Whatever happened to IPOs?

Weekly Corporate Growth Report, Sep 23, 2002 by Dolbeck, Andrew

There's a new IPO on the market. LipoScience Inc., which develops & markets new clinical diagnostic applications of spectroscopy, is making an initial public offering. This is news because it is the first major U.S. IPO since the August 16 offering made by Windrose Medical Properties - an almost six week gap that marks the longest dry spell for IPOs this year. The market has only seen 87 IPOs so far this year, for a total of $22.54 billion raised, according to Dealogic LLC in New York. By this point of the year in 1994, $53.84 had already been raised. The Wall Street Journal reports that there were 500 IPOs in 1999.

When long stretches occur between IPOs, market watchers look to the first new offering for signs of investor demand. Other companies waiting to go public, and the banks that represent them, will be anxiously watching LipoScience's bid to sell $75 million worth of shares. "Is it a test? Of course it is. I haven't seen a biotech company go public in months," said Sal Morreale, who follows IPOs for Cantor Fitzgerald LP.

LipoScience can't be held as the final test for all IPOs on the docket. Other IPOs will, of course, be ultimately judged on their own merits. And LipoScience has its own issues - the company isn't profitable, according to its SEC filings, although its sales have been growing, with revenues more than doubling in the first six months of this year. But if LipoScience sells successfully and then trades higher, it could bring more IPOs out of the woodwork.

According to a Goldman Sachs spokeswoman, three fairly sizeable IPOs are being considered for late September: Plains Exploration & Production, Dick's Sporting Goods Inc., and Hornbeck Offshore Services. But whether these offerings will get made remains to be seen. Many firms consider merger and acquisition possibilities as another option, even as they gear up to go public. Ion Track Inc. was another projected IPO that analysts hoped might spark renewed interest in initial public offerings. Ion Track makes equipment that can detect trace amounts of explosives or drugs. Since security and defense is one of the strongest market sectors these days, analysts were optimistic about the company's chances. GE, however, got there first. General Electric is planning to buy Ion Track from its largest shareholder, private equity firm Castle Harlan Inc. Anthony Jenkins, Ion Track's president and chief executive, described the GE deal as "an offer we couldn't refuse."

Even if a resurgence of IPO activity is seen, it may not be business as usual. Recent scandals have brought attention to questionable practices associated with the way investment banks currently handle IPOs. Banks provide market analysis and advice to companies going public, in exchange for shares at the initial offering price. If the banks set the initial stock price low, and the price quickly rises to meet its actual market value, the banks make a profit by immediately selling their shares.

The question, of course, is whether the banks are creating this situation by intentionally pricing the stock at less than its value. The average price gain on the first day of trading in the 1980s was 7.4 percent. It reached 65 percent in 1999 and 2000. VA Software had a first day gain of 698 percent in December 1999. Clearly, not all stocks are priced accurately from the start.

Underpricing hurts companies going public. Since a company making an offering provides shares to the bank at the lower initial offering price, the profit from the early increase in the stock value of those shares goes into the bank's pocket instead of the company's. A recent article in Business Week, referring to companies issuing IPOs, stated, "At the height of the boom, they could have reaped an average of $79 million more in capital had their offering prices been closer to what the market would pay."

The companies issuing IPOs aren't inclined to argue with the banks and shake-up the existing system, even when it works against them. Going public is a difficult, and even scary undertaking, and the banks have the analysts, the experience, and the data. Investor advocate Nell Minnow puts it another way: "If you are 25 years old and operating out of your garage and somebody offers you tens of millions of dollars, are you going to quibble?" Some Wall Street veterans also argue that the publicity buzz around a hot stock may help companies going public get the attention they need. Initially pricing a stock low means that it will rise in value, which makes it look desirable to investors.

If the companies and the banks are both content with the system, why is it coming under scrutiny? The reason we should be concerned, even if the companies being shafted aren't, is the system invites corruption. Credit Suisse First Boston (CSFB) allegedly handed out shares to customers who would kick back some of the gains in the form of inflated commissions. CSFB has paid a $100 million penalty without admitting or denying the charges. Salomon Smith Barney admitted giving 100,000 IPO share-blocks to WorldCom executives, but denies that this, was intended as an incentive to draw in WorldCom business. WorldCom Chief Executive Bernard Ebbers pocketed about $11 million because he had access to 21 "hot" IPOs from Salomon Smith Barney that were not available to ordinary investors.