Going Public: A Revival : Interest in Initial Offerings Perking Up Again After Stock Market Crash; Medstone Sees Bad Timing Turn Good

For Medstone International, the decision to go public in 1987 was the right idea at the wrong time.

After several years of research, the Costa Mesa company was ready to exploit a potentially huge demand for its lithotripsy technology, which pulverizes kidney stones with shock waves.

There was just one catch. Medstone was slated to sell stock to the public for the first time during the week of Oct. 19. But before it could make its initial public offering, the stock market crashed.

In the aftermath of Black Monday, the market for initial stock offerings dried up. Medstone, like scores of other small firms planning to sell shares in late 1987 or early 1988, was forced to postpone its public offering indefinitely.

But a somewhat more stable stock market has revived interest in initial public offerings in recent months. Although the number of firms that have gone public this year remains small compared to last year, the market is showing increasing signs of life.

County Home to Growth Companies

And there are few places where that is more significant than in Orange County, which is home to a thriving community of emerging growth companies in need of money to expand.

Powerec International, a Huntington Beach electronics manufacturer, raised $2.7 million in a July public offering. Delphi Components, a Laguna Niguel defense company, plans to hit the market in September with a $1.25-million stock issue. And OptimumCare, a Laguna Niguel health-care firm, hopes to raise $2.5 million in another September offering.

For Medstone, the stock market collapse may have been a lucky break.

In June, 1988, seven months after the original timetable, Medstone completed its initial public offering. The stock sale generated $13 million, twice as much money as the firm had expected to raise in October.

‘Have No Regrets at All’

“We were disappointed at the time, but now we have no regrets at all,” said Freeman Rose, company founder and chief executive officer.

The investors who bought Medstone stock have fared well, too. In the 11 weeks since the stock was issued, its price has soared from $13 a share to $38.75 in the over-the-counter market.

Medstone’s performance is hardly typical. In fact, several positive developments helped focus investor attention on the firm both before and after its public offering.

In January, the Federal Drug Administration gave Medstone the green light to begin testing the effectiveness of its lithotripsy technology as a treatment for gallstones.

In April, the company received an even bigger boost when the FDA approved the use of Medstone technology on patients.

And since the stock offering, Rose said, there have been persistent rumors within the investment community that Medstone might be acquired by a larger, more established company.

All that has helped Medstone to rack up the best year-to-date stock performance of any initial public offering in the country, according to Going Public: IPO Reporter, a weekly newsletter.

Other Issues Less Spectacular

Other new stock issues have been less spectacular. In fact, only 53 of the 100 most recent initial public offerings are still trading above the price at which the shares were issued.

Selling stock to the public often is the best way for small companies to raise capital needed to expand production, enter new markets or increase research and development.

Public stock offerings have certain advantages over other sources of capital, such as bank loans, bond issues or large private investments.

For one, common stock represents an equity investment instead of a debt, and the company is not obligated to pay back the money it raises. Investors who buy the stock hope to profit from future dividend payments and increasing share prices.

But there are trade-offs. After going public, a company must report its financial results every three months, and its performance is scrutinized by hundreds of shareholders. A dip in quarterly earnings can prompt shareholders to dump the stock.

A publicly owned company also must comply with a complex set of federal, state and local securities regulations. That requires more accountants, more lawyers, and thus, more administrative expense.

After the October market crash, initial public offerings screeched to a sudden stop because investors had no interest in buying shares of small and relatively unproven companies.

But the number of new stock issues has begun to pick up. In July, there were 35 initial public offerings across the country, raising a total of about $1.6 billion, contrasted with the post-crash low of 10 offerings in November, 1987, which generated $299 million. The July, 1987, total was 93 offerings generating almost $3 billion.

For the first six months of this year, 230 initial public offerings have injected $7.9 billion into new public companies. Most of that activity has occurred since April.

“Since the crash, the IPO market has been decimated,” said Evan Guillemin, editor of Going Public. “The market is coming back, but awfully slowly. New issues are being priced at the low end, so it’s taken a lot of convincing to coax companies to accept lower prices.”

It is the job of the securities firm underwriting a new stock issue to determine a price that will satisfy both the company and its new shareholders. The goal is to set a price that will allow the stock to appreciate by about 10% to 15% during the first two weeks of trading.

Much of the current market for new stock issues centers around California’s emerging high-technology companies, said John B. Morris, an investment banker with the Newport Beach office of R.B. Marich, a Denver firm specializing in $5 million to $10 million offerings.

Morris said there will always be a market for high-tech companies with a good story to tell.

“We don’t really care what the Dow Jones Industrial Average does,” said Morris, whose firm served as the lead underwriter on the recent Powerec issue. “We look for specific companies that have a developed product and are very near profitability.”

Investor Apathy

Morris said that many Orange County companies are good candidates for initial public offerings, but the number of deals is limited by investor apathy.

“There’s a potential for two or three a week here in Orange County, but there’s only so much demand,” he said. “We look for the one or two best candidates.”

Powerec was one such candidate, Morris said, because of its potential to corner a growing market for silicon-on-sapphire transducers, pressure-sensitive electronic devices that monitor everything from tire pressure in jet aircraft to oil pressure in cars.

Founded in 1985, Powerec’s clients include General Electric, Pratt & Whitney, Lockheed, General Dynamics and AT & T. Its biggest customer, however, is the U.S Army, which uses another Powerec device called an arc suppressor in its M-1 tanks. The suppressors protect sensitive electronic equipment from dangerous power surges caused by lightning or nuclear explosions.

Most of the $900-million domestic market for transducers is controlled by large electronic firms. But Powerec’s devices are capable of performing accurately at much higher temperatures than competing products, according to Armen N. Sahagen, Powerec’s founder and chief executive.

Sahagen said the company has identified a $200-million niche for high-end transducers, and he believes that his company can capture most of that market.

Production Only Limit

“We are only limited by what we can produce,” said Sahagen, who owns 38% of the company’s stock. “This is a product that no one else can make.”

While the sale of 1,365,000 shares of Powerec raised $2.7 million, only time will tell if investors will realize a healthy return. Issued at $2 a share, Powerec stock closed Friday at $1.875.

It also remains to be seen if the company will be profitable. In the 12 months ended Aug. 31, 1987, the company lost $819,848 on sales of $389,845. The company hasn’t released results for the current fiscal year, but it has stated that its losses will be about half of last year’s and that it should begin turning a profit soon. Sahagen predicted that sales will be more than $1 million in fiscal 1989 and will top $5 million the following year.

Meanwhile, Medstone already is in the black. It reported its first profitable quarter in March and has earned $5.2 million on sales of $14.7 million for the first six months of 1988.

Medstone chief executive Rose said the company’s stock has soared primarily because its shares are the only way to invest directly in lithotripsy technology, which provides an alternative to surgical removal of kidney stones. Rose estimated that the potential market for lithotripsy devices exceeds $5 billion in annual sales.

“The marketplace for this technology is totally new,” he said.

INITIAL PUBLIC OFFERINGS

U.S Amount California Amount Period Issues (millions) Issues (millions) July, 1987 93 $2,950.5 15 $249.4 August, 1987 83 1,612.2 12 191.6 September, 1987 79 3,600.8 19 385.4 October, 1987 48 3,898.7 5 69.0 November, 1987 10 298.8 -- -- December, 1987 13 220.8 -- -- January, 1988 16 307.9 1 2.5 February, 1988 16 427.9 4 69.1 March, 1988 26 532.4 7 116.2 April, 1988 29 1,040.9 3 75.3 May, 1988 32 983.4 4 80.5 June, 1988 49 2,308.4 7 1,014.6 July, 1988 35 1,625.8 3 67.7 August, 1988 27 719.2 4 78.9 Total 556 $20,527.8 84 $2,400.2

Source: IDD Information Services Inc.