Is This IPO Hopeful The Market’s Next Big Gainer?

One month ago, almost to the day, I shared this little Wall Street fact of life: The pace of initial public offerings (IPOs) always follows the broader market.

So it should come as no surprise that, as the S&P 500 Index has already charged 9% higher this year, IPO activity is heating up, too.

This week alone, nine companies plan to go public.

Who cares? Well, you should. Because one of those companies happens to be Marin Software (MRIN).

In February, I singled out Marin as a possible “hot IPO,” thanks to its leverage to the mobile advertising boom. (Remember, mobile advertising spending is expected to surge from $3.2 billion last year to $20 billion by 2015.)

However, there was one big caveat: price.

Since overpaying for an IPO never makes investment sense – and Marin hadn’t provided a proposed pricing range yet – we couldn’t determine whether or not it represented a bargain.

But we can now. So let’s get to it before the company begins trading tomorrow.

Survey Says…
Later tonight, underwriters plan to price Marin’s IPO between $11 and $13 per share.

Is that a fair price range?

Normally, we could tell in a flash.

We’d simply pull up everyone’s favorite valuation metric – the trusty price-to-earnings ratio – for each of the company’s competitors and the broad market. Then we’d compare it to the IPO in question, based on its earnings per share.

In Marin’s case, however, it’s not that easy.

As I previously noted, much like every other small-cap, mobile advertising company – including Augme Technologies (AUGT), Millennial Media, Inc. (MM) and Velti Plc (VELT) – Marin isn’t profitable yet.

Given the infancy of the mobile advertising industry, though, we shouldn’t immediately shun these companies because of their lack of profitability as potential investments. I assure you, the growth and, in turn, profits are forthcoming.

Thankfully, we do have two alternative and meaningful valuation proxies that we can use to determine a fair price to pay for Marin.

More specifically, we can evaluate previous investments by venture capital firms and price-to-sales (P/S) ratios for similar companies.

~Valuation Proxy #1: Venture Capital Investments
In November 2012, Marin raised almost $20 million through a private placement with existing stockholders. Its official purchase price? $13.5312 per share.

And since Marin has increased its sales since November, it’s not a stretch to assume that the stock is more valuable as a result.

So, based on previous investments, the proposed range of $11 to $13 per share represents a modest bargain.

Granted, the venture capital firms’ average cost per share is actually lower than $13.53. That’s because they had invested in previous financing rounds (dating as far back as 2010) at lower prices (as low as $5.53 per share).

Nevertheless, if we get a chance to buy in at prices equal to their most recent investment, we should take it.

~Valuation Proxy #2: Price-to-Sales Ratios
The going P/S ratio for a mobile advertising firm is between 2 and 3. But that’s based on an extremely small sample size.

In a broader context, Marin is really a software-as-a-service (SaaS) company. And if we include those companies in our analysis – including salesforce.com (CRM), Guidewire (GWRE) and Workday (WDAY) – the range of P/S ratios checks in at 8 on the low end and 36 on the high end.

Now, I’m always a bit conservative when it comes to valuing an IPO.

Accordingly, let’s use a P/S ratio range of 8 to 10 for Marin. Doing so values shares at about $15.80 to $19.75. So, again, the proposed pricing range of $11 to $13 appears to be a bargain.

Granted, underwriters might be underpricing the deal to produce a one-day pop. They’ve been known to stack the deck, so to speak, to make their track record appear more impressive.

But that’s precisely why we’re completing our valuation analysis in advance of the stock’s debut. It’s the only way to remain rational with our purchasing decisions.

You see, if the IPO does, indeed, pop out of the gates, we know at what point the price becomes prohibitive.

As for most other investors, who usually don’t hear about an IPO until it begins trading – well, they’re left to their own devices (i.e. – human nature).

When they see a dramatic price run-up for an IPO, they often buy in, thinking it’s a momentum play that should be purchased at any price. And more often than not, such an investment “strategy” yields losses, not profits.

Bottom line: Based on previous venture capital investments, the explosive growth on the horizon for mobile advertising firms and prevailing price-to-sales ratios, Marin is a compelling investment for under $20 per share.

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