spillover to the public markets in terms of bubble like conditions (performance and valuations) of nemonitors, went public in June at a ~$4 billion valuation now boasts a market cap of over $8 billion. It should be noted that Fitbit generated just $132 million of earnings in 2014. In addition, accordCapital the average first day pop of IPOs during 2015 has been 16%, representing the second highest average first day return over the past 10 years.

Average First Day Pop is 16% This Year

Source: RenaissanceCapital.com

35.017.9 17.6

161.0

267.5

1998 1999 2000 2001 2002

- 8 -

available for companies that fall under the cut off including the ability to submit IPO documents confidentially ation and financial statement reporting disclosures. According to a 2014 report by

growth companies chose the provision to file confidentially, with 90% utilizing the ability to disclose limited compensation information and 45% providing just two years of audited financial statements compared with the standard 3 year reporting history.

Median Annual Revenue of IPO Companies 1998 to 2014 ($MM)

Source: SEC filings and IPO Vital Signs via WilmerHale 2015 IPO Report

called unicorns and VC markets have received a disproportionate amount of the press surrounding elevated company valuations, there has been some spillover to the public markets in terms of bubble like conditions (performance and valuations) of new issues. Fitbit, which is a maker of wearable activity monitors, went public in June at a ~$4 billion valuation now boasts a market cap of over $8 billion. It should be noted that Fitbit generated just $132 million of earnings in 2014. In addition, according to data from Renaissance Capital the average first day pop of IPOs during 2015 has been 16%, representing the second highest average

Average First Day Pop is 16% This Year

Source: RenaissanceCapital.com

267.5

144.5

85.7105.9

111.1

74.5

126.0

229.0

97.6 98.7

133.6

89.9

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

available for companies that fall under the cut off including the ability to submit IPO documents confidentially ation and financial statement reporting disclosures. According to a 2014 report by

growth companies chose the provision to file confidentially, with 90% utilizing 45% providing just two years of audited financial

1998 to 2014 ($MM)

called unicorns and VC markets have received a disproportionate amount of the press surrounding elevated company valuations, there has been some spillover to the public markets in terms of

w issues. Fitbit, which is a maker of wearable activity monitors, went public in June at a ~$4 billion valuation now boasts a market cap of over $8 billion. It should be

ing to data from Renaissance Capital the average first day pop of IPOs during 2015 has been 16%, representing the second highest average

89.9

68.2

2013 2014

Introduction

During 2014, the IPOs of life sciences companies, which accounted for 40% of the U.S. IPO market,

ended the year 35% above their offering price on average with 62% selling above their offering price at yearend. Meanwhile, U.S. tech IPOs during 2014 (28% of the of 24%. While the performance of recent IPOs has been robust, the quality of IPOs is deteriorating. As illustrated in the chart below, 71% of the IPOs during 2014 were not generating earnings according toof the University of Florida. It should be noted that this represents the highest level of unprofitable IPOs since 2000 when 80% of IPOs were losing money.

Percent of IPOs with No Earnings

Source: Prof. Jay Ritter, University of Florida

While there are some bubble-like conditions being experienced by recent IPOs, it is interesting to note

that the exuberance within this segment of the public markets hasn’t really carried over to the broader market. For example, the current forward P/E of thehistorical range) looks reasonable given the outlook for earnings growth (~12% projected for 2015). It should also be noted that that the Information Technology sector trades on par with Sin-line with its 25 year average and offers lower future growth prospects. Meanwhile, the frothy conditions of recent healthcare/life sciences IPOs has not carried over to overall health care sector, which at a forward P/E 16.1x trades in-line with its historical range. While valuations of health care stocks have expanded in recent years, overall valuations seem reasonable in light of the future growth outlook for the sector (~25% EPS growth is 2015 forecast for the health care sector).

While there could be a spillover effect into the public equity markets if/when the late stage bubble bursts, we believe that the largest impact will likely be felt by venture cap companies, investors and their employees. Andreessen Horowitz, which is a significant participant in late stage venture financing (~$4 billion in AUM), has noted some of the differences to help support the current fundraising environment vs. the dot com bubble including the number of people online (4 billion now vsfunding now represents just 2.6% of the economy vs. nearly 11% in 1999. While we acknowledge that there are differences now vs. then, we also would caution against using this type of data to support currentvaluations. We believe the following statement does a good job of encapsulating the risks in the current environment:

“Unlike the 2001 bubble, this one is on latestartups don't even want to go pIPO. The burst will definitely hurt these companies, leading many of them to shut down. It will also hurt the venture capital funds that have heavily invested in them.”

- 9 -

2014, the IPOs of life sciences companies, which accounted for 40% of the U.S. IPO market, ended the year 35% above their offering price on average with 62% selling above their offering price at yearend. Meanwhile, U.S. tech IPOs during 2014 (28% of the total) posted an average gain through year end 2014 of 24%. While the performance of recent IPOs has been robust, the quality of IPOs is deteriorating. As illustrated in the chart below, 71% of the IPOs during 2014 were not generating earnings according toof the University of Florida. It should be noted that this represents the highest level of unprofitable IPOs since 2000 when 80% of IPOs were losing money.

Percent of IPOs with No Earnings

Source: Prof. Jay Ritter, University of Florida

like conditions being experienced by recent IPOs, it is interesting to note that the exuberance within this segment of the public markets hasn’t really carried over to the broader market. For example, the current forward P/E of the S&P 500 Info Tech Sector at 15.2x (representing the low end of its historical range) looks reasonable given the outlook for earnings growth (~12% projected for 2015). It should also be noted that that the Information Technology sector trades on par with S&P 500 (15.3x), which is trading

line with its 25 year average and offers lower future growth prospects. Meanwhile, the frothy conditions of recent healthcare/life sciences IPOs has not carried over to overall health care sector, which at a forward P/E

line with its historical range. While valuations of health care stocks have expanded in recent years, overall valuations seem reasonable in light of the future growth outlook for the sector (~25% EPS growth

h care sector).

While there could be a spillover effect into the public equity markets if/when the late stage bubble bursts, we believe that the largest impact will likely be felt by venture cap companies, investors and their

z, which is a significant participant in late stage venture financing (~$4 billion in AUM), has noted some of the differences to help support the current fundraising environment vs. the dot com bubble including the number of people online (4 billion now vs. just 40 million in 1995) and the fact that tech funding now represents just 2.6% of the economy vs. nearly 11% in 1999. While we acknowledge that there are differences now vs. then, we also would caution against using this type of data to support currentvaluations. We believe the following statement does a good job of encapsulating the risks in the current

“Unlike the 2001 bubble, this one is on late-stage private startups. These billionstartups don't even want to go public because they know they'll not get the same valuations at IPO. The burst will definitely hurt these companies, leading many of them to shut down. It will also hurt the venture capital funds that have heavily invested in them.”

– Darius Lahoutifard, founder of Business Hangouts

2014, the IPOs of life sciences companies, which accounted for 40% of the U.S. IPO market, ended the year 35% above their offering price on average with 62% selling above their offering price at year-

total) posted an average gain through year end 2014 of 24%. While the performance of recent IPOs has been robust, the quality of IPOs is deteriorating. As illustrated in the chart below, 71% of the IPOs during 2014 were not generating earnings according to Jay Ritter of the University of Florida. It should be noted that this represents the highest level of unprofitable IPOs since

like conditions being experienced by recent IPOs, it is interesting to note that the exuberance within this segment of the public markets hasn’t really carried over to the broader market.

S&P 500 Info Tech Sector at 15.2x (representing the low end of its historical range) looks reasonable given the outlook for earnings growth (~12% projected for 2015). It should

&P 500 (15.3x), which is trading line with its 25 year average and offers lower future growth prospects. Meanwhile, the frothy conditions of

recent healthcare/life sciences IPOs has not carried over to overall health care sector, which at a forward P/E of line with its historical range. While valuations of health care stocks have expanded in recent

years, overall valuations seem reasonable in light of the future growth outlook for the sector (~25% EPS growth

While there could be a spillover effect into the public equity markets if/when the late stage bubble bursts, we believe that the largest impact will likely be felt by venture cap companies, investors and their

z, which is a significant participant in late stage venture financing (~$4 billion in AUM), has noted some of the differences to help support the current fundraising environment vs. the dot com

. just 40 million in 1995) and the fact that tech funding now represents just 2.6% of the economy vs. nearly 11% in 1999. While we acknowledge that there are differences now vs. then, we also would caution against using this type of data to support current frothy pre-IPO valuations. We believe the following statement does a good job of encapsulating the risks in the current

stage private startups. These billion-dollar ublic because they know they'll not get the same valuations at

IPO. The burst will definitely hurt these companies, leading many of them to shut down. It will

ounder of Business Hangouts

Introduction

Analyzing Historical Performance of IPOs

“Does IPO stand for Instant Profit Opportunity or It’s Probably Overconundrum is that both answers are generally investor’s time horizon.”

– Jacksonville University study (published in Journal of Business & Economic Research)

The recent strength of the IPO market is hard to debate. Metrics such as the number of IPOs and the associated proceeds of these transactions confirm that act1990s . IPO activity often reflects the performance and valuation of the stock market, as well as the general tone of the overall economic backdrop. Although the size and nature of companies “going publilong-term, there are a few things that never change. Chief amongst these recurring themes include an ample numbers of buyers and sellers willing to participate in these transactions, and a financial system highly incentivized to enable them. For a typical investor, participating in the IPO market can have appeal on multiple levels. Performance of IPOs can often be strong in the nearfor market participants. Moreover, large or strongly within the financial media, helping to contribute to positive investor sentiment. For issuing companies, these events provide an opportunity to raise capital and monetize the ownership stakes of the fiearly-stage financial backers. Whether wealth is being created or transferred in these cases often depends on the specific fundamentals of the individual companies. The historical performance of IPOs indicates a mixed picture at best, suggesting that investors should be cautious and discriminating when assessing these types of opportunities.

From a historical perspective, the short term performance of IPOs has been positive. According to a study conducted by the University of Florida, the average first1980-2014 period was 17.9%. Importantlyindividual year within that time period, with most pronounced appreciation for the years 1999 and 2000. In fact, during 1999 and 2000 average first day gains were 57% and 46%, respectively, rlevels of the “Internet Bubble” era. Ironically, companies completing IPOs in 1999 and 2000 were also among the least impressive from a financial perspective. During the 1999Wilmer Hale), only 26% of IPO firms were profitable and the median annual revenue of these enterprises was a modest $18 million. To provide some perspective, during the 2010and median annual firm revenue was $98 million.public company likely make the IPO decision a more complicated one for smaller firms in recent years. According to an Ernst and Young survey, being public adds an average of $2.5 million to a compastructure. However, it may be erroneous to assume favorable performance trends are a result of the IPO firms’ strong fundamentals. Rather, it may reflect a conscious decision by firms and investment banks to underIPO issues relative to fair value. A study by Jacksonville University (published in the AprilJournal of Business & Economics Research) offers several potential explanations for this phenomenon including enhancing the marketability of the IPO and creating positfuture secondary offerings.

Assessing IPOs from a longeractually underperform when making an assessment from a multiconducted by Betterment Investing, IPOs completed since 2004 have a median underperformance of 18% compared to a diversified basket of stocks. Additionally, IPOs tend to decline on an absolute basis over the long-term. This poor record is supported by a study from University of Florida for the period 1970that time frame, average 5-year returns for IPOs came in at a decline of approximately 3%. This same study confirmed that the majority of IPOs returns were derived beneficiaries of IPOs were underwriters and large institutional investors. Based on the finding of these various studies, the overall IPO process appears to more closely resemble wealth transfer rather tfrom the perspective of a long-term investor.

The historical track record of IPOs is far from impressive. However, investors should not assume that this segment is completely lacking in potential opportunities. Some types of IPOs posseperformance profiles. For example, companies that sell a smaller portion of their respective firms to the public tend to have a better track record. A 2013 study (conducted by Boston University and Tel Aviv University)

- 10 -

Analyzing Historical Performance of IPOs

“Does IPO stand for Instant Profit Opportunity or It’s Probably Overconundrum is that both answers are generally correct. The answer appears to depend on the

Jacksonville University study (published in Journal of Business & Economic Research)

The recent strength of the IPO market is hard to debate. Metrics such as the number of IPOs and the associated proceeds of these transactions confirm that activity has returned to levels not seen since the late 1990s . IPO activity often reflects the performance and valuation of the stock market, as well as the general tone of the overall economic backdrop. Although the size and nature of companies “going publi

term, there are a few things that never change. Chief amongst these recurring themes include an ample numbers of buyers and sellers willing to participate in these transactions, and a financial system highly

them. For a typical investor, participating in the IPO market can have appeal on multiple levels. Performance of IPOs can often be strong in the near-term, suggesting a potential investment opportunity for market participants. Moreover, large or strongly performing IPOs are often well publicized developments within the financial media, helping to contribute to positive investor sentiment. For issuing companies, these events provide an opportunity to raise capital and monetize the ownership stakes of the fi

stage financial backers. Whether wealth is being created or transferred in these cases often depends on the specific fundamentals of the individual companies. The historical performance of IPOs indicates a mixed

gesting that investors should be cautious and discriminating when assessing these types of

From a historical perspective, the short term performance of IPOs has been positive. According to a study conducted by the University of Florida, the average first-day gain for IPOs (relative to IPO price) during the

2014 period was 17.9%. Importantly the average first-day performance figure was positive for every individual year within that time period, with most pronounced appreciation for the years 1999 and 2000. In fact, during 1999 and 2000 average first day gains were 57% and 46%, respectively, reflecting the peak enthusiasm levels of the “Internet Bubble” era. Ironically, companies completing IPOs in 1999 and 2000 were also among the least impressive from a financial perspective. During the 1999-2000 time frame (as reported by law firm

e), only 26% of IPO firms were profitable and the median annual revenue of these enterprises was a modest $18 million. To provide some perspective, during the 2010-2014 period 49% of IPO firms were profitable and median annual firm revenue was $98 million. Importantly, the increasing costs associated with being a public company likely make the IPO decision a more complicated one for smaller firms in recent years. According to an Ernst and Young survey, being public adds an average of $2.5 million to a compastructure. However, it may be erroneous to assume favorable performance trends are a result of the IPO firms’ strong fundamentals. Rather, it may reflect a conscious decision by firms and investment banks to under

ir value. A study by Jacksonville University (published in the AprilJournal of Business & Economics Research) offers several potential explanations for this phenomenon including enhancing the marketability of the IPO and creating positive performance momentum for the IPO to facilitate

Assessing IPOs from a longer-term view, a less favorable picture begins to materialize. In fact, IPOs actually underperform when making an assessment from a multi-year perspective. According to analysis conducted by Betterment Investing, IPOs completed since 2004 have a median underperformance of 18% compared to a diversified basket of stocks. Additionally, IPOs tend to decline on an absolute basis over the

record is supported by a study from University of Florida for the period 1970year returns for IPOs came in at a decline of approximately 3%. This same study

confirmed that the majority of IPOs returns were derived from the first day of trading, and that the primary beneficiaries of IPOs were underwriters and large institutional investors. Based on the finding of these various studies, the overall IPO process appears to more closely resemble wealth transfer rather t

term investor.

The historical track record of IPOs is far from impressive. However, investors should not assume that this segment is completely lacking in potential opportunities. Some types of IPOs posseperformance profiles. For example, companies that sell a smaller portion of their respective firms to the public tend to have a better track record. A 2013 study (conducted by Boston University and Tel Aviv University)

“Does IPO stand for Instant Profit Opportunity or It’s Probably Over-priced? The . The answer appears to depend on the

Jacksonville University study (published in Journal of Business & Economic Research)

The recent strength of the IPO market is hard to debate. Metrics such as the number of IPOs and the ivity has returned to levels not seen since the late

1990s . IPO activity often reflects the performance and valuation of the stock market, as well as the general tone of the overall economic backdrop. Although the size and nature of companies “going public” can vary over the

term, there are a few things that never change. Chief amongst these recurring themes include an ample numbers of buyers and sellers willing to participate in these transactions, and a financial system highly

them. For a typical investor, participating in the IPO market can have appeal on multiple term, suggesting a potential investment opportunity

performing IPOs are often well publicized developments within the financial media, helping to contribute to positive investor sentiment. For issuing companies, these events provide an opportunity to raise capital and monetize the ownership stakes of the firms’ founders and

stage financial backers. Whether wealth is being created or transferred in these cases often depends on the specific fundamentals of the individual companies. The historical performance of IPOs indicates a mixed

gesting that investors should be cautious and discriminating when assessing these types of

From a historical perspective, the short term performance of IPOs has been positive. According to a day gain for IPOs (relative to IPO price) during the day performance figure was positive for every

individual year within that time period, with most pronounced appreciation for the years 1999 and 2000. In fact, eflecting the peak enthusiasm

levels of the “Internet Bubble” era. Ironically, companies completing IPOs in 1999 and 2000 were also among 2000 time frame (as reported by law firm

e), only 26% of IPO firms were profitable and the median annual revenue of these enterprises was a 2014 period 49% of IPO firms were profitable

Importantly, the increasing costs associated with being a public company likely make the IPO decision a more complicated one for smaller firms in recent years. According to an Ernst and Young survey, being public adds an average of $2.5 million to a company’s cost structure. However, it may be erroneous to assume favorable performance trends are a result of the IPO firms’ strong fundamentals. Rather, it may reflect a conscious decision by firms and investment banks to under-price

ir value. A study by Jacksonville University (published in the April-2008 edition of the Journal of Business & Economics Research) offers several potential explanations for this phenomenon including

ive performance momentum for the IPO to facilitate

term view, a less favorable picture begins to materialize. In fact, IPOs tive. According to analysis

conducted by Betterment Investing, IPOs completed since 2004 have a median underperformance of 18% compared to a diversified basket of stocks. Additionally, IPOs tend to decline on an absolute basis over the

record is supported by a study from University of Florida for the period 1970-2010. During year returns for IPOs came in at a decline of approximately 3%. This same study

from the first day of trading, and that the primary beneficiaries of IPOs were underwriters and large institutional investors. Based on the finding of these various studies, the overall IPO process appears to more closely resemble wealth transfer rather than wealth creation

The historical track record of IPOs is far from impressive. However, investors should not assume that this segment is completely lacking in potential opportunities. Some types of IPOs possess more impressive performance profiles. For example, companies that sell a smaller portion of their respective firms to the public tend to have a better track record. A 2013 study (conducted by Boston University and Tel Aviv University)

Introduction

indicated that companies that sell less than 20% of their shares have the best 3(outperforming the broader market by 21% on average). Additionally, transactions described as “Reto outperform the broader universe of IPOs. These IPOs remarketplace and can take several forms. One example from recent years was the sale of governmentAIG shares back to public investors in 2011. In many cases these resupported by ample information and often benefiting from operational improvements (or debt reduction in the case of Bankruptcies) enacted by private owners.

Overall, the historical analysis of IPO performance is instructive on several fronts. It provthat the IPO market ultimately proves disappointing for longcompanies, and large institutions largely capture whatever gains are available in the nearinappropriate to completely ignore this segment of the market as pockets of opportunity do exist in some of the previously discussed areas (such as reyears and the initial IPO buzz subsides, some of these offer attractive buying opportunities. Ultimately, market participants must apply the same discriminating criteria to IPO companies that would be applied to any other publicly traded firms.

Potential Areas of Investment - Sorting through recent IPOs (2012

If bubble-like conditions and extreme risk characteristics continue to take hold in the IPO field over the coming quarters, this should translate to divergence in performance between high and lowsome of the sub-sectors of the IPO category that may be of particular interest.

Broken IPOs

“Broken IPOs,” or companies trading below their initial public offering price, could offer fertile hunting ground for investors with a contrarian bent. Boyar Research estimates there are a whopping 105 broken IPOs from the start of 2012 or later with current account for the stock market’s strong upward trajectory since 2012, we estimate there are 78 companies ($500 million minimum market cap) that have underperformed the S&P 500 by at least 20 percentage pointssince 2012. Most of these companies appear to have earned their underperformance and do not pass our quality screen, but we believe the list also includes at least a few hidden gems that have been overly punished. Two of the companies profiled in this issnegative publicity at SeaWorld following the sector in the case of MRC Global.

High Short Interest IPOs

Heavily shorted IPOs represent another potentially treacherous pool of stocks that could be appealingwhether long or short. Again, many of these companies deserve the investor skepticism directed their way. A healthy IPO pricing environment and strong firstopportunities for discerning short sellers. Additionally, many companies have come public with a very limited float (often as low as 10-20% of shares shorting shares but can also preclude heavy selling pressure when insider lockidentified 54 companies with current market caps of at least $500 million from the list of IPOs since 2012 that have 20% or more of their float sold overlap with the list of broken IPOs. Most are top performers from the redrestaurant categories. While most have finally begun to experience declinethere could be plenty of room to the downside in many cases. For example, despite the aforementioned Fitbit’s (42% of float sold short) meteoric sales growth (over 300% in 1H 2015), we wonder whether a device company is really worth $8 billion or ~5x 2015E sales? At the very least, the stock appears to lack a margin of safety, even after its market value plummeted from close to $11 billion just a little more than a month ago. But on the other hand, for shrewd stock pickers who can spot an oversold company among this list, a short squeeze could amplify returns. We believe investors who have sold short 28% of SeaWorld’s float could face a squeeze if new management so much as stabilizes the business following the recent brand d

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panies that sell less than 20% of their shares have the best 3-year performance profile (outperforming the broader market by 21% on average). Additionally, transactions described as “Reto outperform the broader universe of IPOs. These IPOs re-introduce formerly public entities back into the marketplace and can take several forms. One example from recent years was the sale of governmentAIG shares back to public investors in 2011. In many cases these re-IPOs are already familiar to the marksupported by ample information and often benefiting from operational improvements (or debt reduction in the case of Bankruptcies) enacted by private owners.

Overall, the historical analysis of IPO performance is instructive on several fronts. It provthat the IPO market ultimately proves disappointing for long-term investors, and that underwriters, issuing companies, and large institutions largely capture whatever gains are available in the near-

pletely ignore this segment of the market as pockets of opportunity do exist in some of the previously discussed areas (such as re-IPOs). Additionally, as many IPO shares underperform over the ensuing years and the initial IPO buzz subsides, some of these “broken IPOs” may approach valuations that begin to offer attractive buying opportunities. Ultimately, market participants must apply the same discriminating criteria to IPO companies that would be applied to any other publicly traded firms.

Sorting through recent IPOs (2012-present)

like conditions and extreme risk characteristics continue to take hold in the IPO field over the coming quarters, this should translate to good opportunities for stock picking (alpha generation) as volatility and divergence in performance between high and low-quality IPOs eventually takes hold. Below we briefly highlight

sectors of the IPO category that may be of particular interest.

es trading below their initial public offering price, could offer fertile hunting ground for investors with a contrarian bent. Boyar Research estimates there are a whopping 105 broken IPOs from the start of 2012 or later with current market caps over $500 million. Slicing the data slightly differently to account for the stock market’s strong upward trajectory since 2012, we estimate there are 78 companies

million minimum market cap) that have underperformed the S&P 500 by at least 20 percentage pointssince 2012. Most of these companies appear to have earned their underperformance and do not pass our quality screen, but we believe the list also includes at least a few hidden gems that have been overly punished. Two of the companies profiled in this issue are on the list due to what we believe are temporary headwinds: negative publicity at SeaWorld following the Blackfish documentary, and industry-wide pressure in the energy

represent another potentially treacherous pool of stocks that could be appealingwhether long or short. Again, many of these companies deserve the investor skepticism directed their way.

healthy IPO pricing environment and strong first-day performance of IPOs in recent years has created ample opportunities for discerning short sellers. Additionally, many companies have come public with a very limited

20% of shares outstanding), which decreases liquidity and increases the cost oshorting shares but can also preclude heavy selling pressure when insider lock-up arrangements expire. We identified 54 companies with current market caps of at least $500 million from the list of IPOs since 2012 that

short as of September 14, 2015. Notably, only 14 of these companies overlap with the list of broken IPOs. Most are top performers from the red-hot biotech, Internet, or fastrestaurant categories. While most have finally begun to experience declines since the market turned in May, there could be plenty of room to the downside in many cases. For example, despite the aforementioned Fitbit’s (42% of float sold short) meteoric sales growth (over 300% in 1H 2015), we wonder whether a device company

ally worth $8 billion or ~5x 2015E sales? At the very least, the stock appears to lack a margin of safety, even after its market value plummeted from close to $11 billion just a little more than a month ago. But on the

who can spot an oversold company among this list, a short squeeze could amplify returns. We believe investors who have sold short 28% of SeaWorld’s float could face a squeeze if new management so much as stabilizes the business following the recent brand damage.

year performance profile (outperforming the broader market by 21% on average). Additionally, transactions described as “Re-IPOs” tend

ntroduce formerly public entities back into the marketplace and can take several forms. One example from recent years was the sale of government-owned

IPOs are already familiar to the market, supported by ample information and often benefiting from operational improvements (or debt reduction in the

Overall, the historical analysis of IPO performance is instructive on several fronts. It provides evidence term investors, and that underwriters, issuing

-term. Yet, it would be pletely ignore this segment of the market as pockets of opportunity do exist in some of the

IPOs). Additionally, as many IPO shares underperform over the ensuing “broken IPOs” may approach valuations that begin to

offer attractive buying opportunities. Ultimately, market participants must apply the same discriminating criteria

like conditions and extreme risk characteristics continue to take hold in the IPO field over the neration) as volatility and

quality IPOs eventually takes hold. Below we briefly highlight

es trading below their initial public offering price, could offer fertile hunting ground for investors with a contrarian bent. Boyar Research estimates there are a whopping 105 broken IPOs

million. Slicing the data slightly differently to account for the stock market’s strong upward trajectory since 2012, we estimate there are 78 companies

million minimum market cap) that have underperformed the S&P 500 by at least 20 percentage points since 2012. Most of these companies appear to have earned their underperformance and do not pass our quality screen, but we believe the list also includes at least a few hidden gems that have been overly punished.

ue are on the list due to what we believe are temporary headwinds: wide pressure in the energy

represent another potentially treacherous pool of stocks that could be appealing—whether long or short. Again, many of these companies deserve the investor skepticism directed their way.

of IPOs in recent years has created ample opportunities for discerning short sellers. Additionally, many companies have come public with a very limited

), which decreases liquidity and increases the cost of up arrangements expire. We

identified 54 companies with current market caps of at least $500 million from the list of IPOs since 2012 that short as of September 14, 2015. Notably, only 14 of these companies

hot biotech, Internet, or fast-casual s since the market turned in May,

there could be plenty of room to the downside in many cases. For example, despite the aforementioned Fitbit’s (42% of float sold short) meteoric sales growth (over 300% in 1H 2015), we wonder whether a device company

ally worth $8 billion or ~5x 2015E sales? At the very least, the stock appears to lack a margin of safety, even after its market value plummeted from close to $11 billion just a little more than a month ago. But on the

who can spot an oversold company among this list, a short squeeze could amplify returns. We believe investors who have sold short 28% of SeaWorld’s float could face a squeeze if new

Introduction

Re-IPOs

Another sub-category to highlight is “Reacquired by private equity firms. As mentionedwhole. Although often still highly leveraged, they typically have more proven business profitability than younger, venture-backed IPOs and are well managed. According to Dealogic data, there were 78 private equityIPOs in 2014 that raised $30.0 billion. That was essentially on pa$30.6 billion in 2013. SeaWorld also fits this category, with Blackstone still holding a 21.6% stake nearly 6 years after acquiring the business from Anheuser

Equity Carve-Out IPOs

An equity carve-out IPO occurs when a company completes the sale of a stake in a subsidiary via an IPO. It is not uncommon for a carve-out IPO to be followed by a spin off or split off. In a subsequent spin off, shares are distributed to all of the parent’s shareholders,their parent shares for all, none or a portion of the subsidiary. Not only does a split off enable a parent to distribute its remaining stake in a subsidiary, but also can serve as a form of share buycarve-out transactions structured as spin offs include Sunoco/SunCoke Energy (2012), Motorola/Freescale Semiconductor (2004) and GE’s planned spinMeanwhile, McDonald’s/Chipotle (2006 split off), Bristol(2013 split off) are three historical transactions that fall into the split off category. In June 2015, IAC/InterActiveCorp (profiled in AAF’s February 2015 issue) announceMatch Group by offering less than 20% of the shares to the public. The Match Group IPO is expected to be completed in the fourth quarter of 2015.

Typically, the parent company maintains a majority ownership stake in tof at least 80% of the voting power of the shares in order for the subsequent spinoff to qualify as a tax free transaction. While a parent maintains control after the IPO, the carve out will have its own board, management team and will issue its own financial statements. Proceeds from the IPO are either retained by the subsidiary or distributed to the parent company. One advantage of the carveappropriate for the security, which is in contrast to a straight spin off transaction that may result in shares being distributed to an investor base with no intention of holding the stock. In addition, the carveestablish a valuation for the shares before a parent spins ocarve-out structure can help a business attain a public market valuation infactors that often pressure its valuation. These factors include low liquidity, ovedistribution of shares and governance concerns since the parent company is still in control. Accordingly, we believe that carve outs should not be overlooked as a source of undervalued investment opportunities.

Re-Listings/Reorganization

Companies undergoing reorganization that find their shares relisted have long been a fertile source of prospective investment ideas for value investors. A 1998 study conducted by Allan C. Eberhart et. al revealed that there were large positive excess returns in the 200 days following rebe underfollowed and overlooked by investors, at least initially. In contrast to traditional IPOs, companies emerging from bankruptcy or other type of corporate restructurigiven the absence of formal roadshows associated with these securities. A lenders’ presentation is often the only opportunity for these businesses to present themselves to the investment community and these invesgatherings tend to command much smaller audiences compared to IPO roadshows. It is also worth noting that there may be some sort of stigma associated with these companies, especially ones that have undergone a bankruptcy process. However, there are manto poor capital structure decisions rather than the underlying performance of the business. In April 2015, Analysis Focus featured shares of Tribune Media, which is a recent reorganiextended bankruptcy stay in December 2012 and subsequently garnered a formal NYSE listing in December 2014. While some of Tribune’s businesses were facing challenges at the time of the bankruptcy filing (e.g. publishing, which was spun off poston the asset rich media business as the financial crisis was gaining steam ultimately proved to be its undoing. We believe Eastman Kodak, which is formally profiled being overlooked by investors. While the consumer film business ultimately proved to be the former Kodak’s

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category to highlight is “Re-IPOs” or the re-listing of formerly public companies that were mentioned, these companies have historically out-performed IPOs as a

hly leveraged, they typically have more proven business profitability than younger, backed IPOs and are well managed. According to Dealogic data, there were 78 private equity

IPOs in 2014 that raised $30.0 billion. That was essentially on par with the 78 PE-backed offerings that raised $30.6 billion in 2013. SeaWorld also fits this category, with Blackstone still holding a 21.6% stake nearly 6 years after acquiring the business from Anheuser-Busch InBev.

out IPO occurs when a company completes the sale of a stake in a subsidiary via an out IPO to be followed by a spin off or split off. In a subsequent spin off,

shares are distributed to all of the parent’s shareholders, while a split off involves making an offer to exchange their parent shares for all, none or a portion of the subsidiary. Not only does a split off enable a parent to distribute its remaining stake in a subsidiary, but also can serve as a form of share buy

out transactions structured as spin offs include Sunoco/SunCoke Energy (2012), Motorola/Freescale Semiconductor (2004) and GE’s planned spin-off of the rest of Synchrony Financial following its 2014 IPO.

tle (2006 split off), Bristol-Myers/Mead Johnson (2009 split off) and Pfizer/Zoetis (2013 split off) are three historical transactions that fall into the split off category. In June 2015,

’s February 2015 issue) announced plans to carve out its stake in The Match Group by offering less than 20% of the shares to the public. The Match Group IPO is expected to be completed in the fourth quarter of 2015.

Typically, the parent company maintains a majority ownership stake in the subsidiary following the IPO of at least 80% of the voting power of the shares in order for the subsequent spinoff to qualify as a tax free transaction. While a parent maintains control after the IPO, the carve out will have its own board, management

am and will issue its own financial statements. Proceeds from the IPO are either retained by the subsidiary or distributed to the parent company. One advantage of the carve-out structure is it can create an investor base

is in contrast to a straight spin off transaction that may result in shares being distributed to an investor base with no intention of holding the stock. In addition, the carveestablish a valuation for the shares before a parent spins off the remaining shares to its shareholders. While the

out structure can help a business attain a public market valuation in-line with its fair value, there are a few factors that often pressure its valuation. These factors include low liquidity, overhang from the potential future distribution of shares and governance concerns since the parent company is still in control. Accordingly, we believe that carve outs should not be overlooked as a source of undervalued investment opportunities.

Companies undergoing reorganization that find their shares relisted have long been a fertile source of prospective investment ideas for value investors. A 1998 study conducted by Allan C. Eberhart et. al revealed

ve excess returns in the 200 days following re-emergence. These businesses tend to be underfollowed and overlooked by investors, at least initially. In contrast to traditional IPOs, companies emerging from bankruptcy or other type of corporate restructurings typically emerge with much less fanfare given the absence of formal roadshows associated with these securities. A lenders’ presentation is often the only opportunity for these businesses to present themselves to the investment community and these invesgatherings tend to command much smaller audiences compared to IPO roadshows. It is also worth noting that there may be some sort of stigma associated with these companies, especially ones that have undergone a bankruptcy process. However, there are many instances where the bankruptcy filing can be primarily attributed to poor capital structure decisions rather than the underlying performance of the business. In April 2015,

featured shares of Tribune Media, which is a recent reorganization IPO that emerged from an extended bankruptcy stay in December 2012 and subsequently garnered a formal NYSE listing in December 2014. While some of Tribune’s businesses were facing challenges at the time of the bankruptcy filing

ch was spun off post-bankruptcy in August 2014), the nearly 10x leverage that Sam Zell put on the asset rich media business as the financial crisis was gaining steam ultimately proved to be its undoing. We believe Eastman Kodak, which is formally profiled in this issue, is an example of a reorganization that is being overlooked by investors. While the consumer film business ultimately proved to be the former Kodak’s

listing of formerly public companies that were performed IPOs as a

hly leveraged, they typically have more proven business profitability than younger, backed IPOs and are well managed. According to Dealogic data, there were 78 private equity-backed

backed offerings that raised $30.6 billion in 2013. SeaWorld also fits this category, with Blackstone still holding a 21.6% stake nearly 6 years

out IPO occurs when a company completes the sale of a stake in a subsidiary via an out IPO to be followed by a spin off or split off. In a subsequent spin off,

while a split off involves making an offer to exchange their parent shares for all, none or a portion of the subsidiary. Not only does a split off enable a parent to distribute its remaining stake in a subsidiary, but also can serve as a form of share buyback. Examples of

out transactions structured as spin offs include Sunoco/SunCoke Energy (2012), Motorola/Freescale off of the rest of Synchrony Financial following its 2014 IPO.

Myers/Mead Johnson (2009 split off) and Pfizer/Zoetis (2013 split off) are three historical transactions that fall into the split off category. In June 2015,

d plans to carve out its stake in The Match Group by offering less than 20% of the shares to the public. The Match Group IPO is expected to be

he subsidiary following the IPO of at least 80% of the voting power of the shares in order for the subsequent spinoff to qualify as a tax free transaction. While a parent maintains control after the IPO, the carve out will have its own board, management

am and will issue its own financial statements. Proceeds from the IPO are either retained by the subsidiary or out structure is it can create an investor base

is in contrast to a straight spin off transaction that may result in shares being distributed to an investor base with no intention of holding the stock. In addition, the carve-out also helps to

ff the remaining shares to its shareholders. While the line with its fair value, there are a few

rhang from the potential future distribution of shares and governance concerns since the parent company is still in control. Accordingly, we believe that carve outs should not be overlooked as a source of undervalued investment opportunities.

Companies undergoing reorganization that find their shares relisted have long been a fertile source of prospective investment ideas for value investors. A 1998 study conducted by Allan C. Eberhart et. al revealed

emergence. These businesses tend to be underfollowed and overlooked by investors, at least initially. In contrast to traditional IPOs, companies

ngs typically emerge with much less fanfare given the absence of formal roadshows associated with these securities. A lenders’ presentation is often the only opportunity for these businesses to present themselves to the investment community and these investor gatherings tend to command much smaller audiences compared to IPO roadshows. It is also worth noting that there may be some sort of stigma associated with these companies, especially ones that have undergone a

y instances where the bankruptcy filing can be primarily attributed to poor capital structure decisions rather than the underlying performance of the business. In April 2015, Asset

zation IPO that emerged from an extended bankruptcy stay in December 2012 and subsequently garnered a formal NYSE listing in December 2014. While some of Tribune’s businesses were facing challenges at the time of the bankruptcy filing

bankruptcy in August 2014), the nearly 10x leverage that Sam Zell put on the asset rich media business as the financial crisis was gaining steam ultimately proved to be its undoing.

in this issue, is an example of a reorganization that is being overlooked by investors. While the consumer film business ultimately proved to be the former Kodak’s

Introduction

demise, the new Kodak operates a group of businesses that serve the commercial printing marthe market is overlooking the attractive stream of recurring/consumable revenues that its businesses generate.

Reverse/Backdoor IPOs

There are several other types of IPOs that also merit some attention by investors. One segment of the IPO market that has gained renewed traction during recent years is the special purpose acquisition company (also known as SPACs or blank check companies). SPACs can be considered a form of reverse IPO, since the entity first raises funds via the public market SPACs have been launched which have raised over $4 billion in proceeds (average deal size has been over $140 million). Importantly, activity related to SPACs had largely subsided following the ehitting a bottom of $39 million raised in 2009. Such entities are often speculative in nature, as investors are basically at the mercy of the SPAC management as it pertains to potential acquisitions. As a result, investors are better served by focusing on management teams who possess a well established record of value creating M&A. Another form of reverse merger that gained popularity during recent years has been the trend of private firms (many located in China) acquiring publicly tradethe equity markets. In many cases, this approach is less expensive and is less burdensome for the companies from a regulatory perspective. These transactions should also be closely scrutinized by potethe reduced regulatory requirements involved. In several cases, Chinese firms that accessed the U.S equity markets via reverse merger were forced to ultimately delist from exchanges due to problems related to financial reporting. However, it would be erroneous to assume all reverse mergers from China are inherently fraudulent. In fact, a 2013 study by Stanford’s Graduate School of Business found that Chinese reverse mergers actually outperformed as a group compared to other publicly tr

Value/Growth Historical Performance

Earlier In the introduction, we noted that the last time IPO volume was as high as it was in 2014 was near the end of the dotcom bubble years (1999value investors, the recent outperformance of the growth arena. Looking at annualized total return data for rolling Cap) Value versus Growth indices, we note that growth’s annualized total more than one percent in 3 calendar tenindices began 12/31/1978) – the ten years ended 1998, 1999 and 2014 (see chart below). This year, for the eight months ending August 31, 2015, the Russell 1000 Growth Index is ~7.1% ahead of its value counterpart helping the ten years ended August 31, 2015 growth outperformance accelerate to over 2% from 1.2% in 2014 making it likely that we will once again have aoutperformance. It is interesting to note that outperformance could have been greater had a number of the successful unicorns gone public versus retaining their private status. Remarkably, after the last bacrolling 10-years of significant growth outperformance, value (starting in 2000) outperformed growth for seven consecutive calendar years (one year periods) In addition, value, unlike growth, did not produce any negative ten1989-2014 timeframe.

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demise, the new Kodak operates a group of businesses that serve the commercial printing marthe market is overlooking the attractive stream of recurring/consumable revenues that its businesses generate.

There are several other types of IPOs that also merit some attention by investors. One segment of the market that has gained renewed traction during recent years is the special purpose acquisition company

(also known as SPACs or blank check companies). SPACs can be considered a form of reverse IPO, since the entity first raises funds via the public market prior to acquiring any actual businesses. Since 2013, over 30 SPACs have been launched which have raised over $4 billion in proceeds (average deal size has been over $140 million). Importantly, activity related to SPACs had largely subsided following the ehitting a bottom of $39 million raised in 2009. Such entities are often speculative in nature, as investors are basically at the mercy of the SPAC management as it pertains to potential acquisitions. As a result, investors

ved by focusing on management teams who possess a well established record of value creating M&A. Another form of reverse merger that gained popularity during recent years has been the trend of private firms (many located in China) acquiring publicly traded shell companies as an alternative method of accessing the equity markets. In many cases, this approach is less expensive and is less burdensome for the companies from a regulatory perspective. These transactions should also be closely scrutinized by potethe reduced regulatory requirements involved. In several cases, Chinese firms that accessed the U.S equity markets via reverse merger were forced to ultimately delist from exchanges due to problems related to financial

ver, it would be erroneous to assume all reverse mergers from China are inherently fraudulent. In fact, a 2013 study by Stanford’s Graduate School of Business found that Chinese reverse mergers actually outperformed as a group compared to other publicly traded industry peers.

Performance and IPO Activity

Earlier In the introduction, we noted that the last time IPO volume was as high as it was in 2014 was near the end of the dotcom bubble years (1999-2000) and postulated whether a warning light was flashing. As value investors, the recent outperformance of growth versus value also reinforces possible caution, especially in the growth arena. Looking at annualized total return data for rolling ten-year periods for the Russell 1000 (Large Cap) Value versus Growth indices, we note that growth’s annualized total return has only outperformed value by more than one percent in 3 calendar ten-year rolling periods since the ten years ended 1989 (Russell 1000

the ten years ended 1998, 1999 and 2014 (see chart below). This year, for the months ending August 31, 2015, the Russell 1000 Growth Index is ~7.1% ahead of its value counterpart

helping the ten years ended August 31, 2015 growth outperformance accelerate to over 2% from 1.2% in 2014 making it likely that we will once again have a second back-to-back period of meaningful growth outperformance. It is interesting to note that outperformance could have been greater had a number of the successful unicorns gone public versus retaining their private status. Remarkably, after the last bac

years of significant growth outperformance, value (starting in 2000) outperformed growth for seven consecutive calendar years (one year periods) – including 2003, which was a +30% market return year.

did not produce any negative ten-year annualized return periods during the

demise, the new Kodak operates a group of businesses that serve the commercial printing market. We believe the market is overlooking the attractive stream of recurring/consumable revenues that its businesses generate.

There are several other types of IPOs that also merit some attention by investors. One segment of the market that has gained renewed traction during recent years is the special purpose acquisition company

(also known as SPACs or blank check companies). SPACs can be considered a form of reverse IPO, since the prior to acquiring any actual businesses. Since 2013, over 30

SPACs have been launched which have raised over $4 billion in proceeds (average deal size has been over $140 million). Importantly, activity related to SPACs had largely subsided following the economic recession, hitting a bottom of $39 million raised in 2009. Such entities are often speculative in nature, as investors are basically at the mercy of the SPAC management as it pertains to potential acquisitions. As a result, investors

ved by focusing on management teams who possess a well established record of value creating M&A. Another form of reverse merger that gained popularity during recent years has been the trend of private

d shell companies as an alternative method of accessing the equity markets. In many cases, this approach is less expensive and is less burdensome for the companies from a regulatory perspective. These transactions should also be closely scrutinized by potential investors given the reduced regulatory requirements involved. In several cases, Chinese firms that accessed the U.S equity markets via reverse merger were forced to ultimately delist from exchanges due to problems related to financial

ver, it would be erroneous to assume all reverse mergers from China are inherently fraudulent. In fact, a 2013 study by Stanford’s Graduate School of Business found that Chinese reverse mergers actually

Earlier In the introduction, we noted that the last time IPO volume was as high as it was in 2014 was 2000) and postulated whether a warning light was flashing. As

growth versus value also reinforces possible caution, especially in periods for the Russell 1000 (Large

return has only outperformed value by year rolling periods since the ten years ended 1989 (Russell 1000

the ten years ended 1998, 1999 and 2014 (see chart below). This year, for the months ending August 31, 2015, the Russell 1000 Growth Index is ~7.1% ahead of its value counterpart

helping the ten years ended August 31, 2015 growth outperformance accelerate to over 2% from 1.2% in 2014 – back period of meaningful growth

outperformance. It is interesting to note that outperformance could have been greater had a number of the successful unicorns gone public versus retaining their private status. Remarkably, after the last back-to-back

years of significant growth outperformance, value (starting in 2000) outperformed growth for seven including 2003, which was a +30% market return year.

year annualized return periods during the

Introduction

Annualized Ten

Source: Russell.com and St. Louis Fed

While the value investing style has many studies backing its long

(Fama and French, etc.), the Russell 1000 Growth index has benefited in the last couple of years on a relative performance basis due to its large sector weightings in Technology (22% as of 6/30/2015 including a 6+% weight in Apple) and Health Care (18.1%), while the Russell 1000 Value index has its largest weightings in Financials (29.8%) and the dramatically underperforming Energy sector (14.3%). With many biotech firms (included in the Health Care sector) and “new” technologyvolatile stock environment, we await with interest the value versus growth outcomes in the coming months (and years). Since we believe value’s recent relative underperformance may soon be nearing an enupdates on three stocks previously probed by the market at significant discounts to our estimated intrinsic values (DFS) and Sysco (SYY).

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

Russell 1000 Value Index

- 14 -

Annualized Ten-Year Rolling Performance

Source: Russell.com and St. Louis Fed

While the value investing style has many studies backing its long-term outperformance versus growth (Fama and French, etc.), the Russell 1000 Growth index has benefited in the last couple of years on a relative performance basis due to its large sector weightings in Technology (22% as of 6/30/2015 including a 6+%

ple) and Health Care (18.1%), while the Russell 1000 Value index has its largest weightings in Financials (29.8%) and the dramatically underperforming Energy sector (14.3%). With many biotech firms (included in the Health Care sector) and “new” technology companies carrying “pricey” valuations in the current volatile stock environment, we await with interest the value versus growth outcomes in the coming months (and years). Since we believe value’s recent relative underperformance may soon be nearing an enupdates on three stocks previously probed by Asset Analysis Focus, which we believe are currently priced by the market at significant discounts to our estimated intrinsic values – Coach (COH) , Discover Financial Services

Russell 1000 Value Index Russell 1000 Growth Index Value minus Growth

outperformance versus growth (Fama and French, etc.), the Russell 1000 Growth index has benefited in the last couple of years on a relative performance basis due to its large sector weightings in Technology (22% as of 6/30/2015 including a 6+%

ple) and Health Care (18.1%), while the Russell 1000 Value index has its largest weightings in Financials (29.8%) and the dramatically underperforming Energy sector (14.3%). With many biotech firms

companies carrying “pricey” valuations in the current volatile stock environment, we await with interest the value versus growth outcomes in the coming months (and years). Since we believe value’s recent relative underperformance may soon be nearing an end, we present

, which we believe are currently priced by Coach (COH) , Discover Financial Services