Deals May Strain On Refco News;

Dismal July Sends IPO Investors Packing

Investment Dealer’s Digest

Colleen Marie O'Connor

July 17, 2006

The easy explanation for July's dearth of IPOs is the summer doldrums, but investors and analysts have begun whispering that the steady increase in prices of oil and natural gas is another factor in the recent slowdown.

For example, Hexion Specialty Chemicals, touted as the world's largest producer of thermosetting resins, which are used in paints and adhesives, recently postponed its IPO offering. Seeking to raise as much as $532 million in a deal slated for late June or early July and led by Credit Suisse and Goldman Sachs, the offering was pulled from the calendar on June 21.

Still in a quiet period, sources close to the deal were mum about the problem, but sources in the institutional investor community said concern arose over the impact that rising costs of raw materials could have on the issuer. They pointed out notes in its S-1, where Hexion states that in Q1 2006, it faced 13% and 7% increases in phenol and methanol, respectively, costs triggered by the higher cost of natural gas. (In fact, costs for many of its raw materials have been on the rise since 2005, a less-than-stellar trend in the eyes of investors.)

IPO investors have been scrutinizing income statements from hopeful issuers "more sharply than they were in the second quarter" for signs of an oil impact, said a source at a top-tier equity capital markets desk. The source declined to be named due to pending business.

Oil prices, which have remained stubbornly high all year, seemingly reached a new high each day last week, as tensions between Israel and Lebanon escalated into artillery exchanges. At press time, oil was $78 a barrel.

Signs of investor concern first surfaced back in May, noted Francis Gaskins, president of ipodesktop.com, an independent research firm. While the IPO market was still extremely strong, Mueller Water Products, which initially sought $450 million, instead raised $400 million when the issue priced at the low end of its range on May 26.

Energy supply interruption and cost increases, by extension, were risk factors that investors grabbed a hold of, Gaskins explained. Mueller is a manufacturer of such products as hydrants and valves and therefore exposed to raw material costs.

"Nowadays, high oil prices continue to have a slow-motion, deleterious effect on income statements in a number of industries-except the energy sector, of course," said Gaskins.

To be sure, industries that rely on purchasing petroleum-based products, especially plastics, have seen prices escalate. The Bureau of Labor Statistics found an 18% increase in the cost of plastics used in construction, for example, over the last 12 months. Other examples crop up elsewhere-Stand-ard & Poor's cut Cooper Tire & Rubber from the S&P 500, as that industry struggles with a surge in raw material prices. And companies manufacturing products that need to be shipped have had to deal with gasoline prices at the pump being passed on down to them.

By mid-July, just three IPOs had left the gate this month, with varying degrees of success. By contrast, 27 deals were done in July 2005.

Of course, not everyone is so sure the IPO slowdown is due to the price of crude oil.

"Many IPOs are from growth sectors," said Doug Baird, head of US equity capital markets at Deutsche Bank, meaning it's unclear how affected they are by the cost of a barrel of crude.

"For your typical IPO company, it doesn't seem like crude oil would be a big cost."

Experts point out that the IPO market slowdown is directly attributable to the decline of the overall US stock market. And ever-present interest rate/inflation concerns weigh heavily as well.

"Investors are saying, let's just hunker down and see where third-quarter earnings come out," said Peter Falvey, a managing director at Revolution Partners, a Boston-based investment bank. Better indications of where the year may pan out will come after the Labor Day holiday, he noted.

Still, the IPO market hasn't died. S-1s this month have come from Penn Virginia GP Holdings and Stallion Oilfield Services, both in energy and mining, and WNS Holdings, a business services sector play.

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