Quality IPOs Will Return, Accompanied By Underpricing

Tuesday, June 10, 2003

Dan Seligman, Forbes, http://

Quality IPOs Will Return, Accompanied By Underpricing

Abstracted from: The New New Issues

By: Dan Seligman

Forbes - March 31, 2003, Pgs. 105-107

Quality deals still appeal. Investment bankers know that business has rarely been this tough: In the first years of the new decade, the number of IPOs launched is down by a stunning amount. The famine of 2002 saw only 70 new offerings come to market (the worst record in 23 years); to compound the drought, not a single deal launched in January 2003 (the first dry month in some 40 years). Yet, Dan Seligman suggests, the IPO market seems likely to improve over the course of the year. At least 54 deals are being readied for pricing, and market observers estimate that 2003's total IPO count will certainly equal 2002's. Despite the dearth of IPOsor perhaps because of itstrong, well-financed private companies with established business lines are launching themselves into the capital markets.

A company must display firm footing in a cold market to appeal to today's skittish investors. Contrast the late 1990s, when an idea on the back of an envelope could launch an IPO, with the current market, which supports IPOs only from companies with operating track records. In 2002, nearly one quarter of all IPOs were either splitoffs or spinoffs, and 2003 may continue the trend: one deal in the pipeline is Time Warner Cable, a division of AOL Time Warner.
Spinning and flipping on the road to gains.

IPOs launched in the precarious years following the 1987 market crash had higher returns over time than did stocks in the general market. For example, 1988's offerings saw market returns over the next three years of 56%, or 9% higher than a comparable market index. By the late 1990s, first-day IPO prices routinely doubled, the average first-day price pop being 27%. However, most retail investors were shut out of this action; on the whole, reminds the author, opportunities to turn a quick buck by flipping or spinning new issues were reserved for company insiders or institutions. Contrast that with today's first-day price gain of 8%, and it is easy to see that current IPO investors are more of the buy-and-hold variety.

A study by University of Florida's Jay Ritter, who has been tracking IPOs for a decade, concludes that the IPO price-pop phenomenon was a result of systematic underpricing. He estimates that $107 billion, or $17 million per issue, was left on the table from 1980 througn 2002. If the IPO market picks up, history suggests, so will the practice of underpricing new issues. Leaving profits on the table.

At first glance, underpricing seems a puzzling phenomenon, being counterintuitive for the issuerswho ought to want the largest possible proceedsand the investment bankerswho ought to seek the largest possible gross spreads from a deal. The author lists several rationales that account for the contradiction. Underpricing might attract more investors and thus provide some cushion against a market setback. A more compelling reason may be that entrepreneurs are more concerned with changing the magnitude of their wealth than with absolute numbers. For example, Morgan Stanley left $30.25 per share on the table in pricing Netscape's 1995 IPO. It is unlikely that this bothered James Clark, Netscape's cofounder, since his net worth soared to $544 million on the first day of trading. Underpricing may also help the retail side, thus adding commissions to what the banker earns from the gross spread. In fact, retail commissions are a larger pool of money than the gross spread, which is usually limited to 7% of the offering price.

Abstracted from Forbes, published by Forbes Inc., 60 5th Avenue, New York, NY 10011.

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