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IPOs: Look Out Below


For years, investors lucky enough or plugged-in enough to get allocations of initial public offerings had a license to print money. At the height of the NASDAQ market boom, the "first-day pop" became notorious as issues such as VA Linux Systems (LNUX) soared as much as 700% overnight. Investment bankers made fortunes as they handed out favors to their friends, leaving retail investors who couldn't get shares fuming, and companies angry that so much of their money was being left on the table.

No longer. After the scandals -- and reforms -- of the past two years, the IPO market is a very different place. These days, the first-day jump averages 12%, barely a fifth of the typical 68% pop back in the heady times of 1999. More than 40% of the 21 IPOs launched in the four weeks through Nov. 25 are now trading below their offering prices, as opposed to the 28% that typically suffered such a fate over the past decade. And those are just the deals that made it to market. More than half of the listings planned this year have been delayed or withdrawn, compared with a 21% annual dropout rate over the past decade, according to Thomson Financial Corp.

Getting to a fairer and more sober IPO market is proving to be a painful process for investors, corporate executives, and investment bankers. So far this year, shareholders have lost nearly $1 billion on issues that tanked. Their companies may have to wait as much as a year to rebuild enough investor confidence to raise more money through follow-on offerings, say bankers. And if the line of wrecks continues to grow, Wall Street may face an even harder sell for the roughly 60 companies that have already filed to go public and are hoping to raise about $60 billion. "If we see a string of IPOs that do not succeed, the window will shut," says Stuart J.M. Collinson, a partner at Forward Ventures, a venture-capital firm in San Diego that funds biotech startups.

BETTER BEHAVIOR

That's a risk that many of the participants are prepared to run if it means that the market is gaining credibility by not bidding new issues up to the sky. Says Alison L. May, CEO of RedEnvelope (REDE) Inc.: "It never made sense to me that a successful IPO was something that would go out at $15 and the next day the stock was at $45, as in the go-go years. That money should have gone to the company. I don't think the public completely understands this yet." Shares of RedEnvelope are down 14% from their Sept. 25 offering price of $14. Even some of the biggest losers in the aftermarket say they're relieved they got their deals done. "The IPO gives us resources," says John F. Thero, CFO of Acusphere, (ACUS) a startup trying to develop drugs to fight heart disease that went public on Oct. 8 after a three-year wait and is now trading at 50% below its offering price.

Some of the post-offering sag in prices is the product of recent reforms. Tighter rules in the wake of the Wall Street scandals mean that investment banks are now prevented from supporting new issues as they once did. For example, analysts are no longer allowed to appear in road shows at which bankers give would-be IPO buyers the hard sell, making it tougher to generate buzz about all but the most outstanding deals. Nor can analysts do reports on the IPOs their banks have backed until 40 days after an IPO, so they can't give faltering stocks a bullish nudge any longer. And on Nov. 24, the NASD, the primary regulator of the NASDAQ Stock Market where many IPOs list for trading, proposed another round of rules designed to hold bankers more accountable for their IPO pricing.

Bankers may be behaving better because of the new scrutiny. Still they aren't discriminating enough for skeptical investors who long complained that too many immature companies were being brought to market. The main characteristic of companies trading below their IPO prices, says Kathleen S. Smith, research analyst at IPO research outfit Renaissance Capital Corp., is "that they aren't earning any money." Money losers among the recent crop of IPOs include Acusphere and Advancis Pharmaceutical (AVNC) Corp., which makes drugs to fight infectious diseases such as pneumonia.

None of these factors would matter so much in a strong bull market. But with the stock market headed toward its first winning year since 1999, many investors -- particularly pension funds and mutual funds -- are reluctant to take a flier on new issues that could drag down their returns. Says George J. Milstein, a banker at San Francisco investment bank Pacific Growth Equities Inc.: "They want to make sure they end the year with positive performance." That's evident from the way institutional investors are acting. Instead of bidding for upstart companies, they have, for instance, been buying convertible bonds -- loans that investors can convert to shares at predetermined prices in the future -- and follow-on issues of stock from companies already trading. "IPOs are competing for the same dollar with follow-ons offered by companies with existing products and existing markets," says Christopher J. Raymond, biotech analyst at Robert W. Baird & Co.

EXPECTATIONS GAME

Big investors' preference for surer bets puts the newbies at a big disadvantage. Fledgling companies overall have raised $9 billion in IPOs this year, while companies that are already public issued $68 billion in stock and $88 billion in convertibles, says Thomson.

The competition is likely to get even stiffer next year as heavyweights and blue chips start to tap the IPO market. In the opening months of 2004, online search outfit Google Inc. is expected to launch a blockbuster IPO to raise as much as $2 billion, giving it a valuation of $18 billion to $20 billion. And on Nov. 18, General Electric (GE) Co. announced that it expects to offer about 30% of its life and mortgage insurance unit, worth at least $3 billion, early next year.

Already, the companies that have succeeded in going public are being held to far higher standards. If they fall short of what the market expects, traders dump their shares in a nanosecond. Consider AMIS Holdings Inc., a 37-year-old speciality semiconductor company that raised $600 million on Sept. 23 in what was promoted as one of the biggest tech IPOs of the year. Starting on Oct. 29, speculators fled and the stock plunged from $21.80 to $18.65 in three weeks. Reason: The company had reported earnings below the estimates it gave to investors in pre-launch road shows, according to Beverly Twing, an investor-relations consultant to AMIS. Investors "didn't see the pop they wanted, so they bailed," says Twing.

Even companies that start out as big winners can't assume that investors will stay loyal. DVD-software maker InterVideo (IVII) Inc.'s stock price doubled to 28 within six weeks of its July 17 offering. But it plunged to 11 on Nov. 6 after the company reported revenues of $14.4 million -- a record, but a mere $100,000 short of analysts' forecasts. "We understand it's all about expectations," says Randall "Randy" Bambrough, InterVideo's chief financial officer. "Painfully so, I guess."

Some optimists think a handful of companies from the current crop of IPOs will eventually shine through as new market leaders. Says William R. Hambrecht, chairman and CEO of online IPO auction firm WR Hambrecht + Co.: "I think we're going back to the class of 1986," which featured Oracle (ORCL), Microsoft (MSFT), and Adobe Systems (ADBE). "That was the wave of underwritings that came after the bubble of 1983 and 1984 had been punctured." If he's right, the IPO market will finally be performing the function it should have been all along: raising capital for promising companies on fair terms for all the players. By Emily Thornton and David Henry in New York, with Arlene Weintraub in Los Angeles


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