The recent successful Xero initial public offering (IPO) and the current BurgerFuel IPO have drawn comparisons to the 42 Below listing in 2003. The common characteristics of these 3 IPOs are that the companies involved all had minimal or negative earnings, valuations that implied significant growth and a global strategy. The products, markets and business models of the 3 companies are completely different. Commentators have cited the returns provided to investors in 42 Below, “Shareholders made a lot of money out of it” (at approximately 2 min 20 sec), as a guide to the potential returns available from growth companies. Valuecruncher has posted previously on both the Xero and BurgerFuel IPOs. Given the comparisons Valuecruncher has decided to review the return provided to investors in the 42 Below IPO.
42 Below undertook an IPO in September 2003 issuing 31 million shares at $0.50 raising $15.5 million (every 3 shares purchased in the IPO was accompanied by 1 warrant with an exercise price of $0.50 available for exercise during October 2005). The issue price of $0.50 implied a post-money valuation of $60.5 million. At the time of listing 42 Below had negative earnings.
Post the IPO 42 Below traded significantly below the IPO price of $0.50 and remained below $0.50 for the majority of the first year it was listed. In the year ending 31 March 2004 42 Below had operating revenues of $4.41 million and an operating deficit of $1.125 million. This is to be expected from a company such as 42 Below that is developing products, expanding into new markets and building a brand.
42 Below continued to grow sales and in the 2005 financial year had operating revenues of $12.58 million producing an operating deficit of $5.22 million. A key driver of revenue growth in the 2005 year was increased sales in the U.S.. During the 2005 calendar year 42 Below consistently traded above $0.50 and at times over $0.80. In 2005 42 Below engaged Macquarie to advise on strategic issues surrounding development of international opportunities, the Bacardi offer arose as a result of this process.
In the 2006 financial year 42 Below continued to exhibit strong revenue growth increasing operating revenue to $17.0 million and improving the operating deficit to $2.8 million. A key contributor to these improved results was a foreign exchange gain of approximately $1.2 million.
After being listed for 2 1/2 years and nearly 4 full years of financial reporting 42 Below had grown revenues to approximately $17 million, established a strong brand in the New Zealand market for premium spirits and had grown sales in the U.S. to over $6 million in 2006. Despite this 42 Below was still not profitable. Although 42 Below were growing revenues, these revenues were spread across geographical segments (primarily New Zealand and the United States). Based on management forecasts for the 2007 financial year 42 Below was expecting trading revenues to grow to $18.2 and EBIT of ($4.9) million [compared to ($3.7) million in 2006].
On 27 September 2006 Bacardi made a full takeover offer for 42 Below at a price of $0.77. The day prior to the offer 42 Below closed at $0.57 and had traded at a volume weighted average price of $0.55 in the 6 months prior to the offer. Valuecruncher has discussed the framework required to evaluate the Bacardi offer in a previous post.
The offer from Bacardi represents a 54% return for an investor in the IPO, this represents an annualised return of 15.5%. Based on the $0.57 price the day before the offer the gross return would have been 14% or 4.5% annualised. In Valuecruncher’s opinion the Bacardi offer represented an excellent opportunity for investors to realise value from a company that had done a great job building a brand and penetrating the tough U.S. market but was showing no signs of reaching profitability.
A professional early stage investor (i.e. a venture capitalist) targets a 10x return on investment over a period of 5-7 years. The 42 Below return for IPO investors (even with the sale to Bacardi) is well below this targeted level.
Although the 15.5% annualised return realised via the Bacardi offer was a significant improvement on the pre-offer price it can hardly be described as a “home run” return for investors in a startup IPO. Citing the 42 Below result as validation for investing in early stage growth companies on the NZX is misleading. Each investment should be considered on it’s merits. Companies such as Xero have the ability to develop into global players and have significant upside potential but investors should not be relying on a 42 Below style exit to realise their return. If these growth companies achieve a significant global presence investors should expect a return well in excess of 15% per annum (of course any return is a function of the price paid).
Note: This analysis focuses on the return to an investor in the 42 Below IPO who adopted a buy and hold strategy and does not incorporate potential returns from any warrants exercised.