This phenomena of newly public Internet stocks doubling in their debuts, followed by a precipitous decline below the original price, and then surging again once their underwriters start coverage of the stock illustrates just how fragile these suspects offerings can be.
To the average investor, any upgrade or initiation of a "buy" rating is clear signal that professional money managers are infatuated with the stock. That isn't really the case, but it's still manufacturers demand and gives some of these stocks a second wind.
It's a simple game. But for investors to win they must be able to discern between self-serving plaudits and upgrades based on merit.
This week, Net2Phone Inc. (Nasdaq: NTOP), an Internet telephony company, got a huge surge after its underwriters started coverage with "buy" recommendations.
Deutsche Banc Alex Brown, Bear Stearns and lead underwriter Hambrecht & Quist all leaped at the chance to recommend Net2Phone the minute its post-IPO quiet period concluded.
Net2Phone shares predictably jumped nearly $8 a share, or 17 percent.
On their own merit, those "buy' recommendations don't really mean too much. You can bet the likes of Ferris Baker Watts, Fahnestock & Co. and C.E. Unterberg Towbin will do the same to one of its recent offerings, Musicmaker.com Inc. (Nasdaq: HITS), just as soon as they can even though the company posted a huge loss this week on sales of only $47,000.
It's a dog with fleas, but there's an unwritten (who knows maybe it really is written somewhere) agreement between underwriters and their clients. These investment houses are trampling each other to bring these new companies and their huge underwriting fees in house.
All objectivity goes out the window. Regardless of the company's realistic potential, these underwriters will start the stocks with "buy" recommendations in the hopes of sparking another rally.
It happens every time.
But in the rare case of a company like Net2Phone, the groundswell of investor support is almost understandable.(We say "almost" because we know day traders are playing with the stock. We also know the history behind Internet telephony companies.)
On top of the underwriters' salute, Net2Phone named a new president, Jonathan Fram, and signed a pretty significant distribution deal with Compaq Computer Corp. (NYSE: CPQ).
The deal calls for Compaq to include a button linking to a co-branded site in its Presario Internet keyboards. A Community Center button on the keyboard will connect users to a site that contains the telephony software. Once it's downloaded, users can launch the software by pressing that button.
The following day Net2Phone jumped on a pact with Sprint Corp. (Nasdaq: FON).
The company has also signed a distribution deal with America Online Inc. (NYSE: AOL), and has relationships with NBC and GE Capital.
Net2Phone got another boost after the company announced that its chief operating officer would be speaking at a telecommunications conference in New York last week.
By the time the dust settled, Net2Phone shares had more than doubled in a week, jumping from an Aug. 20 close of 35 ? to around 70 or so Friday.
Alloy Online Inc. (Nasdaq: ALOY) didn't double this week, but it got a nice shot in the arm after one of its co-manager, Volpe Brown Whelan & Co, upgraded it from a "buy" to a "strong buy."
Alloy Online, a Web site that basically caters to the interests and tastes of the so-called Generation Y, has watched its stock steadily slip into an abyss following its May initial public offering.
It's not the worst new Internet stock trading these days, but it's no blue chip.
In its first quarter, Alloy Online reported a smaller-than-expected loss of $2.3 million, or 26 cents a share, on sales of $2.5 million.
After its lukewarm debut, Alloy Online shares marched up to an all-time high of 23 3/16 in July before slipping back to a low of 8 3/4 earlier this month.
Obviously there's a world of difference between the prospects of an Alloy Online versus Net2Phone.
But an investor who wasn't paying attention could easily see the upgrades of both stocks and figure these analysts really know what they're talking about.
The truth is this was an exceptionally good week for the brokerage firms.
They were half right.