Forbes Investment Guide

How to Make Money In New Issues

Scott DeCarlo, Susan Kitchens, Shlomo Reifman, Research by: Godwin Maidment and Brian Zajac 06.05.06

http://www.forbes.com/home/free_forbes/2006/0605/175.html

indexPic.gifThe majority of initial public offerings deliver dismal results. But a few superstar stocks, like Cisco, Dell and Microsoft, more than make up for the flops.

Are you likely to beat the market buying new issues? the answer to that question depends on how many new issues you buy. Buy one and you are more likely than not to do worse than the market. Buy a lot and you are likely to beat the market. Such is the somewhat paradoxical result of our study of 5,900 initial offerings between Jan. 1, 1986 and Apr. 28, 2006.

We measure new issues with a statistic we call relative-to-market performance, defined as the value of $100 invested in the new issue divided by the value of $1 invested on the same date in the S&P 500 index. So, 100 is a market-tracking performance. Since it's impossible for average Joes to get in on the most desirable issues at the offering price, we assume purchase at the closing price on the first day.

Over the past two decades underwriters have raised $461 billion for new issuers of stock. Collectively the capital was well spent: The average performance score was 106. That assumes the companies were held through their last day as publicly traded companies or, if they are still around, through Apr. 28.

The median performance, on the other hand, was a dismal 48. That means half the new issues would have left you at least 52% poorer than someone buying an index fund instead.

What's going on? A toned-down version of what happens in venture capital, in which a tiny handful of huge winners makes up for a large population of losers. The winners list for new issues includes eight that would have turned an initial $10,000 into $1 million or more. Though off sharply from its peak during the tech bubble, Cisco Systems nudged out Dell Computer for the top spot, with a $2.7 million ending value.

Two patterns emerge that will help you be a winner in buying newly public companies.

One is that you usually do better buying in years when new issues are scarce. When demand is weak, underwriters are less likely to shovel out the garbage. The worst year: 2000, when 350 companies went public in the last hurrah of the tech boom and underwriters raised $56 billion. The average stock from 2000 has a relative-to-market performance of 67, and 105 of these stocks lost 95% or more. Contrast that with 2002, one of the leanest years of the two decades, with only 67 initial public offerings, raising $18 billion. The 2002 class has an average score of 139.

The other rule is that, as noted by Jay R. Ritter, finance professor at the University of Florida, you are better off buying established companies. Our analysis of new issues for which we have revenue information indicates that over the past two decades the 1,838 companies with sales of at least $50 million at the time of offering delivered an average relative-to-market performance of 134. The 3,197 smaller companies came in with a score of 89.

BIGGEST NEW ISSUES

Below: the 25 biggest public offerings since the start of 1986. Stocks that outperformed the S&P 500 have a relative-to-market score over 100.

Company Lead Underwriter Offer date Offer value ($bil) Performance from first-day close Rel to S&P 500¹

AT&T Wireless Svcs Goldman Sachs 4/00 $10.6 61

Kraft Foods CS First Boston 6/01 8.7 95

United Parcel Service Morgan Stanley 11/99 5.5 125

CIT Group Goldman Sachs 7/02 4.6 178

Conoco Morgan Stanley 10/98 4.4 122

Travelers Property Citigroup 3/02 3.9 92

Goldman Sachs Goldman Sachs 5/99 3.7 232

Agere Systems Morgan Stanley 3/01 3.6 23

Charter Communications Goldman Sachs 11/99 3.2 5

Lucent Technologies Morgan Stanley 4/96 3.0 18

Prudential Finl Goldman Sachs 12/01 3.0 228

MetLife CS First Boston 4/00 2.9 401

Infinity Broadcasting Merrill Lynch 12/98 2.9 124

Genworth Finl Morgan Stanley 5/04 2.8 145

Fox Entertainment Group Merrill Lynch 11/98 2.8 138

Pepsi Bottling Group Merrill Lynch 3/99 2.3 291

Agilent Technologies Morgan Stanley 11/99 2.2 98

Allstate Goldman Sachs 6/93 2.1 133

BearingPoint Morgan Stanley 2/01 2.0 40

Associates First Capital Goldman Sachs 5/96 1.9 101

Genuity Morgan Stanley 6/00 1.9 0

Principal Financial Group Goldman Sachs 10/01 1.9 202

Assurant Morgan Stanley 2/04 1.8 168

John Hancock Finl Svcs Morgan Stanley 1/00 1.7 314

Wellpoint Goldman Sachs 10/01 1.7 281

Performance through Apr. 28. ¹Relative to S&P 500 performance: the ending value of $100 invested in the stock divided by the ending value of $1 invested in the S&P 500. ²Issued as America Online.

Sources: Bloomberg Financial Markets; Compustat, FT Interactive Data and Reuters Fundamentals via FactSet Research Systems; Thomson Financial; Wilshire Associates; Forbes.

THE BEST NEW ISSUES

Measured from its closing price at the end of its first day of trading in February 1990, Cisco Systems leads all new issues of the past 20 years in relative-to-market performance.

Company Lead Underwriter Offer date Offer value ($mil) actual Performance from first-day close Rel to S&P 500¹

Cisco Systems Morgan Stanley 02/90 $50 27,017%

6,884

Dell Goldman Sachs 06/88 34 25,697 5,426

Microsoft Goldman Sachs 03/86 59 24,740 4,420

Oracle Deutsche Bank 03/86 32 22,277 3,981

Fastenal Robert W Baird 08/87 9 18,149 4,662

American Power Conversion Oppenheimer 07/88 6 17,400 3,518

Time Warner² Deutsche Bank 03/92 23 15,000 4,721

Harley-Davidson Morgan Stanley 07/86 22 14,690 2,726

Electronic Arts Deutsche Bank 09/89 17 10,751 2,869

Express Scripts Deutsche Bank 06/92 26 9,509 3,006

Maxim Integrated Products Bank of America 02/88 13 9,303 1,921

Qualcomm Lehman Brothers 12/91 64 9,027 2,677

Cognizant Technology Solutions Bank of America 06/98 29 7,533 6,410

Chico's FAS Robert W Baird 03/93 20 7,524 2,606

Apollo Group Citigroup 12/94 35 6,888 2,416

EMC Merrill Lynch 04/86 41 6,495 1,176

Linear Technology Morgan Stanley 05/86 21 6,300 1,204

Altera Goldman Sachs 03/88 22 6,112 1,227

Microchip Technology Deutsche Bank 03/93 20 5,606 1,960

Ascend Communications Morgan Stanley 05/94 26 5,504 1,892

Starbucks Corporation Deutsche Bank 06/92 36 5,447 1,708

T Rowe Price Group Goldman Sachs 04/86 30 5,131 941

SCP Pool Suntrust Robinson Humphrey 10/95 22 4,968 2,260

Charles Schwab Morgan Stanley 09/87 116 4,843 1,211

CDW William Blair 05/93 13 4,826 1,700

Performance through Apr. 28. ¹Relative to S&P 500 performance: the ending value of $100 invested in the stock divided by the ending value of $1 invested in the S&P 500. ²Issued as America Online.

Sources: Bloomberg Financial Markets; Compustat, FT Interactive Data and Reuters Fundamentals via FactSet Research Systems; Thomson Financial; Wilshire Associates; Forbes.

THE WORST NEW ISSUES

The new-issue universe is littered with disasters. In the past two decades these are the biggest deals that went sour and are now worthless.

Company Lead Underwriter Offer date Offer value ($mil) Peak market value ($bil) Peak market value date

Genuity Morgan Stanley 6/00 $1,913 $2.0 7/00

ViaSystems Group Morgan Stanley 3/00 924 2.8 7/00

Burlington Inds Morgan Stanley 3/92 798 1.2 3/94

Williams Comm Group Citigroup 10/99 681 4.0 3/00

Webvan Group Goldman Sachs 11/99 375 5.9 1/00

NorthPoint Comm Group Goldman Sachs 5/99 360 5.3 7/99

Payless Cashways Goldman Sachs 3/93 357 0.8 2/94

Aurora Foods Goldman Sachs 6/98 305 1.3 1/99

NTL CS First Boston 10/93 270 15.1 3/00

AMF Bowling Goldman Sachs 11/97 263 1.8 4/98

Smith Corona Lehman Brothers 7/89 252 0.7 8/89

McLeodUSA Citigroup 6/96 240 16.2 3/00

American Pad & Paper Morgan Stanley 7/96 234 0.7 1/97

Global TeleSystems Merrill Lynch 2/98 222 7.4 6/99

Classic Communications Goldman Sachs 12/99 206 0.6 12/99

Net2000 Communications Goldman Sachs 3/00 200 0.9 3/00

Adelphia Business Solutions Goldman Sachs 5/98 200 4.7 3/00

Rhythms NetConnections Merrill Lynch 4/99 197 5.0 7/99

Impsat Fiber Networks Morgan Stanley 1/00 196 3.8 2/00

Planet Hollywood Bear Stearns 4/96 194 2.7 9/96

Stage Stores CS First Boston 10/96 182 0.9 7/06

Genesis Direct Bear Stearns 5/98 167 0.3 7/98

Starter Corporation William Blair 4/93 167 0.7 5/93

Etoys Goldman Sachs 5/99 166 10.1 10/99

Xpedior CS First Boston 12/99 162 1.6 1/00

Sources: Bloomberg Financial Markets; Compustat, FT Interactive Data and Reuters Fundamentals via FactSet Research Systems; Thomson Financial; Wilshire Associates; Forbes.

THE BIGGEST UNDERWRITERS

Goldman Sachs heads this list as lead underwriter on $95 billion in offerings, but Deutsche Bank ($15 billion) shows, by comparison, the best relative-to-market performance numbers.

Performance figures include those of predecessor underwriters acquired by the surviving entity. Performance through Apr. 28. ¹ Relative to S&P 500 performance: the ending value of $100 invested in the stock divided by the ending value of $1 invested in the S&P 500.

Sources: Bloomberg Financial Markets; Compustat, FT Interactive Data and Reuters Fundamentals via FactSet Research Systems; Thomson Financial; Wilshire Associates; Forbes.

COMING TO MARKET

Francis Gaskins, president of IPOdesktop.com thinks the new issues market will be receptive to these pending offerings, because the companies are well established, carry well-known brand names and strong revenue streams. He cautions, however, that several of these companies are in mature markets and carry significant debt.

Company Business Expected offer value ($bil) Revenues ($bil) Lead underwriter

MasterCard global payments solutions $2.6 $2.8 Goldman Sachs

KBR engineering and construction svcs 0.1 10.1 NA

RBS Global industrial equipment 0.1 1.0 Merrill Lynch

Burger King Hldgs fast-food restaurants 0.4 2.0 JP Morgan Chase

Sources: Hoover's IPO Central, IPOhome.com, Gaskins IPO Desktop