Examine Each Initial Public Offering Carefully

Andrew Leckey

Technology has been a driving force in this year's initial public offerings.

Consider ChangYou.com Ltd. (CYOU), a Chinese online game developer whose stock price jumped 25 percent at its offering day in April on the NASDAQ Stock Market. It is now up more than 100 percent from its IPO price.

The company recently had the U.S. launch of its Dragon Oath martial-arts online game, a hit in Asia for the past three years. It has three more online games scheduled for release here and is opening a subsidiary in Santa Clara, Calif.

Among the 16 other tech IPOs in 2009, price gains of better than 30 percent since their offering have been produced by SolarWinds Inc. (SWI), a management and monitoring software firm; A123Systems Inc. (AONE), a manufacturer of rechargeable lithium-ion batteries; and Opentable Inc. (OPEN), an online reservation site.

In a year of other IPO gains by familiar names such as Hyatt Hotels (H) and Vitamin Shoppe (VSI), the average first-day IPO price "pop" has been 7 percent and the average overall return 10 percent, according to RenaissanceCapital.com.

But don't get the impression we've returned to the wild-and-crazy IPO markets of the past. Some planned IPOs haven't even hatched and others have quickly laid an egg because investor caution rules the roost.

"Demand for IPO money continues to run off the scale, as the need for companies to access the capital markets increases," observed David Menlow, president of IPOfinancial.com in Millburn, N.J. "However, the tug of war is between the comfort level of potential investors and the need for capital for these companies."

Investors are wary of debt-laden companies put on the IPO block by private-equity firms. An example is the Dole Food Co. (DOLE) IPO that was priced at the low end of its expected range, closed lower on its offering day in October and has since declined.

Rather than focus on one market sector, an investor should examine each IPO carefully to see if it makes sense, Menlow advised. Years ago, investors couldn't care less what an IPO did because they just wanted in on the deal, resulting in "a lot of dogs with fleas" among those IPOs, he said.

"We're in the last stage of a double-dip recession and starting to see some rays of sunshine in the IPO market," said Linda Killian, portfolio manager of IPO Plus Aftermarket Fund (IPOSX) in Greenwich, Conn., up 16 percent over the past 12 months. "The IPOs that have come to market have been priced to sell."

Getting the 2009 IPO market off on the right foot was Mead Johnson Nutrition Co. (MJN), a quality spin-off from Bristol-Myers Squibb Co. whose IPO was priced right, Killian noted. When that success was followed by Rosetta Stone Inc. (RST), another viable growth company, other firms were enticed to come to market, too.

IPO Plus Aftermarket Fund, which requires a $5,000 initial investment, buys a portfolio of IPO stocks at the time of the offering and in their subsequent aftermarket trading. The largest of the fund's 23 holdings were recently Visa Inc. (V), Constant Contact Inc. (CTCT), Athena Health Inc. (ATHN), Mead Johnson and Rackspace Hosting Inc. (RAX)

"Individual investors can look for good IPOs that have traded down since they were offered," said Killian. "For instance, RailAmerica Inc. (RA) is below its IPO price and, although leveraged, is a well-run regional freight railroad operating in 27 states and part of Canada that has fared well in the economic downturn."

Institutional investors still drive the overall IPO market, since only select investors at full-service brokers typically get the opportunity to invest in IPOs. Most average investors invest in IPOs on the secondary market after their initial price pop. IPO Plus Aftermarket Fund is another way of doing that.

"The overall stock market is driving the IPO market, which is playing catch-up," explained John Fitzgibbon, founder of IPOScoop.com in Edison, N.J. "The IPO market is a follower, not a leader, and you must have a good stock market in order to get a good IPO market."

Among financial IPOs, Cypress Sharpridge Investments Inc. (CYS) and Invesco Mortgage Capital Inc. (IVR) have made gains, pointed out Fitzgibbon, but "the rest are underwater." Some real estate investment trusts also attempted to sweep up toxic assets into IPOs to get rid of them, but those IPOs have stumbled, he said.

"I always keep an eye on the initial IPO filing versus the final filing, since an increase indicates excessive demand and therefore likely good aftermarket performance," he said.

Rue21 Inc. (RUE), a fast-growing specialty retailer for young women and men whose recent IPO was priced above its expected range and ended its offering day up 28 percent, is "a barn-burner," believes Fitzgibbon. It has had rapid growth and rising profits while displaying ability to predict fads, he said.

He is less enthusiastic about Dollar General Corp. (DG), the largest retail-store IPO in more than a dozen years, because it was loaded with debt by Kolberg Kravis Roberts and "pushed out the door as an IPO." But even though that IPO was priced at the low end of its expected range, it has since risen in price based on current investor confidence in discount retailer prospects.

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Investing - IPO Activity Is Up, But Examine Each Offering Carefully