By Darren Chervitz, CBS MarketWatch
Last update: 07:01 PM July 20, 1998
DALLAS (CBS.MW) -- What the stunning debut
of Broadcast.com proves more than anything else is
that too many investors have no clue how the IPO
process works, a fact backed up by many of the
letters posted on the Internet bulletin boards or sent
to me via e-mail.
If they did, there's no way Broadcast.com (BCST)
would have closed its first day of trading up nearly
250 percent. (See story on Broadcast.com's IPO.)
The folks on Wall Street don't like telling this story since they profit quite
nicely from investor ignorance, but investing in IPOs can be a dangerous
game to play, not only because of the inherent riskiness of the young
companies going public, but because of how uneven the playing field is for
the average investor. (See StockWatch.)
Let's take a quick look at how an IPO is pulled off using broadcast.com as
our example. (For a longer look at the IPO process, read the four-part
ABCs of IPOs series.)
Public offering?
Dallas-based Broadcast.com sold 2.5 million shares
in its IPO at an offering price of $18 each. IPO
stands for initial public offering, but that moniker is
rather misleading. The fact is, only very limited and
privileged parts of the public are able to buy shares
in an IPO at the offering price.
If you were a Broadcast.com employee or somehow
had a close relationship with the company or its
management, or if you had a large account with one
of the bankers handling the IPO, perhaps you were
allowed to buy some shares at $18. The rest of us
had to wait until the shares actually started trading
on the open market -- at 68 1/4 -- to buy a stake.
Most investment banks have in the past couple of
years established relationships with other
brokerages, either through strategic alliances or
acquisitions, that give them access to regular retail
investors. For instance, broadcast.com's lead
underwriter Morgan Stanley merged with retail
broker Dean Witter midway through 1997.
Although these deals have allowed some smaller investors to buy shares in
an IPO at the offering price, mostly they've just helped the underwriters
ensure that demand is strong after the stock starts trading.
Just take a look at some interesting statistics regarding Morgan Stanley-led
IPOs last year. Prior to its merger with Dean Witter In June 1997, Morgan
Stanley's nine deals rose about 10 percent on the first day of trading,
excluding the best and worst performing deal for the period, according to
CommScan's EquiDesk. After the merger, Morgan Stanley's 25 new issues
notched first-day gains of more than 21 percent on average, again excluding
the two deals at the extremes.
What's worse, even investors lucky enough to get shares at the offering
price are STRONGLY discouraged by their brokers from selling those
shares when the stock starts trading, a process called flipping that's often
employed by institutional investors to generate a quick profit. Sell anyway,
and it's likely you'll never get a piece of another IPO, at least not from that
broker.
Ugly performance
Of course, that may not be such a bad thing, considering that study after
study has shown that IPOs significantly underperform the broader market
over time. This is true even when one uses the offering price as the
benchmark; Use the first trade price and the statistics get even scarier.
Things get scarier still when you have a hyped-to-the-hilt IPO like
broadcast.com, which on Monday fell 1 3/4 to 61.
The sad truth is that many investors, either in hopes of getting in on the next
Yahoo stock-slash-rocketship or through the advice of one of Dean Witter's
eager army of brokers, placed an order to buy broadcast.com when it
opened for trading. Unless they set a maximum price at which they would
buy the stock, many of these investors got saddled with shares in the $70
range.
More on Broadcast.com
Maybe Broadcast.com will one day be worth that much. The company,
which aggregates and distributes audio and video content via the Internet,
does have gigantic potential, but there are still several big question marks
surrounding its business plan.
Several news articles about the IPO argued that the company was in
trouble unless the bandwidth of the Internet improved to the point where its
content could achieve TV-like quality. Actually, improved bandwidth could
be the beginning of the end for Broadcast.com.
Broadcast.com has the right to broadcast content of most major
professional and college sports teams and leagues, more than 300 radio
stations, 200 record labels and 17 television networks. It's a killer
programming line-up and one Broadcast.com has bought on the cheap since
many of these entities want to test out the Internet and don't yet view it as a
replacement for TV.
Once bandwidth improves, and more people are logging on to what is an
Internet with TV-quality sound and video, that will all change. Do you
really think broadcast.com will be allowed to air a lineup of football games
as cheaply as it's been doing (audio only to this point), when the television
networks have just spent billions of dollars for that same right?
It seems obvious that the cost of content will go up dramatically for
broadcast.com, and it's not clear how they'll be able to compete in a bidding
war with the better-financed traditional media plays.
I. P.O.nder
Of course, this is just the type of question that was likely raised and
answered during the company's road show, a pre-IPO series of
management presentations given only to prospective institutional investors.
Unfortunately, you can't attend these meetings and you'll never know what
goes on in these meetings because the media aren't invited either. It's just
one more reason why the IPO process is so unfriendly to Joe Q. Investor.
"No one ever said the activity of raising capital was a democratic
enterprise," NationsBanc Montgomery Securities syndicate manager Dick
Smith has told me in the past (See related story).
That may be true, but no one has ever said that the process had to profit off
of the ignorance of investors, either.
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