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Thawing out
What investors need to know as the IPO market reheats
By Jonathan Burton, MarketWatch
Last Update: 9:01 PM ET Nov 20, 2009
SAN FRANCISCO (MarketWatch) -- The past month has been the busiest for initial public stock offerings in almost two years. Five deals came out this week alone, on the heels of two well-received debuts the week before, in what may be a hopeful sign for the stock market overall.
Yet retail investors shouldn't expect to find access to the notoriously exclusive IPO market any more public. "IPO" might as well stand for "individuals passed over," though a few back doors are open for those who know where to look.
That is, if it's even worth looking. Many who remember the go-go late 1990s stock market still perceive IPOs as golden tickets for the well-connected and well-heeled. Back then, companies with no earnings or even the most basic fundamental underpinnings had buyers lined up in hopes of doubling or even tripling their money in a matter of hours.
"Ten years ago you could have brought a desk and a chair public," said Scott Sweet, senior managing partner at IPO Boutique, an investor advisory service.
Selective buyers
Not any more. Many of this year's deals have been for high-quality businesses with actual earnings, brought to market by top-drawer underwriting firms.
"They're not only more solid, they generally have good backing," Sweet said about the recent crop of IPOs.
Investors are warming to these deals, but they're being choosy. "Those that languish in the pipeline generally do not meet the criteria that investors and institutions are looking for," Sweet said.
Potential buyers, he noted, want to see improving year-over-year revenues, increasing profits or decreasing losses, a strong business foothold and little debt.
"It's not like every deal is working," added Sal Morreale, institutional sales manager at brokerage Cantor Fitzgerald and an IPO specialist. "The Street is being extremely selective in what it likes." For example, one of this week's hopefuls, medical-record manager HealthPort Inc., had to postpone its offering.
'We're in a discerning IPO market, which is probably one of the best IPO markets you can be in.'
-- Kathleen Smith, Renaissance Capital
Even when deals get done, investors aren't going overboard. Consider what happened on Friday when four companies went public, capping the second-busiest week of the year.
Two issues -- Cloud Peak Energy Inc. CLD, a carve-out of mining giant Rio Tinto PLC RTP, and Global Defense Technology & Systems Inc. GTEC -- priced below expectations and finished their first trading day near where they opened.
The other two -- Chinese hotel chain 7 Days Group Holdings Ltd. SVN and online educator Archipelago Learning Inc. ARCL -- fared relatively better, but even then their first-day gains were just over 13%.
The week's big winner was network security expert Fortinet Inc. FTNT, which enjoyed a first-day surge of 33% on Wednesday. Other notable IPOs this month: clothing retailer Rue21 Inc. RUE, up 25% out of the gate, and solar-industry player STR Holdings Inc. STRI, jumping 31% after its unveiling.
"We're in a discerning IPO market, which is probably one of the best IPO markets you can be in," said Kathleen Smith, a principal at Renaissance Capital, which specializes in IPO research and runs the IPO Plus Mutual Fund IPOSX.
"You see these types of markets after big corrections," she said. "Investors are price sensitive, so deals are unable to be priced at big premiums. Companies should be nervous if they have an overpriced IPO; it may not be successful."
Initial offering questions
Companies can come public too soon, and often do, said IPO Boutique's Sweet, who also trades IPOs for his own account.
He and other IPO experts advise would-be buyers to ask straightforward questions, just as they would for any investment. That's true even if the intent is to flip the IPO shares on day one.
First, determine how much of the company is being offered, Sweet said. Typically a company gives up about one-third of its shares outstanding.
"How much are insiders retaining?" Sweet said. "If insiders are selling and the company is getting nothing, that's a red flag." And be careful, he added, if a speculative company, such as a biotech firm, appears desperate for cash to fund an early-stage product.
Next, find out why the company is going public. "What are the dynamics of the deal?" said Bill Buhr, IPO strategist at investment researcher Morningstar Inc. "Will they keep the proceeds to grow the business?"
If the IPO seems like it's mainly giving top executives a chance to make money, he said, "that's not necessarily a deal I want to get involved in."
Then, Buhr said, dig into the firm's books. Is it profitable? Does it generate cash? Does the business have a competitive advantage over rivals? "You want to see where the [company's] story is heading," he said.
Finally, watch where the deal prices versus expectations. "If it's priced above the filing ranges, you can expect some aftermarket performance," said John Fitzgibbon, Jr., founder of advisory service IPO Scoop. "It means it was oversubscribed and there is ongoing interest in the deal; not every institution got their full allocation."
Getting a share
How can you get a piece of the IPO pie? It's always helped to be a heavy hitter, an active trader, and an all-around good customer to your broker.
"It's just like the big tipper at a hot restaurant," Fitzgibbon said. "You walk to the front of the line, people bow and scrape and show you in."
Still, if you do wrangle shares it probably won't be as much as you want. Selling 100 shares of a $10 stock that moves 20% on the open isn't going to make you rich. But it might make you feel like a player.
For retail investors who want in on IPOs but don't have the ability or the money to keep trading accounts with several brokerages, Fidelity Investments has a new proposition.
The mutual-fund giant is making IPOs and other stock offerings available to some of its brokerage clients through separate arrangements with private-equity firm Kohlberg Kravis Roberts & Co. and with German investment bankers Deutsche Bank DB.
To participate in KKR backed deals -- such as the recent IPO of discount retailer Dollar General Corp. DG -- Fidelity brokerage customers need at least $100,000 in assets at Fidelity and to make 36 or more trades in a 12-month period. Access to IPOs led by Deutsche Bank requires a client to have at least $500,000 at Fidelity and to make the same number of trades over a year.
Said Mark Haggerty, president of Fidelity Capital Markets: "It doesn't mean we can get it for every customer, or even in the allotment they want, but to a great extent it's got us access to a product that in the past a lot of retail investors wouldn't have."
After the shouting
If like most people you don't win the IPO lottery, there are still some options to consider.
The $11 million IPO Plus Aftermarket Fund, one of the only diversified portfolios available to retail investors, is up about 12% for the year so far. The fund owns more than two dozen positions in companies that have gone public over the past couple of years. Its biggest stakes include index provider MSCI Inc. MXB, risk-management software producer Verisk Analytics VRSK, STR Holdings, and retailer Vitamin Shoppe Inc. VSI, which went public in October.
Renaissance is developing an exchange-traded fund that would track the FTSE Renaissance IPO Index, a collection of 103 companies which have gone public in the last two years, Smith said.
The benchmark is up 45% so far this year with contributions from top components Visa Inc. V, MSCI, American Water Works Co. Inc. AWK, Chimera Investment Corp. CIM, Mead Johnson Nutrition Co. MJN and Intrepid Potash Inc. IPI
There's no timeline for Renaissance Capital's ETF, Smith said. That leaves First Trust US IPO Index FPX, which tracks the IPOX-100 U.S. Index, as the lone ETF for IPO investors. The ETF includes the top 100 IPOs by market value from the past four years. About 35% of the fund is concentrated in holdings Visa, Philip Morris International Inc. PM MasterCard Inc. MA Covidien Plc. COV and Viacom Inc. (Class B) VIA.B
And you just might find a company that other investors have overlooked precisely because it's newly traded, and which could see its market value grow over time.
"The real way to play the IPO space, because a lot of times you can't get in early, is to do your own research," said Morningstar's Buhr. "If company A is worth more than the stated range and it doesn't move a lot [on the IPO], that's a situation where you can get into an undervalued asset."
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