IPO Market Perking Up, But Still Not Ready to Party Like It's 1999

[Editor's Note: The IPO market has been recovering gradually since the Great Recession caused almost all activity to grind to a halt. It got a jolt from LinkedIn Corp. after it doubled in price on its first day. We'll have a separate story on LinkedIn tomorrow (Friday).]

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LinkedIn Corp.'s (NYSE: LNKD) initial public offering (IPO) generated a great deal of excitement by surging 109% on its first day of trading.

In fact, the IPO market as a whole is looking its healthiest in years.

There were 69 IPOs through May 31, compared to 52 during the same period last year, according to data from research firm Renaissance Capital of Greenwich, CT.

There were just 63 IPOs throughout all of 2009.

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In terms of total value, the $23.9 billion of deals done so far this year easily outpaces last year's $6.3 billion total over the same period. 2011 is on pace to reach at least $57 billion in total offerings compared to just $38.7 billion in 2010. Indeed, this is shaping up to be the best year since 2000, when $96.9 billion of deals were done.

"The IPO market appears to be in rude health, approaching levels unseen since before the financial crisis," Renaissance wrote on its blog last week.

The success of social media IPOs, such as LinkedIn and Russia's Yandex NV (Nasdaq: YNDX), which rose 55% on its first day, had some sounding the bubble alarm bell, but the facts reveal a more ordinary IPO market.

The average first-day pop of a 2011 offering has been 12% with aftermarket returns of 14.7%, according to Renaissance.

And concerns over weak investor demand pressured several companies to set their IPO in a lower-than-planned price range: Freescale Semiconductor Inc. (NYSE: FSL) priced at $18, 22% below its midpoint; Spirit Airlines Inc. (Nasdaq: SAVE) priced at $12, well below its expected $14 to $16 range.

"It certainly states the gross misconceptions that we are in a bubble market when IPOs with far less allure and cachet are having trouble getting done," Scott Sweet, an investor and senior managing partner at IPO Boutique, told The Financial Times.

Not Created Equal

In fact, LinkedIn is much more the exception than the rule.

"LinkedIn had the combination of a small float plus investor excitement, and that's what caused it to have such a major spike," Darren Fabric, managing director at IPOX Capital Management LLC, told The Wall Street Journal.

Not to mention the added juice from being a social media company - the soaring valuations of not-yet-public Facebook ($74 billion) Zynga ($10.7 billion) and Groupon ($12.7 billion) attest to strong investor appetite for businesses in this category.

But then, even LinkedIn isn't an unqualified success story - its price has fallen 14% in the aftermarket since that boisterous first day. Shares of Yandex have also fallen about 14% in the aftermarket.

And the euphoria over social media companies has been anything but contagious.

The 10 energy IPOs this year rose an average of 4.5% on their first day, with a tepid 7.5% average total return. The eight financial IPOs had an average loss of 0.6%, scratching out just 0.8% in total returns.

Even tech companies, which have accounted for 25 of the 69 IPOs so far this year, were underwhelming. The group had an average first-day pop of 21.5% and a 16.4% total return.

The tame reception to the majority of IPOs -- particularly in recent weeks -- points to an increasingly selective market that prefers growth over value as well as a healthy caution for companies with questionable business models.

Other factors weighing on the IPO market in the United States include a flagging stock market rally and the big spurt in IPOs in April and May. The 37 IPOs in the past two months is already more than the 32 offered during the entire first quarter of the year, and huge secondary offerings, such as the $8.7 billion from American International Group Inc. (NYSE: AIG), have created something of a glut.

"May was a challenge," Dan Cummings, global head of equity capital markets at Bank of America Merrill Lynch, told The FT. "The new issue market takes its cue from the secondary market. As the stock rally has faded, that led to some apathy and a feeling of fatigue."

In addition, some individual IPOs have had specific issues to make investors wary. For example, both Freescale and Spirit Airlines are using most of their IPO proceeds to pay down debt rather than invest in their business.

2011 Scorecard

Among this year's biggest winners and losers so far:
Winners:

  • Pacira Pharmaceuticals Inc (Nasdaq: PCRX), up 108% from its offer price
  • Servicesource International Inc. (Nasdaq: SREV), up 92%
  • Endocyte Inc. (Nasdaq: ECYT), up 97.5%
  • Nielsen Holdings (NYSE: NLSN), up 36.3%
Losers:

  • Kips Bay Medical Inc. (Nasdaq: KIPS) down 62% from its offer price
  • NetQin Mobile Inc. (NYSE: NQ), down 50.9%
  • FriendFinder Networks Inc. (NYSE: FFN), down 44%
  • Boingo Wireless Inc. (Nasdaq: WIFI), down 29.4%
Investing in IPOs is typically a dicey proposition for individual investors, as only institutions are able to buy at the initial price and the aftermarket is often a rocky ride for months.

Some experts advise waiting for the excitement to die down, particularly when considering companies in "hot" sectors, as social media is now.

"The absolute worst time to buy a newly issued firm occurs during hot IPO markets, when investors clamour to buy any new firms in the ‘must-have' industries," Jeremy Siegel, author of "The Future for Investors: Why the Tried and the True Triumph over the Bold and the New," told the Globe and Mail.

Odds are that advice will again be ignored when any social media/Web-based company comes to market this year - be it Facebook, Twitter, Groupon, Zynga or Pandora.

However, several less-celebrated IPOs of 2011 may well be worth a look. These companies have already listed, but are poised to make significant gains in the aftermarket.

  • Pacira Pharmaceuticals (Nasdaq: PCRX): The IPO for Parsippany, NJ-based drug-maker Pacira had a sleepy first day on Feb. 2, with just a 0.3% pop, but has since seen its stock price double. Investors betting that a promising pain treatment drug, Exparel, will get Food and Drug Administration (FDA) approval by July 28 have pushed the stock from its $7 offer price to over $14. Jonathan Aschoff, an analyst for Brean Murray Carret & Co. gave Pacira a price target of $20, writing in a March report that Pacira's total revenue likely "will eventually exceed $1 billion" even if Exparel only captures a small portion of its market.
  • ServiceSource International (Nasdaq: SREV): ServiceSource makes software for service-oriented companies to help them increase renewals and subscriptions. The San Francisco, CA, company's pay-for-performance model is designed to attract business: customers only pay if their revenues increase. Its March 24 IPO gained 21.8% on its first day and 57.8% in the aftermarket. ServiceSource reported a 43% increase in revenue in its first quarter with net income of $17.4 million. Not bad, but the potential market for its services is $159 billion.
  • Arcos Dorados Holdings Inc. (NYSE: ARCO): Based in Buenos, Aires, Argentina, Arcos Dorados is the world's largest McDonald's Corp. (NYSE: MCD) franchisee with over 1,750 locations throughout Latin America. After a nice first-day pop of 24.7% on April 13, this stock has gained only 7.3% in the aftermarket. But it could be a great way to play McDonald's growth in some key emerging markets. Morgan Stanley (NYSE: MS) initiated coverage of Arcos Dorados last week with an overweight rating and a $26 price target, saying the company operates in an attractive and underpenetrated region.
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