1 Follow-On Offering to Buy For Long-Term Gains

After large gains following a successful IPO, it is typical for the company to do a follow-on offering allowing for pre-IPO shareholders to cash out. While this may appear to be the insiders cashing out at the top, the reality is that the top stocks doing these secondary offerings tend to move even higher.

Recent hot stock Rocket Fuel (NASDAQ: FUEL  ) announced plans to sell at least 5 million shares following the release of preliminary fourth-quarter 2013 earnings. The company provides a leading programmable advertising solution based on artificial intelligence, or AI.

Some other recent follow-on offerings from technology firms have performed well, if in different patterns. ChannelAdvisor (NYSE: ECOM  ) traded sideways-to-down for a while after the secondary offering back in early November, but the stock eventually exploded higher. In the case of Splunk (NASDAQ: SPLK  ) , the stock continued rising before being dragged down by the weak overall market last week.

Proposed offering
The company intends to sell 2 million shares, with selling shareholders unloading at least 3 million shares and the option for underwriters to purchase an additional 750,000 shares. At the current price of about $64, the company would raise $128 million prior to fees.

This deal is very similar to the one from ChannelAdvisor. In that scenario, ChannelAdvisor sold 1 million shares, with selling shareholders unloading at least 4 million shares and the option for underwriters to purchase an additional 750,000 shares.The deal was priced at $34, providing the company only $34 million prior to underwriting fees.The stock now sits around $44, providing the follow-on buyers a solid gain of close to 30% in less than three months.

Splunk sold 6 million shares, with the option for underwriters to purchase an additional 900,000 at a price of $81. Though Splunk proposed the offering at a similar time as Rocket Fuel, it priced the offering the next day without any trouble.  Rocket Fuel has taken more than a week to price its offering of a similar amount of shares.

Odd twist of earnings beat
Typically a company will come out and request more funds after a stock has soared to lofty valuations, leaving investors questioning if the insiders are selling at the top. In the case of Rocket Fuel, the company provided preliminary guidance for the fourth quarter that handily beat estimates. The company expects to report revenue of approximately $84.5 million, compared to previous guidance of $75.5 million. The new number equates to a whopping 110% growth rate. Even better, the gross profit rate is expected to increase nearly 140%.

If that wasn't enough, the company guided for 2014 revenues of $420 million-$435 million, which easily beat analyst estimates of around $419 million. With a market cap of slightly over $2 billion, Rocket Fuel trades at a reasonable five times revenue. Compared to the 28 times current revenue of Splunk, which now has a market cap of more than $8 billion, Rocket Fuel is an extreme bargain, especially considering Splunk is growing revenue only at around 40%. Great growth rate, but it's no rocket.

Investors not convinced yet
Despite market-leading revenue growth in excess of 100%, Rocket Fuel continues to struggle in after-market trading. Since the initial day of trading, when the stock shot up nearly 100% toward $60, the stock has spent most of the last four months trading below that level.

The company has quickly become a leader in the programmable digital advertising sector. After the bankruptcy of Velti and difficulties of Millennial Media, it appears that the market is unwilling to give Rocket Fuel a multiple commensurate with its growth rate.

Bottom line
A follow-on offering shouldn't be a major concern to long-term investors unless the stock is being unloaded after large gains when shares are trading at exceptional multiples. In the case of Rocket Fuel, the stock trades at a very reasonable multiple, considering its growth rate. The sideways trading of the stock during the last few months, could make the release of these secondary shares a catalyst to propel the stock higher, similar to ChannelAdvisor after its offering.

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