Prominent Investors Miss Web IPO Payoff

By Scott Thurm and Pui-Wing Tam 

For venture capitalists and other prominent investors in young companies, an initial public offering is supposed to be the big payoff for years of patience. It's not working out that way for some backers of newly public Internet companies.

Disappointing debuts of Web companies such as Facebook Inc. and Zynga Inc. have put some pre-IPO investors under water, leaving them with shares worth less than what they paid. Other investments remain profitable, but with much smaller gains than projected as recently as a few months ago.

The declines underscore the risks behind a recent Silicon Valley investment trend -- jumping into hot companies relatively late in the game, in the hopes of modest profits and outsize bragging rights. Well-known venture firms such as Andreessen Horowitz and Kleiner Perkins Caufield & Byers popularized these investments and helped propel a boom in valuations for private Internet companies.

Once the companies began going public, though, the boom fizzled. Zynga demonstrates the shifting fortunes.

In February 2011, heavyweights Morgan Stanley Investment Management, Fidelity Investments and T. Rowe Price Group Inc. together invested $490 million in the maker of games including "FarmVille" and "Words with Friends," valuing Zynga at $10 billion. The investors paid $14.03 per share, according to Securities and Exchange Commission filings.

In December, Zynga priced the shares for its IPO at $10, amid concerns about its reliance on Facebook.

After an initial surge, the shares have declined, closing Monday at $5.78.

At that price, Zynga is valued at $4.3 billion, less than half its value of 16 months ago. The drop has dragged other pre-IPO investors under water, including Google Inc. and Japan's Softbank Corp., which together invested $295 million in June 2010, at $6.44 a share.

Zynga's earliest investors, including entrepreneur Reid Hoffman and five venture firms, still stand to secure profits on shares they bought for less than 50 cents each.

But declining share prices have "made people pause and think about the high-valuation late-stage rounds," says Mike Volpi, a venture capitalist at Index Ventures. "You'll see people be more sensitive to value."

Index, too, has made pricey late-stage investments, including one last year that valued online-file-sharing start-up Dropbox Inc. at $4 billion. Mr. Volpi calls Dropbox an "exceptional situation," and says Index still likes the investment.

To be sure, the losses in most cases are only on paper, and could reverse. Facebook is down 17% from its $38 IPO price, but gained 11% last week and another 5% on Monday to finish at $31.49.

Some of the venture investors which fueled the late-stage investing craze have reaped profits despite share-price tumbles. Andreessen Horowitz, for instance, got into Facebook in late 2010 when the social network was valued at around $35 billion; Facebook is valued at more than twice that amount today. Andreessen Horowitz is also modestly ahead on its investments in Zynga and Groupon Inc.

Moreover, venture firms showing losses on one deal sometimes stand to reap big gains on others. Several Internet-related IPOs -- including social network LinkedIn Corp., realty site Zillow Inc. and software maker Splunk Inc. -- are trading above their offering prices.

Meritech Capital Partners, a Silicon Valley venture firm known for "late-stage" investments in more mature start-ups, is a few million dollars under water on a 2010 investment in car-sharing service Zipcar Inc. But Meritech stands to gain more than $1 billion on its 40-million-share stake in Facebook, acquired beginning in 2006 at 29 cents a share.

"The 'logo chasing' investing style of paying a public market price for a late private round has been proven to be a flawed model," says Craig Sherman, managing director of Meritech. "You have to do the hard work and be discriminating." Mr. Sherman says Zipcar is the only one of Meritech's nine most recent IPOs in which the firm's stake is under water.

It is common for the shares of newly public companies to decline. On average, shares of the 513 U.S. IPOs between 2007 and June 2011 fell 6.6% from their IPO price over their first year, according to Dealogic. It is less common for shares to fall below the prices paid by venture firms, which typically seek returns of at least 10 times their investment.

As Internet shares drop, more investors are endangered. Meritech is one of two pre-IPO investors under water on Zipcar, after putting $20 million into the company in December 2010 at $15.22 per share. Zipcar went public in April 2011 at $18; its shares have since declined to $10.18.

Shares of Groupon now trade at $11.15, slightly more than half the $20 IPO pricing in November. That is not far above the $7.90 per share at which backers including Morgan Stanley, Andreessen Horowitz, Greylock Partners and Kleiner Perkins invested $950 million in Groupon in late 2010 and early 2011.

"The vast majority of our investments are early stage and that will continue," said David Sze, a partner at Greylock, which invested in Facebook in 2006. Andreessen Horowitz and Kleiner Perkins declined to comment.

At Facebook, early investors such as Accel Partners and investment firms DST Global and Mail.ru stand to make billions, despite the drop in Facebook shares since the IPO. But those who jumped in last year will see much smaller gains, and some may be under water, for now.

The fate of these investors can't be known precisely because they bought existing shares from Facebook employees, rather than newly issued shares from the company. In SEC filings, Facebook says some investors paid more than $50 a share, but the average prices were much lower. In its filings, T. Rowe Price said it paid $25 to $31 a share for its Facebook stake.

Robert Benjamin, a T. Rowe Price spokesman, says "Our social-media pre-IPO investments are part of a larger set of investments by our funds, dispersed among many funds," and typically represent less than 1% of the holdings of any fund.

Fidelity and Morgan Stanley declined to comment, as did Groupon, Zynga and Facebook. Zipcar didn't return phone calls and emails seeking comment.

Write to Scott Thurm at [e-mail] and Pui-Wing Tam at [e-mail]

(END) Dow Jones Newswires

September 25, 2018 02:00 ET (06:00 GMT)

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