So, You Want to Take the IPO Plunge?
Initial public offerings, or IPOs, are an exciting game--but a risky and difficult one for most to win.
There is clearly a mania for these offerings. The Times hears from readers each week--even those on fixed incomes--wondering how they can get a piece of the action. And it’s hard to miss headlines like “IPO! How You Can Make Money on Wall Street’s Latest Craze,” and “IPOs: How to Get the Jump Online,” shouting from the covers of personal finance magazines.
Behind the craze: spectacular stock price gains from once-unknown tech firms such as Inktomi Corp., which doubled on its first trading day; Ticketmaster Online-Citysearch, which nearly tripled in its debut; and TheGlobe.com, up more than sevenfold in its launch. Auction site EBay was up more than thirtyfold in its first seven months.
IPOs are first-time sales of stock to the public by companies that had been privately held. The capital raised in an IPO is typically used to fund expansion, pay off debt or make acquisitions.
Investors relish the big potential returns, seeing IPOs as a way to get in on the next Microsoft.
But studies have shown that most IPO investments are typically laggards in the long run. According to a 1991 study published in the Journal of Finance, for example, three-year returns for 1,526 IPOs during 1975-84 averaged 34.5%, compared with an average of 62% for non-IPO stocks of similar size in similar industries.
“Most investors don’t understand the rules of the game, yet they throw money around like they do. They shouldn’t let the emotional, rather than the rational, part of their brain take over,” said David Menlow, head of IPO Financial Network, a data service in New Jersey. “Do some homework.”
A look at the 2,489 IPOs that came out from 1995 through 1998 provides a similar reality check. About 42% of the stocks were trading below their offer price at the end of 1998. And 21.5% of the deals were trading 50% below their offer price, according to Securities Data Co., a New Jersey data tracker.
But the firm found clear evidence of a split market.
Last year, Internet-related IPOs--the hottest group by far--rose an average of 120%, while non-technology offerings fell an average of 7%.
Boosted by dramatic gains by Internet firms, IPOs that came out during the first quarter of this year surged an average of 94% from their offer price through March 30. Still, Securities Data warned, 19 of the 73 deals done in the first quarter, or 26%, were trading below their offer price by the end of the period.
Let’s say the statistics don’t scare you off. You have an appetite for risk and want to take the IPO plunge.
Now for another dose of reality: even if you want in, IPOs are hard for average investors to buy. Major Wall Street underwriters such as Goldman Sachs & Co. and Merrill Lynch, which lead many IPO deals, won’t sell to you if you aren’t a favored client with a significant investment portfolio.
Most IPOs are gobbled up by large mutual or pension funds and the very wealthy, many of whom sell their offerings after a run-up within hours or days in a practice known as “flipping.” Who do they sell to? Individual investors eager to get a piece of the deal--at any price.
As investors increasingly add IPOs to their shopping lists, a cottage industry of online brokers and other firms is scrambling to meet the surging demand for these sometimes-lucrative, always-risky securities.
Wit Capital Corp., the New York brokerage that pioneered the first-time sale of stock over the Internet, has helped sell IPOs online for a number of companies, such as financial Web site Market-Watch.com. Wit allows investors to open an account with a minimum of $1,000. These customers are then given a chance to buy IPOs on a first-come, first-served basis. Wit usually gets a small percentage of a deal to sell, normally less than 10% of the stock.
The company was started in 1996 by Andrew Klein, who sold shares of his Spring Street Brewing Co. in the first online IPO. Wit itself plans to go public later in the year.
Discount brokers such as Charles Schwab & Co. are also making it easier for clients to buy IPOs and secondary, or subsequent, stock offerings by cutting deals with IPO underwriters.
Schwab offers IPO stocks to clients it considers “suitable,” which means they must have $100,000 in an account or have completed 12 trades in the last year. The rules are flexible, however, and other factors, such as a long-term relationship with Schwab and participation in past IPOs, are considered.
To level the playing field and encourage long-term participation in IPOs while discouraging flipping, Schwab’s rules state that if a client sells an offering less than 30 days after buying in, that person is prohibited from buying other IPOs for six months.
Other firms are launching innovations too, such as the online investment bank recently created by E-Trade Group Inc., the Palo Alto brokerage. Newport Beach-based EOffering plans to offer 50% of any securities deal directly to individuals over the Internet, bypassing brokerages, and the other half to institutional shareholders. The firm is expected to complete its first deal by the end of the year.
Another firm, W.R. Hambrecht & Co., formed by Hambrecht & Quist co-founder Bill Hambrecht, recently sold an IPO for Ravenswood Winery completely online using a “Dutch auction” practice, which allows potential investors to bid on the shares in the weeks before the deal and, as a result, set the price per share. In a Dutch auction, all stock is sold for the clearing price--that is, the lowest bid that would unload every share.
In a typical deal, underwriters set a price range for the stock being sold and then try to sell shares primarily to their large clients.
Under Hambrecht’s system, when there is strong investor demand for a stock, the spread between the initial sale price and the price at which an IPO begins trading is expected to be tightened.
That might help reduce the flood of record-breaking first-day trading gains--and large profits for those who get in from the start. The system could also help the process become fairer to long-term investors.
An alternative way to get a piece of the IPO action, while hedging the risks, is to invest in a mutual fund that puts at least a portion of its money in IPOs, analysts said.
Renaissance Capital’s IPO Plus Aftermarket, a fund launched in late 1997 that invests in newly public companies, returned 18.4% last year, lagging the Standard & Poor’s 500-stock index’s 28.6% return but beating the average aggressive growth fund’s 15.6% return, according to fund tracker Morningstar Inc. Several other funds invest smaller portions of their assets in IPOs, but with mixed results.
Analysts note, of course, that while IPO-themed funds spread the risk around by offering a variety of new issues in one swoop, investors won’t get the upside possible when buying individual stocks.
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At the Conference
The Times’ Investment Strategies Conference, to be held May 22-23 at the Los Angeles Convention Center, features an “IPO Investing” panel, moderated by California Dealin’ columnist Debora Vrana. For registration information, call (800) 350-3211 or visit https://www.latimes.com/isc.
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IPO Info Online
A sampling of Web sites offering information on initial public offerings:
EDGAR (https://www.sec.gov): An acronym for electronic data gathering analysis and retrieval, EDGAR is the Securities and Exchange Commission’s central database. Any company planning an IPO must make an SEC filing, which is placed in the free EDGAR database and posted on the Web within one or two days.
IPO Central (https://www.ipoCentral.com): Much of its information is free, but users can subscribe for $12.95 per month or $124.95 per year. This joint venture between Hoover’s Inc. and EDGAR Online (the SEC’s database) is updated daily. The site lists companies that have filed to go public, “deals of the week” and aftermarket information.
IPO Data Systems (https://www.ipoData.com): Subscriptions cost $15 per month or $180 per year. The site lists IPO filings, performance and top underwriters.
IPO Monitor (https://www.ipomonitor.com): For $29 a month or $290 a year, subscribers get daily e-mail listing companies that have filed to go public and those expected to be priced that week, as well as data on aftermarket performance. Some free information is also available.
Alert-IPO (https://www.ostman.com/alert-ipo): For $34.95 a year, subscribers get daily reports via e-mail on which companies have filed to go public in the last 24 or 48 hours, as well as weekly IPO activity summaries.
IPO Spotlight (https://www.ipoSpotlight.com): For $30 a month, subscribers get basic IPO information plus recommendations on which offerings to buy.
IPO Maven (https://www.ipomaven.com): This free site features a calendar of upcoming IPOs, a list of offerings that look promising and profiles of upcoming deals.
Source: “Investing in IPOs: New Paths to Profit with Initial Public Offerings” by Tom Taulli (Bloomberg Press, 1999)
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Debora Vrana covers investment banking and the securities industry for The Times. She can be reached by e-mail at debora.vrana@latimes.com or by mail at Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.
