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The IPO Market Should Keep Rolling in 2000
S&P analyst Mark Basham expects the tech issues to keep leading market
The IPO market will take a brief rest as 1999 winds down, but it's likely to pick up where it left off in early 2000, says Mark S. Basham, a specialist in small-capitalization stocks and initial public offerings for Standard & Poor's. He thinks the technology sector, including the Internet, is driving the economy, and he recommends investing in companies that provide technologies that enable e-commerce or are targeting the business-to-business e-commerce market.
In a Dec. 14 chat hosted by Business Week Online on America Online, Basham discussed 1999's biggest IPO successes as well as several of his current favorite small-cap stocks. Here's an edited version of Basham's answers to questions from the online audience and from Business Week Online moderator Jack Dierdorff. A full version of the transcript is available on America Online at Keyword: BW Talk.
Q: Mark, what are your latest observations on this amazing stock market?
A: The last month and a half has been generally very good for small-cap stocks, and of course the IPO market has continued to be red hot. Looking ahead, we'll be taking a brief respite in the IPO market as investors and companies look to get past the Y2K issue. But then in January I expect the IPO market to pick up right back where it left off in 1999.
I see the economy generally performing very well in 2000, with growth close to that of 1999 in the 3% to 4% range, and low inflation. This economic backdrop should be very good for small-cap stocks. I would look for low double-digit gains in indexes that track small-cap stocks, such as the S&P SmallCap 600 and Russell 2000.
Q: Will the Net arena continue to be the hottest rocket in the world of small caps and IPOs?
A: I think the technology sector in general -- and that certainly includes the Internet -- is driving the economy. As far as the Internet goes, I would look to companies that provide technologies that enable e-commerce or are targeting the business-to-business e-commerce market. I do have several business-to-consumer Internet stocks that I like, but I think there will faster growth in the other two areas.
Q: Looking back, what were some of the best IPO bets of 1999?
A: We started the year with consumer-oriented IPOs, such as CBS MarketWatch, being the top performers. But by the summer we were starting to see companies that make hardware to build out the physical network of the Internet doing very well, such as Extreme Networks, Foundry Networks, and Juniper Networks.
Then beginning in July, we started to see a new cycle of business-to-business Internet ideas beginning with Ariba. We have since moved on to seeing the Linux area get very hot, and I think where we are right now we should really just pick up in early 2000. The areas that are hot now should still be the hot areas come January.
Q: Let's have some undervalued, overlooked stocks in the Internet arena both foreign and domestic.
A: Right now, I have a buy recommendation on Ticketmaster Online (TMCS). My price target is 60. It has been a very strong performer this month rising from 28 to 45, and I think it still has further to go. I also like Concentric Network (CNCX). This company provides Web hosting and other Internet services primarily to small and medium-sized companies. It has an acquisition pending of a company called Internet Technology Group that should close shortly. Concentric is currently valued like a run-of-the-mill Internet service provider, rather than as a Web services company. I think this stock, which closed today around 28, could rise to 50 by the end of next year.
Q: Would you buy Palm's IPO?
A: 3Com filed just yesterday to sell a portion of its Palm Pilot business. I haven't really had a chance to look at the prospectus for the offering. However, as Palm Pilot incorporates wireless Internet into its products these type of hand-held devices should proliferate even more.
Q: What makes wireless Internet service providers so good for the future?
A: Up to this point, people have been tied to their desktop in order to access the Internet. But with the advent of wireless Internet services, people will begin to use the Internet for a much greater variety of applications than is possible just using a PC on the desktop. I expect a wide variety of wireless access devices, including cell-phone-type devices, Palm-type devices, and laptop computers, to be used to access the Internet using wireless technology. The market for these types of services and devices is vast. It is probably bigger than the PC market.
Q: Who do you like in the ASP [application service provider] market?
A: I have an interesting play in the ASP market. I would play that through Intermedia Communications (ICIX). Intermedia owns 82% of a company called Digex, which is an emerging Web hosting and applications service provider.
Q: With so many of them around, tell us how S&P selects small-cap stocks to follow.
A: S&P has traditionally used a strategy for picking stocks that we like to call buying growth at the right price. So while we have missed out on some of the real high-flying IPOs, our small-cap and IPO stock picks have performed quite well. Investors can look on the personalwealth.com Web site to find a list of small-cap stocks that we currently recommend. Through Nov. 30 that list was up 38% for the year compared with 13% for the S&P 500.
Q: Any more of the top performers you can mention?
A: I have a few more top picks that I can talk about. First of all, Harbinger (HRBC) provides solutions that enable companies to conduct business-to-business e-commerce through its harbinger.net portal. The company is very similar to Commerce One or VerticalNet, but it trades at a much lower valuation, so this is an example of our growth at the right price strategy. A recent IPO that I have made one of our top picks for 2000 is Charter Communications (CHTR). Charter is the fourth-largest cable-TV system operator in the country. It is upgrading its networks to provide advanced services such as digital cable, Internet access, e-mail, video on demand, and eventually, telephone service. S&P recommends overweighting the cable television group. Charter went public one month ago at 19 and is now trading at around 22. Our 12-month price target is 32.
Q: You mentioned overweighting the cable group. Any areas that shuld be underweighted now?
A: Right now we are underweighted in transportation and utilities, and we are overweighted in technology and communications services.
Q: Any comment on small health-care stocks?
A: In this sector I like a stock called RehabCare Group. A lot of other companies have really had a rough go in 1999 because of changes in government insurance programs. But RehabCare has been very good at managing the changes in the market. Earnings in 1999 will rise to $2.08 per share from $1.70 in 1998, and I look for the company to earn $2.45 in 2000. At 20, the stock is extremely undervalued, but we are only market weighted in health care.
Q: How much of a long-term portfolio do you think should be devoted to small-caps?
A: That, of course, depends upon who the portfolio belongs to. If you are in your 20s, a quarter of your portfolio is not unreasonable. But it depends on individual circumstances, and you should probably hire a financial planner to create a customized investment program.
Q: Do you regard small caps as inherently riskier than their bigger brothers?
A: Yes. That is why S&P thinks it is very imporatnt to pay attention to valuation, which is part of our growth-at-the-right-price strategy as opposed to a growth-at-any-price strategy. Because they are less liquid, small-cap stocks tend to be more volatile.
Q: Looking ahead once again, what should we be watching for in IPOs in 2000?
A: Just to sort of elaborate further on wireless Internet access, I think one of the highlights in 2000 will be an IPO for the wireless unit of AT&T. That deal has the potential to be the largest IPO ever. Also, there should be some very big IPOs from insurance companies that are converting from being a "mutual" to stock ownership. That would include John Hancock, MetLife, and Prudential. Both the Prudential and MetLife deals are likely to be larger than the IPO earlier this year from UPS, which was the largest IPO in U.S. history. So, along with all of the real high-flying Internet IPOs, we should see more of these megadeals in 2000.
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