Picking IPO winners becoming a dicey game

The market for initial public offerings is a less festive place these days, even for companies in favored sectors that previously were the center of investor attention.

4 min read
The market for initial public offerings is a less festive place these days, even for companies in favored sectors that previously were the center of investor attention.

Not only are shares of many newly public companies slipping steadily with the broader Nasdaq, but first-day gains of 200 percent and 300 percent have become increasingly infrequent. As the moon shots disappear, analysts say investors may gradually lose their appetite for new issues--further keeping the lid on prices.

"That big pop from the offering price to the first trade is what everyone looks forward to," said George Nichols, an IPO analyst with Morningstar. "If you take that away, there's going to be less IPO participation."

Furthermore, many investors have had their portfolios battered by the five-week, 20 percent decline in the Nasdaq. For them, experts say, investing in IPOs has slipped on the list of priorities as the risks begin to outweigh the potential rewards.

"When a technology portfolio manger is trying to figure out whether they should hold or sell the Ciscos, the Intels and the JDSes in the world, it's going to be very difficult to get their attention on whether they should hold a new, emerging name," said Mark Dicioccio, managing director of Lehman Brothers. "In that kind of environment, people are simply unwilling to invest money in a new name."

That sentiment could hamper the debuts of two tech companies this week: chip design software maker Synplicity and MCE Companies, which makes parts for wireless infrastructure equipment. Meanwhile, the much-anticipated IPO of Transmeta, which makes chips for notebooks and other portable devices, is expected to debut later this month.

Investors who continue to examine IPOs may not like what they find. It is common practice for fund managers to examine leading companies in a market as well as companies that recently launched IPOs. If the sibling companies have done well, this could speak well for the prospective IPOs, and vice versa.

But with the Nasdaq down, few sectors can showcase strong companies, even those in the much-touted optical networking arena. While companies in this sector have pulled off respectable IPOs despite today's topsy-turvy market, the returns pale compared with those launched earlier in the summer.

Fiber-optic networking company ONI Systems, which launched its IPO June 1, gained 238 percent in its first day of trading. New Focus, an optical components maker that began trading May 18, soared 155 percent. And Sonus Networks, a maker of networking devices, gained 119 percent in its May 25 offering.

Last week, however, the response to Oplink Communications, which makes fiber-optic components for optical networks, was strong but tempered. The shares rose 87 percent in their debut despite an 8 percent drop for the Nasdaq that week.

Why the change of heart? Comparable companies have had a rough several weeks. JDS Uniphase has fallen 26 percent since Sept. 1, Sycamore Networks has fallen 45 percent during the same period, and ONI Systems is down 44 percent.

"The environment has changed," said William Klein, an analyst with Wasserstein Perella Securities. "There's no safe place in this market."

Fund managers say they can no longer count on certain sectors to be winners--such as semiconductor and optical networking--or on others sectors such as e-commerce and business-to-business to be poor performers. The lack of direction adds to the worries that the potential rewards are dwarfed by the risks.

"The market over the past few weeks has been very un-thematic, much more schematic," said Dave Nadig, a portfolio manager with MetaMarkets.com. "You'll see upstarts doing really well, while stalwarts will be down. As someone managing money every day, it makes it harder work."

Still, the procession of IPOs continues.

Last Friday, for example, seven companies filed S1 papers, demonstrating their intent to launch initial public offerings, a confident move by both the companies and the investment banks handling the sales.

These companies did not come solely from favored sectors, rather from a variety of backgrounds including energy, software and corporate technical training.

Such moves, coupled with a steady calendar of IPOs and a smattering of strong debuts, leads some investors to remain optimistic in the face of what could be deemed a bear market.

"I think most people believe that while we're seeing a pretty serious correction here, we're not going down another 20 percent," Nadig said. "We're sort of fishing for the bottom here."

As for the near-term direction of the IPO market, analysts say investors should keep an eye on the same headlines that are rocking tech shares on a daily basis: earnings warnings and actual quarterly results.