Feasting on a Banquet of Internet
Offerings
By EDWARD WYATT
emiconductors in the 1970s. Software in the 1980s. Biotechnology
in 1991. The Internet in 1999.
Roughly once a decade, as some emerging technology reaches critical
mass, start-up companies rush to cash in on the ensuing enthusiasm by
selling their stock to the public.
On Wall Street, where nothing
succeeds like excess, investment
bankers take a Darwinian view of
these frenzies, pushing as many
companies as possible through the
financing process while the public's
appetite is whetted but before it is
sated.
This year, it is a feast. The eager
Internet start-ups are so numerous
that investment banks tell of having
to turn away potential clients while
some companies have resorted to
trying creative methods to whisk
their documents through regulatory
approvals. A company might list
itself in the transportation industry,
for example, if it plans to sell airline
tickets over the Internet.
Barring a midsummer market
collapse, more than 100 newly
public companies might be
competing for the attention of
investors before the usual August
break of investment bankers, the
finance professionals say.
"We've certainly seen other booms,
but we've never seen anything like
this," said Kenneth R. Fitzsimmons,
director of capital markets at
BancBoston Robertson Stephens,
the San Francisco firm that has been
one of the biggest underwriters of
Internet stock offerings in the last six
months. "The market is far more frenetic, and companies are getting
higher absolute valuations than ever before."
The bankers typically scrutinize a company's financial condition and
business plan, and they promise to provide coverage of the stock once
trading starts.
Compared with past frenzies, this one is extreme in several ways.
Internet-related businesses already account for a bigger portion of the
total number of new issues than biotechnology companies ever did, and
these new stocks are rising higher and faster than anything in recent
memory.
While individual investors and day traders are contributing to the activity,
institutional investors like mutual and pension funds are also eagerly
chasing companies that many of them would have previously dismissed as
speculative. Those big investors, ever mindful of investors' high
expectations, are holding onto their shares longer, dampening supply and
reinforcing the upward rise of many Internet stocks.
All this interest is putting some strains on the initial-offering system, which
usually steers the public's money only to the most promising companies.
Jesus Cabrera, who oversees the State Street Emerging Growth fund,
says so many Internet companies are jockeying to go public that he
cannot make it to all the "road shows," the presentations at which
company managers and their bankers use to describe the company's
prospects.
His solution: Watch some of the road shows over the Internet, on a
service called Netroadshow.com.
"I place value in meeting companies in person so I can see the whites of
their eyes," Cabrera said. "But if I tried to go to them all, I wouldn't have
a life," or much time to manage a $100 million mutual fund.
Portfolio managers might take comfort in knowing that it has been hard to
lose money investing in an Internet public offering in the last year. The
point was driven home again on Friday, when shares of
USInternetworking, iTurf and Extreme Networks each jumped more
than 100 percent from their offering prices in their first day of trading.
Such leaps are typical of the more than two dozen Internet-related
companies that have completed initial offerings so far in 1999, and an
improvement over the performance of similar offerings last year.
Fitzsimmons said his research shows that Internet offerings jumped nearly
70 percent, on average, in their first day of trading last year.
According to Thomson Financial Securities Data, a quarter of the initial
public offerings so far this year have been for Internet-related companies,
up from less than 10 percent last year. In 1991, when biotechnology
companies were all the rage, those concerns represented about 20
percent of new issues.
The $9.4 billion raised in all types of new public offerings in the first
quarter of this year was a record, leading many on Wall Street to believe
that 1999 could follow the path set in 1991, when a hot market for
biotechnology offerings led to a record year for underwriters.
Investors, meanwhile, have shrugged at high-profile deals that in past
years would have dominated headlines.
On March 30, Pepsi Bottling, the largest bottler and seller of Pepsi
products, completed the largest initial public offering this year by selling
$2.3 billion of its shares at $23 apiece. The shares sank more than a
point their first day of trading and have since fallen further, closing at
$21.4375 on Friday.
Delphi Automotive, which makes auto components and systems, sold
$1.7 billion of shares at $17 apiece in early February. Though the shares
have spent most of their time at $18 or more, they have recently slipped
to less than the offering price, closing at $17.4375 on Friday.
"The current IPO market is significantly more concentrated in one sector
than I've ever seen it," said Scott Sipprelle, a co-founder of the Midtown
Research Group, which tracks initial offerings, and the former head of the
equity capital markets division of Morgan Stanley Dean Witter.
That might be diverting money away from promising companies in other
industries. Global Markets Access, an insurer based in Hamilton,
Bermuda, had planned to raise $244 million in an initial offering to be
underwritten by Merrill Lynch & Co. and Prudential Securities but
withdrew its offering on March 31, citing market conditions.
It certainly is straining the lives of bankers, lawyers, accountants, printers
and others who keep the IPO machine running.
"We've never been this busy, and we're turning things down," said
Fitzsimmons of BancBoston Robertson Stephens. While the firm's
committee that reviews underwritings has always rejected some deals
because of poor quality, "we're having to pick and choose the deals we
do much more now," he said, citing the high volume.
Perhaps of greatest concern to investors, however, is the relative
shortage of analysts who understand and can follow the Internet
companies once they begin trading. There is an almost endless supply of
potential Internet companies -- which are often little more than a business
plan and some financial projections. But few analysts can make sense of
both Internet technology and the economic models that will lead to
success on the new medium.
David Readerman, a software and Internet analyst at Thomas Weisel
Partners, a San Francisco investment bank, notes that while nearly every
investment bank has at least two or three bankers working on
Internet-related offerings, they have one securities analyst, at most, to
follow the companies once the stock is trading.
Analysts will play a far more important role in following Internet
companies, Readerman said, than they did in, say, the biotechnology
boom. In the Food and Drug Administration, biotechnology companies
had an outsider to rule on their products' ultimate success or failure. But
determining the prospects of an Internet company is more prophesy and
conjecture.
People involved in bringing Internet companies to market also complain
of a bottleneck at the Securities and Exchange Commission, which must
review a company's disclosure documents before granting approval to
sell shares.
Investment bankers say the initial review, which is supposed to be
completed within 30 days, is taking closer to six weeks. Chris Ullman, an
SEC spokesman, denied that backlog; he said that while the average time
for review of a filing for initial public offerings had recently been 31 to 33
days, it has now returned to 30 days.
In Silicon Valley there is talk that the fastest way to get an Internet
business to market is to pretend it's not an Internet company. When
companies register with the SEC, the documents are initially routed within
the agency to industry experts based on the company's Standard
Industrial Classification code, a four-digit number indicating the industry
in which the company does business.
Investment bankers and other Wall Street professionals say that
companies have recently been tweaking their industry codes to avoid the
queues numbered in the 7370's, which denotes computer systems and
software.
That queue has been used by a wide variety of companies, including
Priceline.com, which sells discounted airline tickets over the Internet. But
two other companies in a similar business -- Lowestfare.com and Cheap
Tickets Inc. -- used the codes for transportation services and general
business services, respectively.
Ullman said that whatever code a company initially files under, the SEC
will determine the correct industry and route the filing accordingly. In
other words, he advised companies, don't try it.
Companies still cannot get their offerings to the market quickly enough, in
part because they fear missing the opportunity before the financing
window closes.
Investment managers, on the other hand, cannot seem to buy quickly
enough, showing little regard for the outsized valuations at which Internet
companies are going public.
"I had lunch with a mutual fund manager the other day and asked if he'd
played in these Internet IPO's," said L. Keith Mullins, who tracks small
companies at Salomon Smith Barney. "He said he had, so I asked if he
could give me a fundamental reason to own any of these stocks at these
prices. He said no. But he added, 'That's what's working right now."'
George S. Shirk III, managing editor of the New Issues newsletter, said
his publication has recommended that investors "flip," or sell on the first
day of trading, nearly every Internet IPO that has come to market this
year -- provided that an investor can get shares at the initial offering
price, as institutions can but individuals usually cannot.
"We're not seeing a lot that we would recommend for a long-term
investor," he said, particularly after trading begins and the stock has
already more than doubled.
Though individual investors may be left out of the earliest part of the
game, institutions are jumping into deals that, in the not-so-distant past,
would have drawn little enthusiasm.
"Demand by institutional investors has gotten much higher because those
managers want to show these stocks in their portfolios at the end of each
quarter," said Linda Killian, who herself manages a mutual fund that
invests in new offerings, the IPO Plus Aftermarket fund.
Whether the quality of the companies coming public has deteriorated is a
matter of opinion. A decade ago, only rarely could a company go public
without a record of sales growth from three to five years and at least
some profits.
In 1997, though, about a third of the companies completing initial
offerings were losing money, Ms. Killian said. Today, a similar portion
have virtually no sales.
"So if you are simplistic about it and look at traditional measures, you'd
have to say that the quality has plunged," she said. "But if you look at it in
a different way, maybe not. Hindsight will be a great teacher."
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