Although the numbers for 2004 remain significantly below 2000, the last great year in terms of IPO volume, the market for new issues is far stronger this year than during the last three years.
During the first six months of 2004, nearly 90 deals were carried out in the United States, with a combined value approaching $17 billion. In Europe, IPO deals valued at a combined 5.24 billion euros took place over the first quarter of 2004. Although those numbers are a lot lower, they amount to nearly double the volume recorded in Europe during the final quarter of 2003.
Will this trend continue, or will the latest wave of IPOs end with another bursting of a bubble?
Price Not Important
According to Sergio Torassa, a former finance professor at Pompeu Fabra University, “There are significant differences between this wave and the earlier IPO wave. These days, not everyone is getting a piece of the pie. The market has evolved, and investing in an IPO is now a trickier proposition. It is no longer like shooting fish in a barrel.”
During the dot-com boom, many investors made extraordinary returns from Internet companies within mere days of those companies’ initial public offerings. That is not the case now, although one exception to the rule is Eyetech Pharmaceuticals, whose share price in the United States jumped an impressive 111% after its IPO. Five years ago, that rate of return would have been considered quite normal on the NASDAQ. On the other hand, shares of a company called Startek Holdings have lost more than 60% of their value since the IPO.
According to Torassa, “During the IPO wave of the late ‘90s, there was enormous liquidity and many people got involved in the stock market. On television, stock market analysts attracted as much attention as star athletes. The markets behaved with irrational exuberance, and people looked at each new IPO and thought, ‘Since they all go up, I’ll take my chances on this one.’”
In those days, recalls Torassa, “The actual price of a share of stock was not an important factor. People bought stocks, no matter how much they cost. The price was a mere reference point. The only thing that really mattered was buying a stock with the sure belief that you could sell it later at a higher price, even if you were already paying a price far above its value, measured objectively.”
Role of Investment Banks
There have also been changes for the investment banks that manage initial public offerings for companies and ensure that their IPOs are a success. To a large extent, says Torassa, “there is much more transparency, and the various departments of major investment banks are being a lot more cautious. These days, analysts are making more realistic assessments about the value of companies than they did a few years ago. The new standards, which were created after the scandals of Frank Quattrone and Credit Suisse First Boston, are having an impact.”
Quattrone, a star on Wall Street during the bubble, allegedly committed irregularities while managing the IPOs of technology companies. As Credit Suisse First Boston was bringing new shares to the market, its analysts were issuing very positive recommendations for the same companies that were clients of its investment banking division. The goal was allegedly to make the IPOs more profitable. Regulators at NASD (National Association of Securities Dealers) have suspended Quattrone for a year, and he could be disqualified for life.
Manuel Romera, technical director of the financial division of the Instituto de Empresa, agrees that the new transparency norms are having a clear impact in the United States. “Company directors know that if they commit a financial crime, they will go to jail. Investment bankers know that if they make a mistake, they can lose their job and be disgraced. In this sense, the law is much stricter than in Europe, where the law is less clearly defined. The American system is much more logical: If you take a chance and use insider information, you go to jail.”
One area of controversy involves those situations in which an investment bank has links with institutions that want to sell all – or part – of the shares to be placed. In Spain, that happened this year in two cases. One involved Fadesa, and another involved Telecinco. That will also be the case in the near future, when the IPO of Probitas, a pharmaceutical company, takes place.
In the final analysis, says Romera, “what investment banks want to do is place all their shares with the highest possible rate of over-subscription. They don’t worry about leaving behind a negative image, because markets forget very quickly.” For example, he adds, “the deal involving Fadesa was very poorly received, but shortly after that, there was surplus demand for Telecinco, a Spanish television channel. So the market went on functioning, more or less as usual.”
Anticipation Is Preferred
Torassa recommends that banks proceed with caution. “You have to be very careful in these situations because, although both departments may have ‘Chinese walls’ that physically separate personnel in different areas of the bank, this could lead to misunderstandings. Although it is perfectly legal, some people might doubt whether the people who are selling the shares can also share responsibility for placing and evaluating them.”
“That seems like too many roles for one person to play,” warns Torassa. “It is all legal, but you should see if doing things that way really does bring positive results. Maybe you should be more explicit and spell it all out in the written materials you prepare about new shares.”
Torassa trusts the marketplace. “Ultimately, it’s the same market that judges the work of those who place the shares. When you take a short-term view, it winds up being more expensive. If the people who place the issues simply do that and then say goodbye, they can fulfill their goals but they will also create a negative image. It winds up being harder for an investment bank to access capital resources in the marketplace because new companies that want to issue shares choose other institutions that have a better reputation. It is totally counterproductive in the future if you try to issue new shares, but word has gotten around that you achieved a higher return for a deal here and there, at the cost of tarnishing your image.”
Romera remains skeptical, however. “Investors don’t have a historical memory. Some people who invest in funds lose 70% [of their money], but they continue to smile and make jokes with the personnel in the bank’s office. When it comes to assessing the market value of new shares, the big firms have been wrong again and again, but it doesn’t seem to matter.”
On the other hand, Torassa says, “If your only goal, when issuing shares, is to provide an avenue for one of the major shareholders of the company, there are simpler and cheaper ways to do that – such as a private placement for institutional investors. The ultimate result of an IPO should be to provide greater access to funding from financial markets.”
Going Public: Open to Debate
Beyond such considerations, Romera adds, “There is another problem: Whether it is really profitable for companies to go public. For many corporate managers, it’s not worth the trouble because it means continually submitting yourself to a colder sort of [public] scrutiny.”
Romera says the stock market “can act as a distraction for corporate managers. The stock market can wind up being something with an entirely short-term focus. The stock market can take a very negative view of the sort of news that has a positive long-term impact – such as cost-cutting measures. That can influence decision-making. The two poles of opinion are hardening day by day: Those who favor going public, and those who are not willing to submit themselves to the judgment of stock markets.”
However, Torassa believes that everything could change, now that a new wind is blowing through the IPO business. “The situation is quieting down, and companies are profiting from their decision to go public. That is something good for the economy in general, because issuing shares stops being something that happens only when markets are going up. It becomes something structural. Now deals of this sort can be made in any sort of market. That is positive for companies, because it means they can go to the market and get financing in more stable conditions. Of course, it is also profitable for investors, who are more likely to invest. Only one thing about this situation is not positive: IPOs only occur when the indexes show double-digit growth in earnings.”