An initial public offering (IPO) can be an exciting thing, both for the company and its new investors. But studies show that IPOs tend to underperform the market average. As Warren Buffett once explained, businesses that are eager to sell themselves generally aren't a cohort with attractive return potential:
An IPO is like a negotiated transaction -- the seller chooses when to come public -- and it's unlikely to be a time that's favorable to you. So, by scanning 100 IPOs, you're way less likely to find anything interesting than scanning an average group of 100 stocks.
I can think of several IPOs over the past two decades worthy of a place on the list of the worst, but eToys, Pets.com, and Groupon (GRPN 5.75%) had post-IPO blowups that make them especially memorable. Here's the backstory on each company's IPO and nearly immediate decline.
eToys
One of the most spectacular dot-com busts, eToys was one of the first large internet retailers to go public. The company had a noble goal of becoming the internet's go-to destination to purchase children's toys and games.
From a humble start in 1998, the company ballooned in 1999 when it expanded in Canada and the U.K., pouring money into marketing to drive sales. Along the way, it also acquired BabyCenter.com in an all-stock deal worth $150 million. Recklessly abandoning traditional valuation frameworks, eToys paid more than 30 times sales for BabyCenter, an unprofitable online retailer.
It wasn't long before eToys needed to go public to raise money to feed its growth machine. The company went public on May 20, 1999, at a price of $20, and shares rocketed to close at $76 in the first day of trading. Judging by its stock-price performance, you might have thought eToys was almost certain to become the only destination for toy purchases around the world. Some signs pointed that way. In the fourth quarter of 1999, it sold more toys than established rival Toys R Us, an impressive feat.
Of course, sales are but one way to judge a business. Profits and cash flow, which matter most, never materialized for eToys. In truth, that should have been obvious at the time of its public debut: Regulatory filings show that the company was spending as much as $0.81 on marketing for every dollar of sales. Given that retail is inherently a low-margin business, there was little room for any marketing budget at all, let alone the warehousing, sales, and support expenses necessary to keep the doors open.
Data source: eToys S-1 filing with the U.S. Securities and Exchange Commission. Chart by author.
The company quickly burned through cash to drive customers to its online store, a never-ending problem. In the busy fourth quarter of 2000, it spent $72 million on marketing to drive just $131 million of sales. The company had previously forecast sales of $210 million to $240 million during the quarter, which would have justified its outsize spending.
Drained of cash after a poor holiday season, eToys began its liquidation in the first quarter of 2001. In March, less than two years after going public, the company sold the last of its assets to now-defunct KB Toys for $5 million. Shareholders lost every dime they invested.
These three companies declined rapidly after listing on major exchanges. Image source: Getty Images.
Pets.com
If eToys was bad, Pets.com, an online retailer for all things pet-related, was even worse. In a bid to grow at all costs, the company spent millions on over-the-top advertising displays, famously purchasing a Super Bowl ad at a cost of $1.2 million, and launching a balloon of its famous mascot in the 1999 Macy's Thanksgiving Parade.
Pets.com was emblematic of the false gold rush in dot-com business models. By all appearances, companies seemed to operate with the goal of lighting money on fire.
Regulatory filings show that in the first 10.5 months of business, Pets.com sold $5.8 million of product that it paid $13.4 million for. In effect, it was paying retail prices and selling at wholesale. Worse yet, its beefy marketing budget meant that it spent a whopping $7.34 on marketing for every $1 of sales it recorded. The only thing worse than selling inventory at a loss is spending money on advertising so you can sell even more inventory at even larger losses.
Data source: Pets.com S-1 filing with the U.S. Securities and Exchange Commission. Chart by author.
Alas, this was the dot-com boom, and no one really cared about profits or durable business models. After all, most new IPOs popped on the first day of trading, and continued to rise, regardless of the businesses' profitability. Pets.com went public at $11 per share, shortly rising to $14, following in the footsteps of most IPOs during the era -- but $14 marked the top. The company's share price dropped precipitously as it burned through the cash from its initial public offering.
Pets.com had a short life as a public company. Just 268 days after it went public, it was in liquidation. PetSmart acquired the few valuable assets it had, including the Pets.com domain name. As for its famous mascot, a subprime auto lender by the name of BarNone purchased the rights to the sock puppet for $125,000, later using it in commercials with the tagline "Everyone deserves a second chance." That is, everyone except Pets.com.
Groupon
The online discounter Groupon is still around today, but its fall from grace was so quick that it deserves its place on the list of worst-ever IPOs.
The site launched in November 2008, just as the economy was headed into near-collapse during the ensuing financial crisis. It quickly found no shortage of customers searching for discounts, or businesses willing to provide them. In fact, Groupon hit $1 billion in sales faster than any company in history.
The business model was simple. Groupon collected email addresses of consumers, who were promised deep discounts from local businesses. Once it had enough subscribers in any given locale, it pitched small mom-and-pop shops the opportunity to sell their products and services at deep discounts to its subscribers.
Seemingly everyone benefited from the service. Businesses received an influx of cash and new customers, subscribers got the deals they signed up for, and Groupon collected a hefty haul by playing middleman.
For a short time, it seemed as though Groupon was on top of the world. In late 2010, barely two years after its founding, Groupon rejected a takeover bid by Google (now Alphabet) that valued the company at $6 billion. It seemed like the smart thing to do a year later, when its IPO valued the company at about $12.7 billion.
Groupon went public at a price of $20, and shares later opened for public trading at $28 per share. But it was all downhill from there. By the end of 2012, less than 13 months after it went public, shares traded for less than $5 each.
The company's business model had inherent flaws that were hidden by its short operating history. Groupon's growth relied on a continuous supply of sales-starved businesses to supply it with deep discounts. After the original discount and Groupon's take of each sale, businesses might receive just $10 for a product or service that carried an ordinary retail price of $40. For obvious reasons, not many businesses can survive while discounting their products by 75%.
Sales growth slowed after Groupon's IPO, and profits have been difficult to come by. Visitors are now greeted with deals for local businesses they didn't know existed, rather than the most popular, must-visit eateries and retailers in their area that were common when the service launched.
The company has since pivoted somewhat, placing greater emphasis on the sale of discounted consumer goods to its subscribers, and add-on marketing services for its partners. But returning to its IPO glory seems improbable, if not impossible.
