IPOs: No Deals on the Horizon

The U.S. market for initial public offerings is "dead as a doornail," with companies eager for capital stuck in limbo. What could spark a revival?

"Dead as a doornail." "Nonexistent." "Abysmal." "Broken."

Those are assessments of the market for initial public offerings, when new companies float their shares in the stock market. Just one U.S. company, an atypical IPO called Mead Johnson Nutrition (MJN), has dared make its stock market premiere so far this year.

Just one other outfit, a newly formed real estate investment trust called Madison Square Capital, has any chance of going public soon. But prospects for that REIT's IPO seem to be fading.

The IPO market's problems match the problems in the stock market, where major indexes trade at levels not seen since the mid-1990s.

"Until the stock market starts recovering, the worldwide IPO market is going to continue in its current state—where you can't even feel a pulse," says Jay Ritter, an IPO expert and finance professor at the University of Florida.

Not Worth the Trouble

The market is valuing new companies so cheaply that private investors—whether private equity firms or venture capitalists—don't think an IPO is worth it, Ritter says. Extreme volatility in the market also is scaring off IPOs, says IPO watcher Tim Walker at research firm Hoover's.

"You can't rely on enough stability on the stock exchanges from day to day," Walker says. "Every day, we're seeing these wild ups and downs that have nothing to do with the health of a company."

The dead IPO market hurts the economy by shutting off a key way companies raise money for expansion. On Mar. 4, Changing World Technologies, a biofuel maker, filed for bankruptcy protection shortly after abandoning an effort to go public.

The Lone Contender

The only company currently on the U.S. IPO calendar is Madison Square Capital. On paper at least, the new REIT's strategy looks attractive: raise $300 million in an IPO and invest in mortgage debt that is relatively safe because it has the implied backing of the federal government. Because of low interest rates, profit margins on such a business could be wide. A similar REIT, Annaly Capital Management (NLY) had been a standout financial stock—at least until a recent sell-off.

But after weeks of delays, Madison hasn't pulled the trigger on its IPO. Scott Sweet of IPO Boutique expects its IPO to be postponed. "They just can't find buyers," he says.

The problem with Madison reflects broader problems with IPOs. First, investors simply aren't willing to take any extra risk. Why, Sweet asks, would an investor speculate on a new REIT when he or she could invest in an existing REIT with a proven track record? Furthermore, many of the existing companies are trading at relatively cheap valuations.

Who Wants to Be in Mortgages?

A second problem with Madison—which plagues many other IPOs—is the huge amount of uncertainty among investors these days. For a business specializing in mortgages, "there is just too much change happening in that area," says Kathy Smith of Renaissance Capital in Greenwich, Conn. The federal government is changing mortgage rules by the week. For firms in other areas, the uncertainty comes from other regulatory confusion, as well as the worsening economy and credit crisis.

How long before the IPO market revives? Sweet, who has followed the IPO market for 35 years, says he has never seen it this slow.

The market is prone to long droughts. One of the worst started in the brutal bear market of the 1970s, Ritter says. "When the IPO market dried up in the spring of 1973, it really took about eight years before there was substantial volume again," he says.

Measures of valuation—ratios of price to earnings or market to book value, for example—needed to bounce back before companies and private investors believed IPOs were worthwhile.

A Couple of Winners

One kind of company still seems able to go public in any environment, however. Despite the recent sell-off in stocks, Mead Johnson (MJN) still trades above the starting price of its IPO on Feb. 11. The maker of nutritional products and baby formula has key advantages: a 104-year history, strong brand names, and the backing of its parent company, Bristol-Myers Squibb (BMY), which spun off only a portion of the company. Most IPOs are new, lack strong brands, and are backed only by private equity or venture capital investors.

"Their financials were superb," Sweet says of Mead Johnson. "In any environment, that IPO would have worked."

Despite the tough stock market, other recent IPOs have also fared well. Visa (V) is off only a relatively modest 11% from its IPO in March 2008.

"A lot of people would be relieved if another Visa came to the market," Walker says. "But there aren't many out there."

That's an ironic feature of the current IPO market over the past year. With IPO investors so stingy, "the handful that are getting done are only the best companies."

Thinking Ahead

Lisa Jacobs, an attorney and partner at Shearman & Sterling, says the process of filing for an IPO takes several months. Some optimistic companies are starting the process now in hopes they can go public later this year, says Jacobs.

"The IPO market always comes back," she says. "It's just a question of when."

One possible IPO generating some buzz is Rosetta Stone, a maker of language learning software that filed initial paperwork in September 2008. "Of all the IPOs in the pipeline, that's probably the next one out," Sweet says. "Even though there is no clue as to whether that's going to be in March, April, or May."

Smith, of Renaissance Capital, says government policy might prompt interest in some IPOs when the market stabilizes. For example, new financial companies, with balance sheets much cleaner than their older rivals, might take advantage of low borrowing costs to expand lending. Other, older financial outfits might use IPOs to raise capital by spinning off profitable units. And, she adds, companies that benefit from government stimulus spending may go public in the next year in education, health care, or so-called green businesses.

For now, though, the IPO market is a lonely, quiet place. And it's likely to remain that way until investors' moods change in a fundamental way.

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