Wall Street's Bush Doctrine

John Kerry's defeat isn't the only factor lifting the market, says analyst Tom Taulli, who sees the bulls stampeding into 2005

"The beginning of a bull market that I think will lead into 2005." That's the way Tom Taulli, author, analyst, and venture capitalist, describes the stock market's behavior in the days following the Presidential election. In fact, Taulli, who among other things tracks initial public offerings, says he noticed a change in investor psychology before the election, citing successful IPOs by Dreamworks (DWA ) and shopping.com (SHOP ).

Earlier, 2004 had been a "choppy" year for IPOs, in Taulli's view, but he thinks the tide has turned and that 2005 will be even better, with biotech and other companies coming into the market. Noting the risks as well as the rewards in IPO investing, he urges investors to diversify. And he recommends avoiding high-profile IPOs such as Google (GOOG ) for six months or so until things settle down.

During President George W. Bush's second term, Taulli sees promise in sectors such as pharmaceuticals, financial services, energy, defense, and network security, but he also senses possible buying opportunities in a "Kerry" sector, such as alternative energy.

These were some of the points Taulli made in an investing chat presented Nov. 4 by BusinessWeek Online on America Online, in response to questions from the audience and from Karyn McCormack of BW Online. Following are edited excerpts from this chat. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: Tom, first let's start with your view of the stock market -- do you think this two-day "relief" rally can continue now that the election is over?

A:

I don't view this two-day rally as a relief rally. I think it's the beginning of a bull market that I think will lead into 2005. I cover the IPO market extensively and noticed a major change in investor psychology a few weeks ago, with the successful offerings of Dreamworks and shopping.com. It seems there are real demands for equities from investors, and the fact that they're interested in IPOs is an indication that investors want to ramp up their risk tolerance going forward. I think the last couple of days has been very good news for the markets and won't be a flash in the pan. We also got lucky because oil prices fell as well, which is an important factor.

Q: Will the Bush victory help small businesses? And in turn, the IPO market?

A:

Clearly, investors were happy that we had a seamless election two days ago, and I think investors are happy that Bush is in the White House. We saw a variety of sectors increase on the news of the Bush victory -- financial services, pharmaceuticals, even energy. But I do think Bush has a platform for what he calls an ownership society, and I think that means lower taxes and more incentives for small businesses.

That's good news for entrepreneurs who want to grow their businesses. So Bush is good news for small and medium businesses. But the biggest positive for small business is that there has been a lot of money on the sidelines because of uncertainty regarding the election. That money will start to go into the market and funding of companies.

Q: Google set off some successful IPOs lately. Are there any more in the pipeline that investors should look for?

A:

Very good question. No doubt about it, there are people who made money off the Google IPO, and, more importantly, investors made money in the auction. I do believe that Google has been an important factor in the revival of the IPO market because of its surge. Just as a reminder, though: IPOs are a high-risk sector of the market, and it's something you don't want to put all your money into. You still want to practice diversification and those solid principles of financial planning.

There are a variety of IPOs that look interesting to me. One comes out next week, ZipRealty. The proposed ticker is ZIPR -- the underwriters include UBS and Deutsche Bank. The company was founded in 1999 during the heart of the dot-com surge, and when the markets went into a tailspin, Zip had to hunker down and generate a business model that would make profits. They've done that so far. In the first nine months of 2003, they made $26.3 million, compared to $46 million this year.

Zip focuses strictly on residential real estate. Typically, real estate agents are just that, agents. They make money on commission. At Zip, they're employees, which allows the company more control over their employees.

Housevalues.com (SOLD ), another potential IPO, could go public in a month or so. This company essentially helps real estate agents find customers, and it has grown at a very fast rate.... There's another company that I think will do well, Portal Player. Investors may not know this company, but their biggest customer is Apple Computer (AAPL ). Apple's iPod is growing by leaps and bounds. Portal makes the semiconductors in this unit -- iPod growth has caused revenues for Portal Player to surge. The problem is the company isn't profitable, but just breaks even, even though revenues have tripled in the last year.

Q: Can I get in on private placements?

A:

Absolutely. But it's a lot more difficult than buying a stock or even an IPO. A private placement is an offering of stock or securities by a company to a limited number of investors. An IPO is an offering to the general public. By offering to only a few investors, a company does not have to go through the tough regulations the Securities & Exchange Commission imposes. There are still anti-fraud measures, etc., but there's still less paperwork than going public.

To get in on a placement, there are requirements, often net worth and income requirements [of] $1 million and $250,000 a year, respectively. But that can be waived if you're a "sophisticated" investor. I have a Web site, currentofferings.com, where you can sign up to gain access to private placements. Another source to key into would be attorneys who specialize in corporate finance.

Q: Tom, do you recommend that investors buy the successful IPOs such as Google and salesforce.com (CRM )?

A:

Very good question. I would avoid the high-profile IPOs like Google and Salesforce. In the first four or five months of an IPO, there's a premium built into the stock, which goes away as fundamentals synch. You don't want to be the last person standing buying the stock at the high tick before the fall, and IPOs can fall significantly. We actually saw this with Google, as it came off its highs. Be warned that there are a lot of day traders who like to participate in these IPOs, and there's a lot of volatility.

I like to wait a few more months, since most companies have these lockup contracts. Those under the lockups are prohibited from selling shares for a period of time, sometimes up to six months. Google will have a major lockup expiration in January, I believe. When this happens, it's not uncommon to see employees and directors selling their shares, which puts a lot of pressure on the price. So I wait five or six months. It also pays to wait and see how these companies function -- newly public companies often have difficulty with the public transition. I would stay away from Google, Salesforce, etc., and focus on others that have strong future growth potential.

Q: How do you determine which companies will make it? During the dot-com craze, so many business models ended up failing.

A:

We have the luxury at this point to look back at what failed and what worked. If you look at what worked, such as the eBays (EBAY ) and Amazons (AMZN ), those companies had high gross-profit margins and had business models that worked seamlessly with the Internet. So in terms of looking at the IPO, I want to have a strong sense of what the business model is. Is it sustainable, producing high-growth profit margins compared to industry peers, etc.?

Greenfield Online (SRVY ), a recent IPO, is an example of one that got overshadowed by the Googles of the world. The company started as a survey company -- say a company wants to know how many people use online banking, and how many do not because of, say, security problems. This industry has been around for a long time and is really what we've all gone through with the election and polling. The problem the industry has, at this point, is the do-not-call lists, people with cell phones, and the Internet. Greenfield started as a traditional survey company but dumped this a few years ago and went totally online.

Q: What's hot in venture capital these days?

A:

I talk to many VCs, and they tend to focus on what's hot. What's hot? Just look at the IPO market. Tech is starting to make a comeback, especially in areas like search, so I know that VCs are putting more money to work in companies that are producing cutting-edge technologies. This is an area that's growing very quickly and has a lot of interest. Security, on two fronts, is interesting. Security on networks, PCs, is becoming more and more vital with a recent rise in hacking. I do think also we may see a comeback in some of the consumer online plays. That could be what we've seen here with companies like Zip -- dot-coms are making a comeback as long as there's a solid business model.

Q: What sector do you see benefiting the most in the upcoming year?

A:

The stocks that have had the big move so far are in pharmaceuticals, in financial services, and energy. I think those will be big beneficiaries. I also think we'll see strength in defense contractors and security companies -- those that protect networks from hacker attacks and those kinds of things. The Bush Presidency will be strong for those. The rally, though, has been broad-based, and that's a sign that we're in a bull phase at this point. At the same time, there are certain Kerry sectors that have done well, such as alternative energy. These could be good buying opportunities.

Q: What's your outlook for IPOs for 2005? Will it be as healthy as this year?

A:

This was a choppy year for IPOs, actually. In the summer, we had quite a few companies give up and withdraw their offerings. IPOs thrive in bull markets, and with the recent actions in the market, I see the rest of the year being very strong for IPOs.

I see 2005 being even better, with biotech and others coming into the marketplace and having strong IPOs. Companies will be raising money, hiring new employees, purchasing new products and services -- it's a virtuous cycle. The lack of activity in the last few years has been a hindrance to the economy, I believe, and the IPO surge should help with jobs and economic growth.

Edited by Jack Dierdorff

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