These post-IPO sleepers deserve a second look

Investors are quick to dump a new stock when growth falters. Here's how to recognize when to jump back in.

By StreetAuthority May 3, 2013 2:42PM
Dice on newspaper stock pages copyright Tom Grill, PhotographerBy David Sterman

We're just a few weeks away from the one-year anniversary of the much-hyped initial public offering (IPO) for Facebook (FB).

The social media giant had developed so quickly while it was still a private company that many expected a blockbuster IPO that would immediately soar higher and keep on rising. But Facebook ran into the same issue that dogs many new IPOs: Much of the impressive growth is front-loaded into the quarters ahead of the deal, and by the time the IPO arrives, growth appears to be cooling.

Indeed, many companies choose to go public when they are firing on all cylinders, as they know they have the best chance of selling shares at a high price. When growth invariably cools, investors become disappointed and move on.
 
Shares of Facebook haven't recovered from that tepid IPO and remain more than $10 below the initial offering price. Yet this is still a company on track to boost sales 30% this year (to around $6.6 billion) and another 25% in 2014 (to $8.4 billion).

That's still quite impressive, and the company's most ardent bulls suggest that Facebook -- and its shares -- may still emerge as one of the most dominant technology firms.

Facebook has company. There are many other IPOs that fail to live up to the lofty expectations once held for them. Sometimes, it just takes patience as these company's rebuild credibility with investors and start to deliver smoother financial results.

I've scoured three years' worth of IPOs in search of stumbling young companies that deserve a second look. Here's what I've found.

Vera Bradley (VRA): By the time this provider of women's accessories went public in late 2010, investors thought they were latching on to an early-stage high-growth opportunity.

After all, sales had grown at a 25% pace in the fiscal year that was ending in a few months and would grow at the same pace in fiscal 2012 as well, to more than $450 million. Management spoke of many new and untapped growth avenues such as product line extensions and geographic expansions, helping shares roughly double from the IPO price to more than $50 in the spring of 2011.

One year later, shares would toil in the low $20s, where they still languish today. As noted on StreetAuthority in May 2012, momentum investors jumped ship once they saw that growth was slowing.

Sales are now rising at a projected 10% pace as Vera Bradley's product lines start to mature. Management is intent on squeezing out profits and minimizing its growth focus to just a few areas and a product line geared toward kids developed in tandem with Disney (DIS).

Analysts at Citigroup now expect a more linear growth path, with earnings per share (EPS) exceeding $2 by fiscal 2015 and $2.50 by fiscal 2016. Shares trade for just 9 times that figure, meaning this once-hot growth stock is shaping up as a nice value stock.

Citigroup's view of the business model: "Over the longer term, we continue to believe the Vera Bradley brand, product and design execution will fuel an attractive combination of industry-leading comparable-store sales growth, store expansion, and e-commerce progress."

ExactTarget (ET): As companies look to market their goods and services online, they are turning to a new breed of companies with expertise in email, mobile and other digital strategies. That explains why this company's March 2012 IPO was so well-received, spiking above $27 in its first few days of trading.

More than a year later, shares trade for below $20, thanks in large part to a series of quarterly losses, the result of heavy investments in growth initiatives.

ExactTarget's sales rose more than 40% last year, to $293 million. To maintain growth, ExactTarget is expanding its direct sales force, opening new international offices, beefing up research and development spending, and making tuck-in acquisitions to broaden the suite of service offerings. That probably means continued quarterly losses in the near term, but should set the stage for $450 million in revenue by next year.

Arcos Dorados (ARCO): On the StreetAuthority, I weighed in on this Latin American operator of McDonald's (MCD) franchises a year ago, after shares had fallen sharply from their peak and below the April 2011 IPO price.

This stock continues to languish, largely due to the still-slow Brazilian economy, which has been slumping for several years. Currency effects are hurting right now as well. A strong Brazilian currency led to a rise of just 6% in dollar-denominated revenue in this year's first quarter, blunting the 9.9% gains in comparable-store sales.

Even as the currency headwinds subside, this will never be a high-growth business model: New store openings and same-store sales increases may only boost the top line at a 10% annual pace. Shares should be appealing simply based on demographic positioning.

As I've noted in the past, the foundation is in place for Brazil to once again become one of the fastest-growing major economies in the world -- once the current economic slowdown passes -- highlighted by a rapidly expanding middle class. This company is well-positioned to serve clients who are just now starting to generate disposable income.

Risks to Consider: Young companies that stumble tend to lose their following among Wall Street analysts and fund managers, and until they move back into the spotlight, shares could continue to toil in relative anonymity.

Action to Take: New IPOs often fall out of favor as growth slows, and the key is to find companies that have the ingredients to keep boosting sales at a decent pace as they mature. Other recent IPOs that are far from their initial peaks yet still show long-term promise include BroadSoft (BSFT), RealPage (RP), Millenial Media (MM), Bazaarvoice (BV) and Peregrine Semiconductor (PSMI). All these companies are worthy of further research, now that the crowd has moved on to newer IPOs.

David Sterman does not personally hold positions in any securities mentioned in this article. 

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May 3, 2013 4:10PM
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