That Sinking Feeling

There is a substantial amount of risk focusing your business on an exit such as an IPO Digital Domain Media case in point. Aivars Lode, Avantce

That Sinking Feeling

By: Robert Cyran

The latest IPO disaster is an epic cautionary tale. Special effects creator Digital Domain Media Group, whose credits include “Titanic,” “Transformers” and the Tupac Shakur hologram, filed for bankruptcy protection on Tuesday less than a year after going public. Elements of the company’s problems are shared by other new technology stocks. It’s a case study for investor skepticism.

Oscar winner Digital Domain looks like a candidate for worst financial picture. Though many recent tech IPOs have run into one sort of trouble or another - most notably Facebook losing some $50 billion of market value in a few short months - none has amassed the collection of missteps Digital Domain has, nor so quickly descended into Chapter 11.

For starters, Chief Executive John Textor had said his company was profitable before going public. It was true up to a point. Subsequent disclosures showed it eked out a small gain in 2009 thanks to some government grants, but quickly returned to its money-losing ways. Demand Media did the same thing ahead of its share sale last year. The content farm racked up some $50 million in losses in the years leading up to its IPO despite claims by CEO Richard Rosenblatt it was in the black.

There also has been an overreliance on hype. The digital rendition of late rapper Tupac that appeared alongside Snoop Dogg and Dr. Dre at Coachella got plenty of attention and helped push the company’s shares up 15 percent after the music festival in April. Facebook and Pandora owners will sympathize. They, too, have ridden a wave of consumer-related adoration to valuations that are pretty much unjustifiable by any fundamental analysis.

Digital Domain’s early backers followed what has become a recognizable Silicon Valley playbook. When it floated last November, it wasn’t quite a bright-line event changing a private firm into a public one. A series of previous fundraising exercises, like ones used by Zynga and others, had sucked much of the financial life from the firm. And similarly to Groupon, Digital Domain liked to emphasize non-traditional profit measures.

Even Hollywood would be hard pressed to imagine a riches-to-rags tale like Digital Domain’s. But when it comes to technology stocks, investors need to be especially creative with their suspicions.

Robert Cyran is a columnist with BreakingViews. Opinions expressed here are entirely his own.