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There's More to IPOs Than Just a First Glance

Tuesday, 09 Aug 2011 07:43 AM

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The recent IPOs (initial public offerings) of social networks have created a surge of interest by individual investors rushing to subscribe and hopefully make a quick profit.

But is this the case? If one looks at all the IPOs listed on the NASDAQ and NYSE in 2011, there is a mixed picture. Not all of the IPOs had a sharp rise in their opening. A more important question is — how long does this upside trend last? We can analyze the performance of a few examples of shares that had a recent listing.

One example is GNC, a health-products retailer which raised $360 million in its IPO at the midpoint of expectations at a $16 pricing.

GNC jumped to $16.60 in its opening and closed at $19.05 at end of that day. Unusual to most IPOs, this stock hasn’t dropped below its IPO price even during this stock-market correction and recently traded at about $22.

With many investors avoiding financial stocks, specialty retailers seem to be a safe growth investment. This is especially true with GNC because it doesn’t have much competition and it is expanding in China.

So even if you hadn’t succeeded in getting any allocation of GNC from the IPO and bought it a bit later, you still have quite a decent return of about 30 percent.

Social network IPOs such as LinkedIn, Groupon and Renren (the Chinese equivalent of Facebook) were flavor of the year as investors rushed to buy these highly priced stocks. If one looks at the performance of LinkedIn, then it is really amazing that the IPO price was $45 and closed up 80 percent in the day of issue. It recently traded at about $75.

The reason it traded up so sharply was that as it was the first social network company to be listed and was priced below its market value. LinkedIn, which connects more than 100 million professionals online, has three revenue streams: online ads, premium subscriptions and hiring tools for recruiters.

With a market capitalization of more than $9 billion, $292 million in sales and a forward price earnings of more than 300, it is richly priced. Renren had a different performance due to the underwriter’s decision to increase the listed price by 30 percent.

Renren, which was listed at $14, jumped sharply May 4 to touch $24 but closed below the IPO price at $12.85. Today it is trading quite far from its IPO price at $6.75.

Groupon, the deal-of–the–day website that sells heavily discounted gift certificates usable at local or national companies, has postponed its IPO until September with an expected valuation in access of $10 billion, Groupon already has several competitors, for example Living Social and Google Offers started by Google after its failure to buy it for $6 billion.

HomeAway, the online vacation rental marketplace for travelers who don’t wish to stay in a hotel, doesn’t have many competitors.

HomeAway (AWAY) priced its IPO at $27 (a market capitalization of $2 billion) and started trading at $36 jumped up to $42 and closed the first day at $38.70. It is now trading at about $31.70, which is about 17 percent above its listed price but not much more than its first-day trading.

Dunkin’ Donuts surged 47 percent to $27.85 during the first day of trading. Priced at the high end of the marketed range - $19 – it is now trading at $25.70, still above the IPO but below the first day traded price. Dunkin’ Donuts was sold at a higher valuation than Starbucks as their CEO said that they have plans to double their stores in the United States.

Another outperforming IPO is Teavana, a speciality retailer of premium loose tea leafs and tea ware that was priced at $17 but still opening up more than 66 percent to close at $27.80. It is trading today at the price of around $25.50. One explanation for its surge is the low float of shares with the CEO still owning about 58 percent and a private equity firm owning about 20 percent.

You should analyze these IPOs much in the same way as one would carry out valuation of other shares, see if the model has competition or has a moat and look at how long is the lockup period. The lockup period can be 60, 90 or even 180 days where the major shareholders (top managers and founders) are prohibited to sell their shares. Once the lockup period expires, one can expect a sharp drop in the price of the share.

For example, Tesla Motors dropped from $32 to $25 once the lockup expired. Investors should also look if the broker listing the share decided to price the IPO at the lower, middle or higher range of originally estimated price.

It might in some cases make sense to buy the shares during periods of correction rather than rush in and buy during the first day especially if there was a sharp runup. One should also be aware that several IPOs started trading at below the price that investors subscribed to (Wesco Aircraft Holding).

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