Are These 3 ‘Busted’ IPOs Worth Buying?

When it comes to IPOs, you can either be fortunate enough to buy into a deal on the offering price… or you must wait for shares to drop back to earth.

#-ad_banner-#In recent years, many new issues have busted out of the starting gate and never looked back, leaving shares trading at valuations that can only be justified with a very long time horizon.

Of further concern, many of these hot IPOs hold real risk when insiders are freed from holding shares as part of the lockup expiration. As an example, I recently cautioned that 465 million shares of Twitter (NYSE: TWTR) will be hitting the market in May — a powerful headwind for a cooling IPO.

Instead of following hot IPOs, it makes better sense to follow the laggards. These are the companies that have either already fallen below their offering price, or fallen sharply from their post-IPO peaks. To be sure, many of these new issues deserve the drubbing they have received, but some companies just need to deliver better and more consistent results to build a shareholder base.

Here are three 2013 IPOs that have fallen out of bed but show solid turnaround potential.

1.  SFX Entertainment (Nasdaq: SFXE )
This concert promoter went public in October at $13 a share, and eventually moved below $9, where it remains today. The company produces roughly 30 major annual outdoor music events and another 700 to 800 indoor concerts every year. SFX’s focus on electronic dance music has been a sweet spot, with such festivals seeing a 40% hike in attendance from 2007 through 2012, compared with a 2% gain for the broader industry.

The primary goal of the IPO was to use shares as part of a roll-up strategy in this highly fragmented industry. SFX is the global leader — and still has less than 10% market share. For example, the company recently bought a 50% stake in “Rock in Rio,” which has attracted 7 million attendees over the years at its concerts held in South America and Europe. (There are plans to launch a similar festival in the U.S. in 2015.)

By controlling more events and venues, management can gain better overhead leverage with equipment and corporate staffing while also pursuing better terms with sponsors. A December deal with Anheuser-Busch InBev (NYSE: BUD), for example, is a “multi-year, multi-event deal that goes beyond traditional event-level sponsorships,” according to analysts at UBS.

So why is this IPO in a funk? First, a series of upfront investments ahead of planned growth means that margins on EBITDA (earnings before interest, taxes, depreciation and amortization) hover around 5% to 6%. SFX has acquired a dozen smaller rivals in the past 18 months (accounting for $350 million in revenue), and management is in the process of streamlining overhead. They believe that this business can generate 20% EBITDA margins once the acquisition strategy has ripened, but investors are taking a wait-and-see attitude.

Second, some investors are concerned that electronic dance music is a fad, so management will need to show consistent attendance at 2014 events to ease those concerns. Lastly, the company is being sued by a pair of former employees who allege that they were promised $100 million in shares at the IPO.

This is clearly a messy debut for this concert promoter, yet investors will have a fresh chance to gauge the health of this business when fourth-quarter results are released in coming weeks. A clear path to higher EBITDA margins will be a key catalyst for a share price rebound.

 

2. Ply Gem Holdings (NYSE: PGEM )
Back in November, I suggested this homebuilding products provider had 50% upside. Though shares surged from $14.50 to $18 over the following six weeks, they have slid back since then after another quarter of tepid results.

The key for this busted IPO is the ability to generate strong enough cash flow to rapidly pay down its debt load. The recent slowdown in new home construction means that process will take longer than I envisioned. For example, analysts had expected Ply Gem to earn nearly $1 a share in 2014, and earnings per share (EPS) now looks to be closer to $0.40 a share.

Still, all signs point to a recovery in the housing market, especially in 2015 and 2016, and Ply Gem should be a clear beneficiary as the debt loads fall, and the company’s enterprise value-to-EBITDA ratio starts to expand. I’ll be examining fourth-quarter results when they’re released March 14 to track the process of cash flow growth and debt reductions.

 

3. Potbelly (Nasdaq: PBPB )

This October 2013 IPO shot out of the gate: A planned $14 offering price was met with strong demand, and shares opened above $30 on the first day of trading. Though they stayed aloft in subsequent months, a recent quarterly shortfall has pushed shares back down to $20.

If you’ve ever been to a Potbelly, you can understand why investors were excited. The restaurants have an innovative layout that allows you to order your meal while online, and it’s ready to go a few minutes later at the checkout register. The emphasis is on fresh ingredients, and it clearly shows, as Potbelly typically garners very high reviews on Yelp (NYSE: YELP) and other services.

Management initially chose to build most of its restaurants in just a few cities to control growth and site location. Media spending is fairly low, thanks to strong word of mouth. Trouble, is, the weather in its Chicago and Washington, D.C., hubs has been atrocious. So fourth-quarter results gave the appearance of a struggling restaurant chain with slowing comps. Same-store sales growth of just 0.7% was well below analysts’ forecasts and recent growth rates.

Yet it’s far too soon to write off the chain. Store-level profit margins hover around 20% and should stay that way as management appears every committed to locating new stores in areas with strong demographics yet reasonable rents.

To be sure, management has already noted that first-quarter results will also be affected by the weather and also by upfront investments in overhead. But later in 2014, look for comparable-store sales to rebound and for investors to focus again on the company’s steady expansion plans.

As is the case with any newly public company, Potbelly’s management now must work to rebuild a shareholder base that has been burned. But its core business model still looks to be in solid shape.

Risks to Consider: Newly public companies lack the shareholder base to help them weather tough quarters and tough market conditions. If the markets head lower from here, than that will be just one more hurdle for these “broken” IPOs to overcome.

Action to Take –> There’s no reason to rush out and buy any of these three stocks as near-term results are likely to remain lackluster. But the recent pullbacks in each stock have created much better entry points than before. These are all good companies to monitor as they deliver their next set of quarterly earnings for signs of stabilization and growth.

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