Taomee to Price IPO in Tough Market for Chinese Companies

When China-based children’s online portal Taomee prices its initial public offering (IPO) this week, it might not get the reception it has been hoping for.

Source: Taomee

Hot offerings by American firms like LinkedIn and Groupon are stealing the thunder from China-based IPO hopefuls, experts say. Moreover, poor aftermarket performance by recent Chinese IPOs, allegations of fraud and corporate governance issues make investors wary of these companies.

“Chinese IPOs had their day in the sun,” said David Menlow, president of IPOfinancial.com.

They just don't have the attractiveness versus the new resurgence in interest for the U.S. IPOs. Chinese stocks are in a lose-lose situation. The more the underwriters try to bring them to market, the worse the reception will be.”

Michael Clendenin, managing director at Shanghai-based advisory firm RedTechAdvisors, says the blind belief of U.S. investors in China growth story is over. “It used to be enough in the past, but it’s clear that this will not be enough in the future.”

Matt Therian, a research analyst at Renaissance Capital, agrees that investor enthusiasm for China-based IPOs has cooled, but he says investors are still paying attention to fundamentals. As a result, he said Taomee should benefit.

"[Taomee's] numbers look good and they have a solid online product in kids games and an expanding offline strategy that will look to emulate Disney’s business model of merchandising popular characters." -Managing director, RedTechAdvisors, Michael Clendenin

With 27 million registered accounts, Taomee is one of the leading children's entertainment and media companies in China. The company hopes to raise $72 million by offering 7.2 million American depository shares at a price range of $9 to $11. It plans to list on the NYSE under the symbol TAOM and is tentatively scheduled to price Thursday.

“They have a fast-growing business. From commercial launch in 2008, their sales have grown to a $50 million annual run rate,” said Therian. He said with an almost 40 percent net profit margin, it’s a highly profitable business.

Clendenin also expects strong investor interest in Taomee. “The numbers look good and they have a solid online product in kids games and an expanding offline strategy that will look to emulate Disney’s business model of merchandising popular characters.”

“The company is not reliant on the ads market or untested models of monetization,” adds Clendenin. “They actually get Chinese users to pay out-of-pocket for their services and that’s not easy to do here.”

But Francis Gaskins, president of research firm IPO Desktop, is skeptical. “Taomee is not a growth company. Their year-over-year numbers look great, but their growth plateaued for the past four quarters.”

Gaskins says it’s reminiscent of Renren which had similar issues. The highly anticipated stock started trading in early May and now is down more than 29 percent since its first day close.

Taomee, in fact, warned in its prospectus that it may not sustain its historical growth rate due to economic factors and competition. The company also expects higher operating costs and marketing expenditures in connection with development of its online virtual world communities.

“Even if this IPO prices well, they are unlikely to sustain it in the aftermarket”, Gaskins told CNBC.

In fact, dismal performance by recent Chinese IPOs means weaker pricing for the upcoming offerings, says Gaskins. “Nobody is making money on these stocks.”

According to data compiled by CNBC, on average, Chinese IPOs that priced this year lost 20.5 percent since their first day close. Only dating site Jiayuan is a notable exception.

“Aftermarket performance in the Chinese stocks is a validation that whatever is being priced, for the most part, is not getting institutional support,” says Menlow. He thinks investors can potentially see more delays, withdrawals and weaker pricing for the upcoming Chinese IPOs in 2011.

So far this year, 15 China-based companies filed for IPOs and 10 companies priced, according to data from Renaissance Capital. For the entire 2010, those numbers were 52 and 41 respectively. Two China-based companies withdrew their IPOs just last month citing “poor market conditions.”

Experts don’t expect any blockbuster China-based IPOs for the rest of this year.

“We need to wait until 2012, when e-commerce site 360buy goes IPO and possibly Taobao, the eBay of China,” says Clendenin. “Those will be the big ones to watch.”