Analyst Watch: Stop the Internet IPO madness

4 min read

After a two-week span in which more than a dozen Internet companies held initial public offerings, investors must be struggling to see the point. For every CyberSource or Software.com success story, there's a Comps.com or iTurf disaster.

Now, I understand the law of supply and demand and good old common sense does a fine job of separating the quality properties from the garbage. But my question is: Why is the garbage allowed on the floor in the first place?

At some point, the brokerage houses that trample one another to manage or underwrite these suspect offerings must be held accountable.

The IPO Market: Too much junk?

Would it really be so bad to take a pass on an Internet company that doesn't have any substantial sales, much less profits, and is surrounded by dozens of competitors just waiting to steal those two or three customers it does have?

Of course, they'll tell you that they are simply responding to the demand. That's the same line used by your local crack dealer, but that's a story for another day.

This phenomenon isn't limited to the smaller and dare we say less prestigious firms on Wall Street. In fact, some of the more "prestigious" names on Wall Street are the ones serving up some of the worst junk.

"It's amazing to see the types of Internet companies that are being taken public by these firms," said Lou Mazzucchelli, an analyst at Gerard Klauer Mattison. "It's unbelievable. Some of these companies have no business even discussing an IPO, much less doing one."

Why does this happen?

Money of course.

If the demand isn't there, we'll build it

Brokerage firms that underwrite, manage, or co-manage an IPO stand to make millions from an IPO, regardless of how successful it is. In fact, they're banking on a big "buy" surge at the open and perhaps an equally large "sell" surge the day after.

That way they can rack up commissions as well as profits. Maybe iTurf (Nasdaq: TURF) is a joke, but it still shot up above $66 a share before reality set in. Comps.com Inc. (Nasdaq: CDOT) never had a chance, but don't tell that to its underwriters.

Then, like clockwork, the firms that have a vested interest in these newly public stocks will chime in with an upgrade a good two or three weeks after the IPO. That way, there's a chance to get more trades and perhaps another rally.

"There's no question that some of these companies are too green to take public," said Derek Brown, an analyst at Volpe Brown Whelan & Co, which incidentally was an underwriter for Comps.com. "But the demand is very strong. There's a lot of money to be made."

This isn't to say that some of these Internet IPOs aren't respectable. A good number of them are fine investments, for now.

But when brokerage firms are throwing one or two gems in with a pile of garbage, it not only hurts the individuals who buy these stocks but also those holding shares of legitimate, successful Internet companies.

When the market becomes saturated with these rinky-dink Internet IPOs, there's less money that can be invested in solid firms. It drags down the entire market.

Wanna go public? Here's a plan

Finally, let's consider what some of these companies are trying to sell you on.

Profits don't matter. Sales are important, but not necessary. Traffic is king. We'll either be acquired or merge with any equally unprofitable company to become a big money loser with a lot of traffic.

When you sift through all the jargon, that's exactly what a lot of these newly public companies and their brokerage firms are selling you.

By that logic, it would make great sense to start an e-commerce site dedicated to selling $1 bills for 85 cents a whack.

A little advertising and some flashy banners would certainly net some incredible traffic figures. Who wouldn't log on and click away for hours to turn three quarters and a dime into a crisp Washington?

Imagine the traffic this business could garner. Think of the advertising revenue that could be derived.

I'd pay top dollar to have my company advertise on a site where some crazy company is giving away 15 cents on every dollar. It's like a freak show. Some kind of terrible accident that one can't help but watch.

Maybe I'm the crazy one, but I don't think this fictitious (I hope this business model isn't sitting on some guy's desk over at Merrill Lynch or Morgan Stanley Dean Witter) company could meet the overwhelming demand it would create.

And even if it formed a strategic partnership with a company that gave away U.S. postage stamps for 25 cents a piece, I don't think the combined company would stand much of a chance either.

So why do the brokerage firms keep helping companies just slightly more solvent than my fictitious company to the trading floor?