Special Features IPO Madness

By Richard McCaffery

(Dec. 21, 1999) -- The sad thing about initial public offering prices rising faster than baseball salaries is that people start believing in short cuts, like you can expect a 1,000% gain from the average technology stock in the weeks after an offering.

I recently heard a radio conversation about IPOs that ended with this remark: "Initial public offerings. That's the way to go."

There are a few things Fools should know about IPOs. For the record, getting in on an IPO doesn't count as research. And it's darn near impossible for the average Fool to get in on one to begin with. Plus, they're not the get-rich-quick vehicles they're made out to be. Sure, some will manage impressive returns, but many others will crash and burn before they even get started, as Yi-Hsin Chang explains in her feature entitled the ABCs of IPOs.

For another perspective, consider what investing legend Philip Fisher said about purchasing shares of start-ups: "Don't buy into promotional companies," he said. Fisher wrote several pages on the subject in his famous book, Common Stocks and Uncommon Profits.

While this advice may be too rigorous for many investors, especially since the first mover's advantage is so critical for Internet companies, it's true in many respects. Fisher's idea is simple: Don't invest in any company that doesn't have at least two or three years of operating history and one year of operating profit.

If you want to invest in a few well-chosen starlets and can sleep at night, great. Just keep your expectations in check and understand that winners are chosen individually, not in bunches.

That said, let's take a look at the IPO snowfall in 1999. We had a Buffalo winter. Here are a few stats gleaned with the help of Paul Bard, an analyst at Renaissance Capital's IPO Fund.

As of December 10, there were 472 IPOs, which raised a total of $90.3 billion. Compare that to 1998, when 247 companies went public raising $44.6 billion. As you can see, both the number of deals and the amount raised nearly doubled. (For a full list of this year's IPOs, click here.)

Take this a step further to see a distinctive trend in this year's IPO market: The average deal size was enormous, ringing in at about $191 million, compared to last year's $180 million. That's a record, and it tells investors just how much cash is out there hunting for the next Microsoft (Nasdaq: MSFT).

To put this in perspective, Amazon.com (Nasdaq: AMZN), a high-flying IPO in its day, raised a paltry $49.1 million when it went public in May 1997. It seems like a long time ago.

We won't see any records as far as the number of deals this year. That mark was set in 1996 when 502 companies went public, but those players raised just $57.5 billion, so the average deal size of $114.5 million pales in comparison to this year's output.

Much of the wealth is the result of a few big offerings, such as United Parcel Service (NYSE: UPS). Clearly not a start-up or an Internet flash in the pan, the company with the brown trucks that deliver more than 12 million packages and documents daily became the largest initial public offering in history. On November 10 it raised $5.47 billion by selling 109.4 million shares.

UPS followed on the heels of investment banking warhorse Goldman Sachs (NYSE: GS), the 130-year-old firm that went public May 4 at $53 a share, raising $3.66 billion. And don't forget Agilent Technologies (NYSE: A), Hewlett-Packard's (NYSE: HWP) testing and measurement division that went public November 17. Agilent was priced at $30 a share and raised $2.1 billion.

All these offerings represent well-worn, time-tested companies that went public as part of a larger business plan, not an exit strategy. This is not to say all IPOs are junk, but if that's all it took to find great companies, most mutual funds wouldn't stink.

Of course investors are still feasting on technology companies. Of the 472 deals, 297 -- or 63 percent -- were computer- or Internet-related. This compares to 28% of last year's offerings.

These companies also enjoyed the swiftest rise in the first day of trading and in the after-market, when the shares became available to the average investor. The average first day return for computer and Internet companies this year reached 257%, and the average return since the first day of trading hit 98%. Think of that: On average, these stocks doubled in their first year of trading.

Last year those numbers came in at 176% and 50%, respectively.

Think of the pressure this puts on traditional companies. As one chief executive pointed out in a recent StockTalk, capital is virtually free for the taking, and Wall Street doesn't demand profits for years to come. Consider the case of Amazon. Almost overnight, Barnes & Noble (NYSE: BKS) had to face a brand new rival of amazing wealth.

How well has the technology crop done this year? As of December 10, 14 newly traded companies had returned more than 1,000% in their first few weeks of trading. (Click here for a list of the year's best IPOs.) Atop the list is Commerce One (Nasdaq: CMRC), which went public June 30 at $21 a share, closed the first day at $61, and now trades around $416 -- a blistering 1,881% climb.

Commerce One makes e-commerce software that connects buyers and suppliers. For the nine months ended September 30, the company had $16.6 million in revenue and posted a net loss of $34.5 million.

Next in line is Red Hat (Nasdaq: RHAT), the Linux software distributor and service provider that went public August 10 at $14 and now trades around $256. That's good for a 1,729% climb in four short months. The buzz around the Linux operating system is that it's an alternative to Microsoft Windows. Right now the bulk of Linux systems are used on corporate servers, but Red Hat investors have high hopes it will extend to the desktop and mobile appliance markets as well. We'll see.

Also in the Linux vein, Linux systems, software, and services company VA Linux (Nasdaq: LNUX) sold 4.4 million shares December 8 at $30 apiece. The stock soared 733% to close at $239 its first day of trading (I grow dizzy). VA Linux, which had just $18 million in sales in fiscal 1999 and no profits, briefly had a market value around $8 billion. Unreal. Its share price fell steadily in the days following the IPO.

Any survey of the IPO landscape without a glance at the newest crop of Internet equipment companies would miss one of the fastest-growing sectors in the so-called new economy. This was the year investors paid big dollars for companies promising ways to make your network run faster.

Check out Redback Networks (Nasdaq: RBAK), which sold a measly 2.5 million shares May 17 at $11.50 apiece and watched their value skyrocket to $152. Heck, the company's shares have appreciated 1,222% since the offering and have already split.

Redback makes networking solutions that help customers deploy broadband networks. The company had $38 million in revenues through the first nine months and reported a loss of $9.1 million, but it has no long-term debt, a fairly light business model, and is already spinning off cash from operations.

Other companies that fall into the Internet infrastructure category are Juniper Networks (Nasdaq: JNPR), Cobalt Networks (Nasdaq: COBT), Foundry Networks (Nasdaq: FDRY), and Copper Mountain (Nasdaq: CMTN).

Turning from the IPO winners to the losers, take a look at the retail pileup in 1999. Thirteen retail companies went public this year, and as a group they've plunged 20%. Ouch. (Click here for a list of the year's biggest disappointments.)

Notable among the flops is Value America (Nasdaq: VUSA), an online retailer that sells computers, electronics, and a wide range of consumer products. The company went public at $23 on April 7, when shares of Internet retail king Amazon were cresting, but couldn't catch the same wave. Since spring it's fallen about 52% and now trades around $11.

It seems the market exercised some discipline valuing dotcom companies in 1999 after a giddy 1998. Is more of the same on the way for companies that sell Linux-related products, software for business-to-business e-commerce services, and Internet gear? We'll have to wait and see.

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