Interest in IPOs Grows--as Do the Risks
You say you always wanted to own stock in a company that makes polyvinyl-chloride-coated rigid steel piping? You’ll get your chance soon, when Van Nuys-based Ocal Inc. tries to sell shares for the first time.
Or maybe you’ve hankered to have a stake in a business that makes “rapid prototyping systems,” which quickly produce test models of industrial parts or new consumer products from three-dimensional computer images. If so, Torrance-based Helisys Inc.’s upcoming stock offering may be for you.
Of course, chances are that most investors haven’t thought much about either of those businesses. But that won’t stop Wall Street from trying to float those risky new stocks--and many more--this month, in what is shaping up to be the single biggest month for initial public stock offerings since 1983.
Nearly 100 companies nationwide have filed with the Securities and Exchange Commission to go public in March, hoping to raise a total of $3.6 billion by exchanging their shares for investors’ cash.
Ever a boom/bust business, initial public offerings, or IPOs, naturally tend to proliferate when investors’ demand for stocks in general surges. With the market soaring this year, fee-hungry brokerage firms seem to have decided to empty the shelves of private client companies that have been waiting to sell stock.
“Businesses that have never considered going public now are asking, ‘Is there going to be a better time than this?’ ” says Ryan Jacob, director of research at IPO Value Monitor in New York.
But when IPOs boom and investors clamor to get a piece of the action--hunting for exciting new business ideas in an already-inflated stock market--it’s inevitable that the riskiness of the deals offered also rises.
And that is the problem with many of the IPOs scheduled for March, say market veterans. “You’ve got some extremely speculative offerings coming,” warns Mark Basham, new-issues analyst at Standard & Poor’s Corp. in New York.
“A lot of these are very early-stage companies--things that would otherwise be venture capital deals,” adds Carlene Murphy Ziegler, principal at money manager Artisan Partners in Milwaukee.
Helisys, for example, had sales of just $11.5 million in the year ended July 31, and the documentation for the firm’s proposed stock offering notes that its production systems are so new that there isn’t “sufficient customer experience” to know whether the machines are performing correctly.
Nonetheless, Irvine-based brokerage Cruttenden Roth hopes this week to sell 1 million shares of Helisys at between $6.50 and $8.50 apiece.
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Why companies go public is hardly a mystery. Entrepreneurs need funding to make their ideas blossom. For established private firms, selling stock allows the owners and managers to cash out, creating a public market for their shares and often turning them into multimillionaires overnight.
Case in point: Last Thursday, PIA Merchandising Services of Irvine sold 2.3 million shares at $14 each, and the stock rose to close at $15.50 on Friday. The company, which provides the fairly simple service of in-store merchandising for brand-name product makers (i.e., checking store shelves, changing price tags, etc.) has been principally financed by Los Angeles Mayor Richard Riordan’s venture capital firm, Riordan, Lewis & Haden.
The venture firm’s average cost per PIA share: about $1.81. Which means that at PIA’s current market price of $15.50, the original investors’ gain is more than 750%.
Pipe maker Ocal Inc. (1995 sales: $25 million), which hopes to sell 2 million shares at about $5 each, will use about $3 million of the proceeds to pay off bank debt the company incurred to repay loans extended by its chairman. Nothing illegal about that, but investors should look closely at who stands to benefit from an IPO.
Indeed, the question that all would-be IPO investors have to ask is, what are they getting for their capital? A great business with solid growth prospects, or a flash-in-the-pan company that has little chance of long-term success?
Unfortunately, in a hot IPO market too few investors bother to probe that deeply. What many investors are hoping for is simply a quick buck--to buy an IPO at the offering price and have it rise sharply on the first trading day.
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That has been happening a lot lately. Red Brick Systems, whose software is used to manage huge business databases, sold shares at $18 apiece on Jan. 23 and saw them soar to $30.25 on the first day of trading. They’re now at $49.50.
CyberCash Inc., a young company whose software allows for secure electronic payment for goods and services over the Internet, went public at $17 on Feb. 15 and now is at $46.50 a share.
Those are two of the biggest IPO stars of 1996. Most offerings don’t rise so spectacularly, but the IPO game is designed to reward the buyers who get in on the deals, and to create hype for future deals. How? The brokerages handling IPOs try to price the stocks below what the market appears willing to pay, so that investors who can’t get a piece of a deal when offered are willing to bid up the price once the stock begins trading.
And more often than not, the investors buying once trading commences are individuals, who must take a back seat to powerful institutional investors in eagerly awaited IPO deals.
Yet nowadays, competition is so intense for hot IPOs that even many institutional investors say they get only small slices of deals.
Artisan’s Ziegler, for example, wanted 200,000 shares of electrical-connector manufacturer Berg Electronics when it went public Friday at $21 a piece. The brokerage handling the deal gave her just 25,000 shares.
One of the most widely anticipated offerings of this year--Calabasas-based Xylan Inc., which could make its debut as early as this week--is likely to leave many investors out in the cold.
Xylan’s electronic switching technology is considered to be the next big thing in computer networking, allowing ever more powerful--and numerous--computers to easily link with one another.
The company, barely 2 1/2 years old, expects to sell 4.2 million shares for about $20 apiece. But Michael Haines, manager of the Founders Frontier stock fund in Denver, sees Xylan’s stock quickly going to $40 or more. The brokerages handling the deal, he says, are telling institutions that “you’ll be lucky to get a few thousand shares” in the offering because of huge demand.
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Of course, what fuels every IPO boom is the eternal search for potential next-generation growth companies such as Xylan. Every public company, after all, was an IPO once. Every investor dreams of getting in on the ground floor with the next Microsoft.
The reality, however, is that the Microsofts are by definition one in a million. As nearly every survey of IPO performance has shown, the majority of IPOs end up being mediocre investments, or much worse, over the course of a few years.
Turning any small or mid-size business, even a promising one, into a long-term success is a supreme challenge. “One in 10 of these companies knows how to manage the growth that has given them the opportunity to go public in the first place,” says Jeffrey Petherick, co-manager of the Loomis Sayles Small Cap stock fund in Boston.
And when the appetite for IPOs is so strong that many more high-risk offerings than usual make it to market, the odds of long-term success are even lower.
For investors intent on playing the IPO market, the best advice never changes: Do your homework on a company, look for businesses that truly have great growth prospects, and don’t overpay. If you like a stock but hate the price, be content to wait: Often enough, you may find that you’ll get it cheaper in six or nine months, when the hype has evaporated.
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IPO Hits. . .and Misses
Many initial public stock offerings, or IPOs, have been big hits this year as investors have clamored for new ideas. But there also have been some clunkers--IPOs that have quickly fallen below their initial prices. A sampling of 1996 IPOs:
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IPO Friday Percentage Stock (market) price close change Red Brick Systems (O) $18.00 $49.50 +175% CyberCash (O) 17.00 46.50 +174 Mossimo (N) 18.00 24.25 +35 Berg Electronics (N) 21.00 25.50 +21 U.S. Satellite Broadcasting (O) 27.00 32.00 +19 Revlon (N) 24.00 28.25 +18 Dignity Partners (O) 12.00 14.00 +17 PIA Merchandising (O) 14.00 15.50 +11 World Color Press (N) 19.00 20.75 +9 Iron Mountain (O) 16.00 16.00 unch Red Roof Inns (N) 16.00 14.25 -11 Sagebrush (O) 7.00 6.13 -12 New World Coffee (O) 5.50 3.84 -30
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O: Nasdaq; N: NYSE
Source: Securities Data Co.; Bloomberg Business News
