Fighting to hop the IPO express

The truck barreling down Wall Street loaded with this year’s initial public offerings has a squeaky wheel that’s demanding even more grease — retail investors.

And, in an unusual twist, companies that want to go public could become powerful allies in a bid by online brokerages to crack open an IPO market that has been reserved for the super wealthy and the well connected.

“It’s the issuers that are clamoring for the retail investor base to be included in the [IPO] process,” says Scott Ryles, who is heading a soon-to-be-launched investment bank for three brokerages.

The companies want broader participation because they think it will better reflect true demand for the stock — and result in a higher-priced IPO, Mr. Ryles says.

Fueled by the technology sector, last year’s 546 IPOs raised a record $69 billion, according to Thomson Financial Security Data.

Yet on average, the public had a shot at buying only 15% of those new issues. Most went to institutional investors and a few favored clients of brokers and underwriters. The rest went to company insiders.

“It’s a long-established buddy system,” says Stephen R. Chanecka, president of Informed Investors Inc. in Roseville, Calif., a company committed to giving investors access to competitive market information.

“The privileged club is going to fight very hard to keep it the way it is,” he says.

A growing number of online investors say otherwise. Online brokerage accounts, estimated at 5.4 million in 1999, are expected to jump to 20.4 million by 2003, according to Forrester Research Inc. in Cambridge, Mass.

That number, say many observers, translates into a market that underwriters will be forced to reckon with.

Some firms already have taken steps to help investors get in on the 170 offerings now in the pipeline for 2000.

Just this month, underwriter Friedman Billings Ramsey Group of Arlington, Va., launched a system called Offering Marketplace through its online investment bank, fbr.com.

The system enhances what fbr .com has been doing for months by removing potential glitches when investors place online IPO orders.

“We’re trying to democratize the process,” says Suzanne Richardson, president of fbr.com. “The individual investor is becoming an increasingly powerful force in the capital markets, and underwriters have to acknowledge that.”

Since fbr.com jumped into the online IPO arena last April, it has parceled out shares in 24 offerings. When Friedman took New York-based NetCreations Inc. public in November, it allocated 20% of 3.3 million shares to online investors.

Of course, as the lead underwriter, Friedman had more shares to distribute and greater control over how they were divvied up.

Some brokers are launching online investment banks as a way to gain the same kind of control — which, they say, will put more shares in the hands of retail investors.

Online brokerage E*Trade Group Inc., for instance, took a 25% stake last year in online investment bank E*offering. Although E*Trade has made more than 150 IPOs accessible to investors over the past 18 months, its new alliance is expected to boost its offerings.

“With that relationship, when a company goes public, 50% of the shares will go to E*Trade to give to individual investors,” explains an E*Trade spokeswoman.

Meanwhile, online rivals Charles Schwab Corp., TD Waterhouse Group Inc. and Ameritrade Holding Corp. became partners in November with three venture capital firms to create an online investment bank.

It will focus on underwriting and distributing stock offerings for info-tech and Internet companies.

“Online investing has become an extremely important part of the equity capital markets as it relates to technology companies,” says Mr. Ryles, president and CEO of the unnamed venture, which will be up and running in several months.

“Customers of the three partners own as much stock in technology companies as do all the institutional investors combined.”

Also dotting the online investment landscape is San Francisco-based W.R. Hambrecht & Co.’s OpenIPO system, which treats individual bids and institutional bids equally. Famed investment banker Bill Hambrecht started the Dutch auction-style operation.

Even Hambrecht & Quist, the San Francisco firm he founded last year, launched an IPO and Emerging Company Fund designed to give investors better access to IPOs.

After just two months in existence the fund was closed to additional investors because of the flood of money it attracted.

Schwab, meanwhile, took another step that could lead to greater investor access to IPOs.

In November, it received the go-ahead from the Securities and Exchange Commission to let some of its high-end retail investors in on virtual road shows.

Until now, road shows were the exclusive domain of institutional investors.

While all of these moves could be viewed as an effort to level the playing field for average retail investors, whether they will make a marked difference in the distribution of IPOs is another question.

“Customer demand has always outstripped supply,” says Marta von Loewenfeldt, a Schwab spokeswoman. “There have been several instances where if an issuer had given Schwab the entire deal, we could have easily placed all the shares.”

Mr. Chanecka of Informed Investors doesn’t see much changing. “Even with greater access, retail investors’ appetite is going to expand proportionately,” he says. “Both sides are rising quickly.”

Looking at some of the eye-popping returns of 1999, it’s easy to see why.

“IPOs are so high profile now that they’re hard to ignore,” says Kenan Pollack, money editor at Hoover’s Online in Austin, Texas. “People are reading about guys becoming billionaires overnight. How can you ignore that?”

By the end of 1999, 18 new issues had returned more than 1,000%, according to Hoover’s.

Topping the list was Internet Capital Group of Wayne, Pa., whose offering price in August was $12; by yearend it was trading at $170 after a stock split — a 2,733% return.

Rounding out the short list was Silknet Software Inc. of Manchester, N.H. It priced its May IPO at $15 and watched its shares climb 1,000% to close the year at $165.75. Last week, the two stocks were trading at $138 and $137, respectively.

But not all IPOs are racking up the same returns.

MotherNature.com Inc., which went public in December at $13, closed the day at $10.31, a 21% drop. Last week, it was trading at $7.

First-day price pops may turn the heads of investors, but some of the companies going public are doing double-takes, too.

While observers say that some sort of return is a fair expectation for an IPO, due to the risk involved, some of the skyrocketing first-day gains may be an indication of a poorly priced IPO.

“These are speculative investments,” says Ms. Richardson of fbr .com. “So there should be a discount if you’re willing to invest in them. But it shouldn’t be such a ridiculous [first-day] jump.”

Because underwriters typically rely on feedback from a relatively narrow audience — institutional investors — to decide IPO pricing, the price often fails to reflect demand for the stock accurately.

That’s what could unite companies going public and retail investors to open up the IPO process. Wider participation by retail investors would mean more capital for the company itself instead of spoon-feeding gains to select investors in the aftermarket.

A handful of companies tested the market last year with relatively high-priced IPOs. Mr. Pollack points to FreeMarkets Inc. as an example.

After planning to price its December IPO at $16 to $18 a share, the Pittsburgh company bumped it to $40 to $42, and then ended up offering shares at $48.

As it turned out, FreeMarkets made a good bet — but its price possibly could have even gone higher. At $48 a share, the company raised $172.8 million. But at the close of the first trading day, the stock, at $280 was up 483%, making the company’s market cap $892.8 million.

That’s a difference of $720 million — all of which went into investors’ pockets.

Even last year’s largest domestic IPO left a hefty amount on the table.

United Parcel Service, with an offering price of $50, raised $5.4 billion, but missed out on $1.6 billion by the end of the first trading day when the stock closed at $65.

Internet business-to-business companies — or those benefiting from them — were the hottest new issues, say IPO watchers.

This week’s largest offering is expected to be John Hancock Financial Services’ $1.7 billion IPO. The company is offering 102 million shares priced at $16 to $18.

Also rated as hot IPOs by Redherring.com are several more offerings scheduled for this week: Neoforma .com ($63 million), 724 Solutions Inc. ($72 million), Buy.com ($154 million), Extensity Inc. ($36 million), L90 Inc. ($66 million), and ST Assembly Services ($175.5 million).

Whether investors in these companies will see the same kinds of returns that made 1999 the Year of the IPO remains to be seen.

“It’s hard to make predictions,” says Mr. Pollack. “If you had tried to predict what would happen in 1999, you probably would have been wrong.”