After a long drought, initial public offerings are making a comeback.
There are six possible IPOs on the docket for this week. Half of them are technology companies, including national security specialist Global Defense, medical record firm HealthPort, and computer network security company Fortinet. Then, there are coal mining company Cloud Peak Energy, budget hotel chain 7 Days Group Holdings and online education provider Archipelago Learning. They are diverse, but what’s more remarkable for Wall Street is just how many of them there are. If each launches as scheduled, investors will see the most IPOs in a single week since December 2007, The Wall Street Journal reported. But what are they supposed to do with them?
As more capital becomes available for these young companies to enter the market, the question for investors is whether they are good long-term investments or just fodder for day trading.
IPOs by American companies have beaten the S&P 500 by an average 21.3 percentage points since 1995, according to a Bloomberg report, but these investments haven’t outperformed lately. “The offerings of 18 U.S. companies that went public in September and October have underperformed the S&P 500 by 0.4 percentage point on average in the first month of trading, the worst performance in Bloomberg data going back 14 years,” according to the report.
For the individual investor, IPOs can be a risky bet. “There’s a bounce for a while, but it’s more of a trade,” says Doug Roberts, chief investment strategist at ChannelCapitalResearch.com. “There are always exceptions, but if you look long term, they’re not always positive. People start liquidating, and unless you’re in a hot bull market, they don’t perform as well.”
IPOs tend to be growth stocks, or companies whose earnings are expected to grow at an above-average rate relative to the market, but historically, many have suffered from lower returns relative to value stocks, says Jay Ritter, a finance professor at the University of Florida. “Now, the current crop this year has a lot of buyout-backed IPOs, and those tend to be more mature companies that typically aren’t selling at lofty multiples.” In that regard, this year’s class is more conservative compared to the past, particularly to the ‘90s, he says.
“Since it’s not part of the froth of a couple years back, the successful IPOs are those that are being properly and fairly priced,” says David Stone, head of the Corporate and Securities Practice Group at Neal Gerber Eisenberg. “So if the issuers aren’t too aggressive and provide some value for investors to see, those are the ones that are currently having successful launches.”
Whether they’re from private equity funds that are looking to monetize or provide liquidity in their investment, or you’ve got a strong stable company with a long history, you are seeing some quality investments, he says.
“At least throughout this year so far, that’s what I would consider the primary theme of the successful IPOs,” he says. “Overall, you’re now starting to see some more rationality, whether it’s in IPOs or M&A, valuations are starting to come down to more reasonable and sustainable levels.”
Obviously a lot of this has to do with valuations, which have changed drastically. The main procedure used to price offerings is comparable firm valuation, or comparing the new firm to similar companies that are already public, accounting for differences, and hitting the road to tout your story and gauge interest.
Normally, IPOs are priced with a slight discount so there’s a bit of a pop upon offering, says Roberts. “They want it to be reasonable enough that those that bought into the initial offer feel a cushion.”
Prices can be tweaked up to nearly the last minute, and rising prices create more fanfare. Traders saw that phenomenon last week when teen retailer Rue21 priced above its expected range and went on to shoot up 28%.
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