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Success in Pricing IPOs Is Measured in Different Ways

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TIMES STAFF WRITER

Believe it or not, it was once considered not only rare but downright embarrassing when an initial public stock offering, or IPO, rose 200% or more in price on its first trading day.

A move like that was seen as a sign that the stock was priced far too low in the offering, cheating the company out of additional cash to fund its growth.

Which also meant that the underwriter, who is paid large fees to successfully price and sell the deal, had failed to do its job for the company, said Tom Taulli, an analyst with IPO Monitor, a data firm in Calabasas.

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Those days are going, going, gone.

IPOs like the recent one by Theglobe.com, which was priced by its underwriter at $9 a share--only to soar to $97 in the first hours of trading--are instead hailed as huge winners.

“Especially in the world of Internet companies, having a 200% gain or more on the first trading day is now considered a hallmark of a great IPO. It creates a good image for the company,” said Taulli. “There is so much placed on perception.”

Dramatic price gains on an IPO’s first trading day naturally generate an immediate buzz. Although the company’s proceeds in the deal total just what the initial investors pay for the stock--not what buyers pay once the shares begin trading--the company makes headlines and immediately becomes well known, which in the long run is seen as financially beneficial in terms of raising additional money.

What’s more, the initial investors get rich, and the underwriters, while not earning as much as they could have had the deal been priced higher, suddenly become known as IPO gurus, Taulli said.

On Nov. 13, Theglobe.com, a New York company that helps members create their own home pages on the Internet, set a record for a first-day IPO when its stock surged from an offering price of $9 to close at $63.50 a share on Nasdaq, for a 606% gain.

Orders from individual investors are the main force pushing IPOs up so much on their first day of trading, experts say. With Internet stocks red hot in recent weeks, many individuals apparently put in so-called market orders for The-

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globe.com on its first trading day. A market order instructs a broker to buy a stock at the prevailing price--regardless of how high.

Demand for Theglobe.com was so strong that traders were able to open it at $90, or 10 times its IPO price. The stock reached $97 that morning.

“There’s no rational explanation for it,” said one investment banker. “It’s a retail phenomenon. That morning, CNBC was mentioning the deal every half hour. People throw caution to the wind and put in orders to buy at any price.”

But as those retail orders were filled, the price declined for most of the day and ended at $63.50. Since then, the price has slid further. The stock ended at $45.31 on Friday.

Setting the IPO Price

Meanwhile, the initial investors who got the stock at $9 through lead underwriter Bear, Stearns & Co. are “gone by midafternoon the first day,” said one banker.

Still, even at Friday’s close, Theglobe.com is valued at five times its IPO price. Which begs the question: How does an underwriter set that initial share price to be fair to the company and its investors?

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With an established, profitable company, underwriters try to value the stock relative to others in its industry. The underwriter also relies on input from the institutional investors who express interest in the IPO during the “road show,” when the company is presented to potential investors.

But because many technology and Internet-related companies that go public aren’t yet profitable (Theglobe.com has lost $11.5 million so far this year), it’s difficult to price such IPOs using any standard financial model, said David Menlow, president of IPO Financial Network, a New Jersey data firm.

Rather, many are priced based on expectations of future revenue growth, from one to five years out.

Yet at $9, Theglobe.com was priced well below its original expected range of $11 to $13 when the deal was scheduled for mid-October. That range was cut to $8 to $10 because underwriters found potential investors balking. The deal then was postponed altogether--only to be revived by mid-November as the Net sector got hot again.

Bear Stearns declined to comment on the deal because the stock still is in the Securities and Exchange Commission-imposed “quiet period,” when company executives and underwriters can’t say anything that could be interpreted as touting the company.Esther Loewy, a spokeswoman for Theglobe.com, said executives there also could not comment.Precisely because Net stocks had been so hot in the days leading up to the Theglobe.com’s offering, it might seem logical that Bear Stearns could have raised the IPO price range for the 3.1 million shares offered. Even a $10 offering price would have raised 11% more capital for the company.

But experts say underwriters must consider a company’s fundamentals--not market hype--in fairly pricing a deal. In addition, underwriters are keenly aware of the risk in overpricing an IPO. If a company’s stock drops below its IPO price by the first or second day of trading, the deal is considered a failure--a black eye for the underwriters.

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While Bear Stearns certainly made Theglobe.com’s initial investors happy, it also helps itself. In seeking new clients, investment banks often rank themselves by IPO performance, which is measured by how much a stock increases percentage-wise from its initial price over time.

“There’s a lot of competition in the investment-banking world. Goldman [Sachs] has dominated this IPO industry, especially among tech firms, so in order to compete, you will see more of this underpricing to make the numbers look good,” said Taulli. “Bear Stearns is a company you don’t typically hear [associated] with high tech.”

In the next few weeks, Bear Stearns will try another tech IPO: Xoom Inc., a San Francisco-based direct-marketing company on the Internet. The company has filed to sell its shares at $9 to $11.

“Everyone who missed out on Theglobe.com is going to want to get in on Xoom,” Taulli said.

Xoom attracts members with a variety of free services, including home pages, e-mail, chat rooms and online greeting cards. People who sign up with Xoom agree to receive e-mail product pitches.

Xoom had about 3 million members as of Aug. 26 and has added about 20,000 members a day for the past month, the company’s filing said. Not yet profitable, the firm expects $7 million to $10 million in sales this year, according to past interviews with Laurent Massa, who co-founded the company in 1996.

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Debora Vrana can be reached by e-mail at debora.vrana@latimes.com

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