Despite Recent Successes, IPOs Are Risky Propositions

In the past few weeks, it has seemed as if initial public offerings are to the stock market what Furby is to the toy market this holiday season.

Whenever there are a few very successful IPO deals, such as the recent offering from EBay (whose shares have rocketed more than 900% from their offering price) and last week’s Ticketmaster Online-CitySearch (up more than 200% in two days of trading), the flurry of reader letters and e-mail begins:

* “I was wondering if I have to go through a broker to get some of those IPO stocks or not? This is actually my first time thinking about investing in the market, especially with the IPO.”

* “I’m retired and living on a fixed income. My husband died several years ago. I think IPOs might be for me. How do I buy them?”

* “I am a small investor and brand-new to investing. I contacted the underwriters you listed for Xoom.com and E-Tek and was referred to NationsBanc Montgomery Securities due to my investment being less than $5 million. I can’t find NB Montgomery anywhere to call. I have only $2,000 to $4,000 to invest. Am I wasting my time?”

* “Prior to EBay’s IPO . . . I saw no general solicitation to me or the general public. Are promising IPOs like EBay not really initial public offerings? Do you have to know someone at the underwriter (or pay them off)?”

Whoa there, investors.

Remember: Not only are IPOs traditionally hard for anyone but the most exclusive clients of underwriters to get, they are highly risky, speculative investments.

Sure, when you hear about EBay shares rising 165% on the first day of trading, it sounds better than the California Gold Rush.

But 60% of all U.S. IPOs in 1998 have lost money. Of the 308 initial stock sales this year, 186 were trading below the offering price by the end of November, according to CommScan, an investment banking research firm in New York.

California deals haven’t fared much better. Of the 62 IPOs from California-based companies this year, 35 of them, or 56%, are trading below the offering price, according to CommScan.

The historical performance doesn’t change the picture. Of the 588 IPOs sold in 1993, 46% now trade below their opening price. Even more troubling, 81% have returned less than the Nasdaq composite index since the firms went public.

The EBay of 1993 was a highflying company called Boston Chicken Inc., which raised $56 million through an IPO led by Merrill Lynch & Co. On the first day of trading in November 1993, the stock soared as much as 155% from its initial price of $20. It had several good years as business mushroomed and its food sales were strong. But as competition increased, the company’s profit began declining. Indeed, by this October, the company’s stock had dropped to about 50 cents a share on Nasdaq and it filed for bankruptcy.

You might say, “Who cares? If I can get EBay or Xoom.com or one of these high-tech deals guaranteed to be a winner on the first day and sell fairly quickly, my retirement is set, my vacation home is secured and my worries are over.”

If you are like most of us--a modest investor and not a multimillionaire with long-term relationships with a broker--getting in on a good IPO is very difficult.

A cottage industry is trying to make it easier for more investors to buy IPOs. Wit Capital Corp. in New York allows investors to open an account with a minimum $1,000 and these customers are then given a chance to buy some IPOs on a first-come, first-served basis. Wit has received allocations on 32 IPOs this year, with the amount varying by the deal.

Last week, the firm opened a West Coast office in San Francisco.

“Traditionally, IPOs have been reserved for the top-level clients at brokerage firms,” said Susan Berkowitz, spokeswoman for Wit. “Our philosophy is to democratize capital and bring IPOs to the general public using the Internet as a distribution vehicle.”

Some discount brokers such as Charles Schwab & Co. are also trying to make it easier for clients to buy IPOs and secondary stock offerings by making deals with three underwriters: J.P. Morgan & Co., Hambrecht & Quist and Credit Suisse First Boston. Schwab gets a slice of some of the IPOs that those firms underwrite, since the firms don’t have a large network of retail brokers. This year, Schwab has participated in 24 IPOs.

“By forming distribution alliances with these investment banks, we can give our clients access to a product that historically has been available to just an exclusive group of people, the chosen few,” said Schwab’s Marta von Loewenfeldt.

However, Loewenfeldt said that because of the “inherent risk” of IPOs, they are made available only to “sophisticated customers--a group of people [IPOs] are suited for.”

Another firm, Renaissance Capital, offers another way to play this market through its relatively new mutual fund IPO Plus Aftermarket. But from its inception in December 1997 through this past September, the fund reported a negative 6.5% total return, according to Morningstar, the mutual fund tracker.

Indeed, IPOs are considered so risky that even the companies selling them are trying to protect themselves.

Because of an explosion of shareholder suits in recent years by angry investors who bought IPOs only to see the stock collapse, giant insurer American International Group Inc. is offering expanded liability insurance for executives of companies that sell stock through an IPO.

The program, called IPO Gold, covers allegations of fraud and mismanagement, inaccurate financial projections and inadequate disclosure of information.

The program, which provides protection of up to $50 million, also covers criminal and civil investigations of directors and officers, as well as Securities and Exchange Commission probes.

The insurance can be extended to cover the securities firms handling the IPO and to others who typically get named in lawsuits, such as attorneys and accountants.

“The transition from being privately held to publicly traded can be the highest chance of liability in the life of that company,” said Ty Sagalow, chief underwriting officer of the AIG subsidiary that sells IPO insurance. “And frankly, they might not be ready for it.”

Sagalow said AIG will underwrite a variety of deals, not just “the cream of the crop.” AIG hopes investors will see the insurance as added security.

Last week’s IPO frenzy included a deal by E-Tek Dynamics Inc., a maker of components for fiber-optic networks, and one from Ticketmaster Online-CitySearch Inc., an online provider of tickets and local city guides. Xoom.com Inc., which could go public as early as this week, is an online direct-marketing company in San Francisco.

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Debora Vrana can be reached by e-mail at [email protected].