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Can't Get IPOs? Buy the Stocks That Are Hatching Them

John Rubino

You missed most of this week's hottest IPOs, didn't you?

That's OK, so did just about everyone else not connected to Fidelity or Janus or some other big institution. We all want a piece of these things, which means that -- the sales pitches of E*Trade and Wit Capital notwithstanding -- virtually no one gets in at the offer price consistently.

But readers who caught Cory Johnson's Feb. 22 column know there's another way to play initial public offerings: You buy the incubators, those CMGI (CMGI - Cramer's Take - Stockpickr) wannabes that fund, nurture and, it's hoped, take public portfolios of hot little tech companies.

Valuing an incubator is a tricky, multistage process, however. Because most hold stakes in both public and private companies, the first, and only easy step, is to multiply the number of public-company shares they own by the current price to get a dollar value. Then divide by the number of incubator shares outstanding to get a per-share figure, as in "every share of incubator A controls $2 of public company B's stock."

The incubator's nonpublic holdings are the hard but much more important part because that's where the future IPO moonshots live. Because they're private companies, they don't have to tell the world about their inner workings. So to get some idea of their value, most analysts find comparable public companies and then assume that the not-yet public firms are in the same ballpark.

This kind of analysis has a couple of obvious shortcomings: Just because a company is in the same business as Cisco (CSCO - Cramer's Take - Stockpickr) or eBay (EBAY - Cramer's Take - Stockpickr), for instance, doesn't mean it's any good at it. And much more ominous for the market in general, the fact that one niche company is worth 20 times sales doesn't mean that the next six clones will be worth the same multiple. Just the opposite is more likely, with too many newcomers causing a shakeout in which everyone's value tanks.

The last thing to consider is management. If the folks in charge of the incubator and/or the portfolio companies have done big things in the past, that's good. If they've had a history of iffy (or nonexistent) results in other fields, then you ask for concrete results in the here and now.

But valuation ambiguities notwithstanding, it's easy to see why incubators are hot. If just one out of a stable of five or six properties turns into a Palm (PALM - Cramer's Take - Stockpickr), then its owner gets both a windfall and serious credibility for future IPOs.

Anyhow, check these out: