Will Rosetta Stone's Stumble Kill that IPO Momentum?

clown-5695Private companies mulling the big move to the Nasdaq should take a look at Rosetta Stone’s five-day stock chart. The language-learning software company had been one of the higher flying IPOs of the year since it priced in April, leading to all sorts of speculation that a much-touted e-learning boom was finally upon us. The stock was so high-flying in fact, that its VCs Norwest Equity Partners and ABS Ventures announced their intentions to finally cash out and sell 4.3 million shares to the market.

That plan– announced just last week– was suddenly scrapped this week when the company announced its third quarter profits will be some ten cents less per share than expected.  The company cited higher than expected sales, marketing and development costs. Note that this isn’t economy related. The sales didn’t fall off– expenses just weren’t managed well. CFO Brian Helman referred to a pretty big screw up from the marketing department in Rosetta Stone’s press release:

“In the current quarter, we experimented with a significant amount of internet and television test marketing programs and we did not expeditiously terminate certain of those programs that were not yielding acceptable results.”

In other words, the business is fine. The management team just looks like a bunch of clowns now. I’m assuming the VCs are annoyed and so are Rosetta Stone’s bankers. William Blair & Co. publicly lashed out about the incident to a Wall Street Journal reporter, saying it reflected poorly on Rosetta Stone and the bank that was going to lead the follow-on round.

This is bad news for more than just Rosetta Stone. It’s possible the deal sours the budding resurgence in sub-$500 million market cap companies too. As we wrote about last week, a small initial float of shares can help a new IPO’s stock hold up well, but it also means VCs and insiders can’t easily sell without crashing the stock.

In the case of Rosetta Stone the float was about 11 million shares, with insiders and investors holding the balance of the roughly 20 million shares outstanding. Liquidity was already going to be tough given a thin average trading volume of 328,000 or so per day. Thanks to this snafu, Norwest Equity Partners and ABS Ventures won’t be getting any liquidity from the company anytime soon. And with how few analysts follow small-cap public companies these days, investors may walk away from Rosetta Stone and never remember to return.

It’s a shame. I’m a huge fan of Rosetta Stone’s products, as I’m currently using them to learn Mandarin and Portuguese. The software has an impressive user interface that makes the drudgery of learning a new language actually feel more like playing a game. I can actually lose myself for hours on Rosetta Stone, invariably leading to an angry email from Arrington asking where some post is. When you find yourself suddenly speaking and understanding a new language, it’s that special kind of high-tech magic.

Over the last few months, I’ve been testing out the hosted version of Rosetta Stone, which had some annoying microphone glitches a few months ago, but has worked brilliantly since I downloaded a newer version. Perhaps the management team needs its own upgrade.