Playing in Today's IPOs and M&A

The current market is far superior to the tech-boom days, says venture capitalist Tom Taulli, who sees a broader mix of more solid companies

Much of the fuel for the late-1990s' tech bubble came from initial public offerings -- many of which collapsed along with the bubble. But the current revival of IPOs has a new and healthier tone, according to Tom Taulli -- author, analyst, venture capitalist, and close follower of IPOs -- as well as activity in the mergers and acquisitions field.

The latest spate of IPOs is diversified across industries, Taulli says, "not just technology, but real estate, insurance, chemical companies -- we've seen a huge array." They're more along traditional IPO lines, he notes, "providing any growth company with the opportunity to get extra capital and grow even faster." They're also high-quality, he adds. One he singles out is International Securities Exchange, which would be an electronic marketplace for put and call options. (Taulli provides information on upcoming IPOs at www.currentofferings.com.)

On the merger front, Taulli sees 2005 as a year for mergers and acquisitions. But he cautions against investing in a stock simply because the company might be involved in an acquisition. A better way to play the M&A arena, he suggests, is to look at investment banks that provide advisory services to buyers and sellers, such as Morgan Stanley (MWD ) or Goldman Sachs (GS ). A purer play, in his view, would be Greenhill & Co. (GHL ).

These were a few of the points Taulli made in an investing chat presented Feb. 24 by BusinessWeek Online on America Online, in response to questions from the audience and from Jack Dierdorff and June Kim of BW Online. Following are edited excerpts from this chat. AOL subscribers can find a full transcript at keyword: BW Talk.

Q: Tom, can you give us your macro view of the stock market as it sort of stumbles along?

A:

As everyone is painfully aware, it has been a rocky stock market in general for 2005, and this is in strong contrast to the great finish we had in 2004. I think this is healthy for the market, to have a correction, and it does present investors with buying opportunities for certain types of stocks that probably got overextended last year.

As always, there are arguments as to why investors are bearish, but that's where investors tend to make their money -- by going against the grain. I'm currently investing my money in equities right now and finding good opportunities in the market.

Q: To follow up, where are you finding the buying opportunities now? Names?

A:

One company that looks strong and has good value is Bankrate (RATE ). It has been around over 30 years, has built a brand in terms of publishing interest rates, and has become a great source of lead generation. Bankrate takes these leads and resells them to companies that make mortgage loans to consumers. It's a very high-margin business, and the company has become very profitable.

Q: What are your thoughts regarding the nanotechology IPOs that will be offered this year?

A:

Last year there was an attempt to get some nanotech IPOs out, the most prominent being Nanosys. But Nanosys was trying to do its IPO during the summer, the worst time of year for IPOs, and it had to withdraw its IPO. I think the prospects for nanotech IPOs in 2005 will still be very difficult -- investors are looking for companies with revenue growth and profits. Being an early-stage business, it may be too early for success for those IPOs (see BW Online, 2/23/05, "High IPO Hurdles for Nanotechs").

Q: You mentioned that right now might be an opportunity to invest in stocks that were overextended last year. Which stocks in particular?

A:

One company I've invested in -- and I think got hit too hard -- was eBay (EBAY ). There's no other company, from what I can tell, that comes near eBay as far as its presence in the marketplace. There was talk that Overstock.com (OSTK ) and some others would put pressure on the company, but I think that's overblown. The price took a hit from overexpectation, in my opinion.

Q: I understand Target (TGT ) may make a bid for Sears (S ). What's up? And any general comments on the M&A field now?

A:

Sears is in play, but it looks like it will go to Kmart (KMRT ). Unless something very unusual happens, I don't see that deal being interrupted. There has been a lot of activity in M&A -- some real megadeals, which means we'll see quite a few more midsize deals coming to the floor. 2005 is a year for M&A. But it's always hard to predict what company will be next -- I'd never buy a company based on believing it's a buyout target. I may, however, take the potential into account when selecting a business.

One way to play this, though, is to position yourself in a firm that provides advisory services for mergers and acquisitions -- basically, an investment bank that will represent a buyer or seller. Morgan Stanley or Goldman Sachs are both decent ideas, but they're not pure plays.

Greenhill & Co. is a great company, a pure play. Robert Greenhill is a legend. He has a solid Rolodex and knows how to get things done. He recognizes the trends in M&A and is building a firm that attempts to reduce the conflicts of interest. I believe this is a great way to play the M&A wave, without trying to guess what company will be bought out next.

Q: Are there any other IPOs coming down the lane that you think investors should look out for?

A:

Yeah, take a look at a company called International Securities Exchange (proposed ticker as ISE). They're looking to list on the NYSE -- they may go public in the next few weeks. They've filed with the SEC already. I do have a Web site (www.currentofferings.com) where I provide research on IPOs. I will probably put out a research report on this company next week.

This is a relatively new company that believes in using the Internet to build a better securities exchange. This is actually the first time since 1973 that a company has had the approval to build a stock exchange. The company has a management team and board of directors who are all from the Who's Who of Wall Street. The company is fully electronic and focuses on equity options -- call and put options. It's currently the largest options exchange in the world.

The options market is growing at a tremendous rate right now and will continue to do so. Investors see the value in the liquidity of options. ISE, in fact, is going to try to focus more on institutional investors and will have growth for years. The Chicago Mercantile Exchange (CME ) went public last year -- that company has done wildly well in the aftermarket. Not to say that that will be the same with ISE, but some investors are betting on strong growth going forward for the company.

Q: Speaking of options, what's new in the options market, and what does it tell us about the investment climate?

A:

What's new in the options market is that it's becoming easier to use through automation. There is a company called optionsXpress (OXPS ) that went public several months ago and is a provider of services for investors to automate the process of options strategy. The traditional notion about options is that it's high-risk, but in actuality, options can be an effective way to generate income and protect the portfolio.

What does this mean for the market? It means investors are trying to protect their downside and look for more conservative strategies. As investors continue to do this, ISE and optionsXpress as well as other companies like them will benefit.

Q: ExxonMobil (XOM ) -- buy, sell, or hold? And are there any small growth opportunities in the energy sector?

A:

I never thought I'd say this, but I'm thinking of buying Exxon! The stock has had a good move, but I believe for the long term, the global oil companies should continue to do well. You'll have both capital appreciation and dividend growth for a while. It's hard to see oil prices coming down significantly. I do think it makes sense for investors to start thinking more about commodity-type businesses. One of the better ones happens to be energy.

Q: With the baby boomers aging, are there interesting new companies in the assisted-living area or elsewhere in health care?

A:

A company that you may want to look at is called Lifeline Systems (LIFE ). They've been around over 30 years and develop alert technologies, with which if you're at home and suffer medical problems, the nearest facilities will be alerted to provide assistance to you. From a demographic standpoint, that business stands to go into a growth phase. As baby boomers get older, they certainly don't want to live in facilities but want to stay in their homes as long as possible.

Lifeline enables this and also helps insurance companies avoid unnecessary hospital costs. Lifeline also has gone to a subscription model, rather than a hardware-selling model, and this should be a great benefit to the stock. The stock has moved somewhat, but I do think it's a diamond in the rough. As it continues to grow and earn money, it will continue to catch on.

Q: Among the IPOs you've seen -- or anticipate -- do you see any industry patterns like tech in the last boom?

A:

The pattern I'm seeing in the IPO market consists of two trends. One is diversification across industry. Not just technology, but real estate, insurance, chemical companies -- we've seen a huge array. This is a healthy change for the market. It's more traditional. IPOs are not about just the latest and the greatest, but about providing any growth company with the opportunity to get extra capital and grow even faster.

Another new facet: The companies are more consistently high-quality companies with consistent models that have barriers to entry. There are still duds in the area, but for the most part we're seeing an assortment of companies that are high-quality.

Q: So these IPOs have a better quality than the ones we saw in the tech bubble?

A:

Yeah. No doubt about it. Some of these are legends -- we saw Dolby Labs (DLB ) go public in the last week. This is a company that was founded 40 years ago and has become a global brand. The company is growing at a fast rate for what you'd think is a mature business. It will also probably continue to grow, since almost every DVD player and disk has some Dolby technology built in. You have a great brand, great revenue model, and great technology rolled up into an IPO for investors.

Q: Do you have any favorites among successful growth companies that are long past the IPO stage?

A:

There's one company I'm an investor in that's clearly well beyond its IPO stage. It's called Entrust (ENTU ). The company has had difficulties over the past couple of years, but a new CEO and management team have come in to restructure operations.

The company's now profitable and is growing very nicely. A recent report shows that it has beaten Wall Street by a great margin. It got its start in digital certificates that provide security for online transactions. Verisign (VRSN ) managed to win in that area, though, so Entrust has had to find other places to grow.

They have a great suite of products, though. Identity theft is becoming a huge problem, and Entrust has launched a new product to deal with this. Entrust has also come up with an artificial intelligence e-mail scanner that companies can use to ensure compliance with federal regulations. The company has been overshadowed in the marketplace, but has turned the corner and has products that appear to be at the right place at the right time.

Edited by Jack Dierdorff

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