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Cashing in on aftermarket bargains!
by Siu-Yee Ng
It wasn't a surprise that 2000 failed to repeat the mania of 1999. The IPO market never repeats itself. And there's no doubt that 1999 was the best year for IPOs ever!
Let's examine the trends in the new issues market. In 1999, two records were set — dollar volume and aftermarket performance. A total of US$100.6 billion was raised, breaking the previous record of 1993, US$57.86 billion. Following the record set in 1993, Wall Street only raised US$33.84 billion the following year — failing to match or beat 1993's IPO performance.
The average 1999 year-end gain in the aftermarket was 199.5% per issue. (The previous record was set in 1995, when the average gain per deal was 39.4%.) In 1996, IPOs registered an average gain of 16.8% each, failing to springboard off 1995's stellar performance. Once again, we see that the IPO market doesn't make back-to-back records.
Also consider the overall 1999 market performance. The IPO market lives and dies by the NASDAQ Composite Index. And last year, the red hot Composite ran up 85.6% to close at 4,069, up from 2,192 on December 31, 1998 — a record single year gain. This benefited the new issues market. The NASDAQ continued to soar in the first quarter of 2000.
127 IPOs debuted in the first quarter of 2000, raising US$28.3 billion. The average deal raised US$220 million, much more than the 59 deals raising US$10.5 billion during the first quarter of 1999. Most deals in the first quarter of 2000 were priced above the expected range. But with the market correction in late March and April, there were doubts about whether the new issues market would be able to continue grabbing huge premiums in future debuts.
Whether they admit it or not, everyone knew that the lofty valuations of the Internet companies could not last forever. With so many companies competing in so many specialized niches, it was obvious that winners and losers would emerge after the dust settled.
By the end of the first quarter of 2000, dot-coms were no longer Wall Street's darlings. An Internet strategy was no longer a business plan in and of itself. Instead, a practical business plan together with tangible profits became the hallmark of companies with solid valuations.
Playing the game
Even before the market selloff in March, new issues were experiencing a slowdown. The IPO market goes in an endless cycle. With the success of IPO debuts at the end of 1999, underwriters brought many young companies public in the first quarter 2000. This not only caused an oversupply problem, the overall quality of the companies was also in question. The inevitable result was that the new issues market went into the next cycle of decline.
The market was hot in the first quarter of 2000, and it seemed any new company could make it. Overall, this depressed returns for new issues, adding to the market turmoil by the end of the quarter.
Investors have seen this correction before. After the Asian crisis in October '98, the IPO front was quiet, with few high-flying debuts. Remember eBay, Inc. (EBAY:NASDAQ)? This online auction company debuted in September 98, and by October was trading as low as US$25.00. The market recovered, and now eBay is a household name. eBay reached a 52-week high of US$255, and that's after a 3-for-1 stock split.
Just like last year's market selloff in April and May, we experienced another one this year. Let's look at a few plays we had in The IPO Trader or in Taipan where we took advantage of market volatility. Numerical Technologies (NMTC:NASDAQ) debuted on April 7 — a time when the market was spiraling downward. Nevertheless NMTC priced at US$14 and opened at US$23 before closing at US$35.56 on the first day. On April 12, the IPO Trader bought NMTC under US$30.50 and sold on May 4 at US$50, for a 64% gain.
Sangamo BioSciences, Inc. (SGMO:NASDAQ) debuted on April 6, pricing at US$15, and remained flat on the first day. We saw an opportunity for an aftermarket play, recommending a buy under US$11.50 in the May issue of Taipan. We should see Sangamo rally in the next couple months. Sell above US$50. On October 13 The IPO Trader saw a short-term trading opportunity. We bought SGMO under US$22 and sold on October 20 at US$35, for a quick 59% profit in just one week!
Rosetta Inpharmatics (RSTA:NASDAQ) debuted on August 3, pricing at US$14, opening at US$16.25 and closing at US$17.88 on the first day. We bought RSTA on Aug. 10 at US$16 in The IPO Trader. Then we sold on September 6 at US$31 for a 91% profit. We're in RSTA again under US$21, positioning ourselves for a biotech rally in the next few months.
My point is that even with a market correction, IPO investors can still make money. Look at the weakness in the IPO market as a buying opportunity. Investors can buy leading companies at reasonable prices. It's important to stick with the hot sectors and pay attention to the company's fundamentals. New issues are volatile, but playing for short term gains is possible. And it also helps to recognize the cycle the market is in.
Three key factors
There are some other strategies for playing the IPO market. New issues are subject to three volatile influences.
Trading momentum is the key influence for the performance of a new issue. Even before an IPO debut, a certain amount of interest will be generated. If the IPO is deemed hot even before it debuts, then the stock will do well. But trading is volatile. There could be huge gains or drops within a few hours.
The second major influence on a new issue is the overall performance of the market it's in. Investors are no longer just looking at the company. If the industry is hot then the IPO will be hot too. Most have rapid sales growth off a small base and large loss growth. Some of them will become the next big thing, but it's hard to tell which ones. So investors are bidding the entire area. If other public companies in the same industry are performing well then the IPO will likely do well also.
Finally, a small supply affects short-term gains on new issues. When investors have fewer options, they tend to buy into companies regardless of quality. So these companies will perform well in the aftermarket. But when the market is crowded, the earlier hot IPOs tend to fall.
Sell or buy?
The IPO market is thinning, and many new companies are postponing their debuts. Who can blame them? During the week of April 10, NASDAQ fell every single day. Panic selling rocked the market and it fell below the 4000 mark, which most analysts thought would be a bottom. But the index continued to fall.
There was another panic sell in October as money managers unloaded their losers for tax write-offs. This explains why October is historically one of the worst trading months of the year. It is the end of the fiscal year for money managers and they are dumping their losers and polishing their portfolios for shareholders. The IPO market managed to survive the bloodbath with an average third quarter IPO return of 62% and a healthy 15% in the aftermarket.
Volatility delays many IPO debuts, but those that do make it out the door will generally be the stronger deals. And those companies that do debut usually trade at reasonable prices, making it possible to build positions in these companies. When the market rebounds these investments will pay off. Of course, there will be duds as well — those companies that have simply run out of cash and need to raise additional capital in the public market.
As we head into 2001, IPO investors have a few things working in their favor. High on the list is what will likely be a moderating interest rate environment. Since about half the American population is somehow invested in the market, the economy is more sensitive to wealth effects than at any other time in history. Knowing this, the Fed will need to take it into account when setting interest rate policies. High oil prices, a weak Euro and a tightening of consumers' purse strings make it unlikely that the Fed will raise rates anytime soon. If the Fed hopes to achieve a soft landing for the economy, we might even see a rate cut. This would be great for the IPO market!
Siu-Yee Ng is the editor of IPO Trader, an IPO alert service that helps readers profit on IPOs and, more importantly, the IPO Aftermarket. Click here to find out how you can put Siu-Yee's expertise and extensive contacts to work for your portfolio.
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