Dealing Yourself Into The Ipo Game

Want to get your hands on the next hot new stock with .com in its name? Unless your broker owes you a big favor, you'll probably have to buy it secondhand after its price has soared. When it comes to initial public offerings, average investors don't stand a chance against professionals, who usually get first crack at hot deals. But you can get into the IPO game another way--through the side door.

To help the little guy gain access to this clubby corner of the market, Renaissance Capital, a Greenwich (Conn.) research firm specializing in newly minted stocks, launched the first mutual fund to invest mainly in IPOs. "We have always gotten allocations [of IPOs] because we are well-known," says Linda Killian, one of three friends who met at Wharton in the late 1970s and went on to found Renaissance in 1991 and the IPO Plus Aftermarket fund in February.

NO REMORSE. So far, Killian and partners have snapped up shares in 10 online offerings--and they have had no remorse about purging their 20-stock portfolio of highfliers to take profits. Among those to go were sensations eBay, VeriSign, and Inktomi. "When stocks get to what we think are unsustainable valuations, we sell them," Killian says.

Although that discipline has caused the fund to pass on some other phenomenal IPO successes, including, the strategy has produced a 3.7% gain through November--not bad, considering that almost 60% of this year's IPOs have dropped below their offering prices, says New York research firm CommScan. The IPO Plus Aftermarket fund also beat its peers in the small-cap growth category, which is down an average of 5.27% this year, according to Morningstar.

But is it a good idea to chase after fresh young stocks? Many experts say no. True, the average new issue rises 16% in its first day of trading, says Jay Ritter, a University of Florida finance professor who specializes in IPOs. But most trail the broader market for the remainder of the year, says Standard & Poor's analyst Mark Basham. Of the 3,477 companies to go public since 1993, about 55% are currently trading at or below their split-adjusted offering prices, CommScan says. And when the market slides, watch out--investors generally flee first the most illiquid and unproven stocks.

FIRST-RATE. Nevertheless, as the successes of Yahoo! and show, some of today's unknowns are tomorrow's household names. When it comes to identifying them, Ritter says, Renaissance has an edge. Renaissance Capital "does first-rate research," he says. "If I were an investor who wanted recent IPOs, their fund seems to be an excellent vehicle."

Killian and her co-managers, William Smith and Kathleen Shelton Smith, a husband-and-wife team, are picky. They have bought shares in less than 20% of the 343 companies that went public so far this year. The no-load fund, which requires a $2,500 minimum investment, concentrates on companies new to the public markets, although it sometimes buys older shares and secondary offerings.

To winnow the field, the managers discard stocks trading at premiums to their industries. That's straightforward enough when it comes to oil and entertainment prospects, such as Conoco and Fox Entertainment Group, which Killian bought on the basis of attractive price-to-cash-flow multiples. But without traditional yardsticks, such as earnings, many Internet companies pose challenges, says Killian. She looks for those with superior business models and competitive edges such as leading market share.

Among those that passed muster is Santa Monica (Calif.)-based GeoCities, whose online chat rooms devoted to topics including football and investing give advertisers access to highly targeted audiences, Killian says. But GeoCities illustrates how the fund managers are careful not to fall in love with their stock picks. When GeoCities reached the undisclosed sum that Killian and her partners figured it was worth, the fund bailed out.

Current holdings include Aurora Foods, a $143 million, San Francisco-based company that has breathed new life into brands including Duncan Hines, Mrs. Butterworth's, and Celeste pizza. Although Aurora's sales are growing faster than those of the average food company, its stock trades at a 20% discount to the industry, based on price-earnings ratios, Killian says. Another favorite is Fox, which sells at a slight discount to its peers despite smash box-office hits, including Titanic, and hot television and cable programming. Killian has her eye on a December 10 IPO from radio powerhouse Infinity Broadcasting, currently part of CBS.

The fund also holds positions in Equant, a Dutch data network provider with global reach, and Boston-based American Tower, which operates more than 2,000 towers that broadcast wireless telecom signals throughout the country.

MISGIVINGS. With valuations for all IPOs except Internet stocks falling back to earth, Killian expects the pace and variety of new offerings--currently the slowest since the 1990 recession--to improve. But others aren't so sanguine. Until investors stop favoring the largest, most liquid stocks, the IPO pipeline is likely to remain inhospitable to all but Internet sensations and established companies, Basham says.

Given the risks of IPO underperformance (not to mention the IPO fund's rich current expense ratio of 2.5%), Morningstar analyst Russel Kinnel says "most people are better served by a fund that just buys some IPOs" (table). Nonetheless, the eight funds with established track records that purchased IPOs most aggressively this year --but are not restricted to newly minted stocks--have returned only 0.07% on average, Morningstar says. These results are a far cry from's 600% first day climb--and a sobering reminder of just how hard it can be to make money in IPOs.

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