The Internet IPO Myth

Not all that long ago, the exploding oil rig was the get-rich symbol for America. Whether portrayed as the result of Jed Clampett's lucky misfire or a gag in a New Yorker cartoon, it was the universal graphical representation of unimaginable found wealth (like a 1977 drawing of a mini-oil rig gushing in the middle of some guy's apartment. Says he: "It's a mixed blessing").

Today's mixed blessing is the Internet IPO: While a few have indeed surged, to the average investor the average Internet IPO over the last seven months has lagged behind the Dow Jones Industrial Average. There you have it, the shocking, shocking truth.

The headlines, of course, scream with the one-day successes of these offerings. Investors Go Wild for IPO From MarketWatch.com (MKTW Quote). EarthWeb (EWBX Quote), theglobe.com (TGLO Quote) Defy IPO Gravity. What happens next is soon forgotten. But a close look reveals that this modern representation of fast money doesn't add up when the numbers are crunched.

When eBay (EBAY Quote) went out on Sept. 24, it changed the expectation of what a Net IPO could do. The IPO market, suffering its longest dry spell since 1985, was warmed by an eBay offering that more than doubled on the first day and kept on going. The stock is now up more than 450%. But the only other stock in the last seven months to repeat that success has been priceline.com (PCLN Quote), which has also been flying since its March 30 open, registering a gain of over 775%.

Richard Peterson, an analyst with Thomson Financial Securities Data, put together a spreadsheet with the performance of eBay and the 48 Internet IPOs since, including priceline.com. He recognizes that an initial spike in trading has been a constant in these names, but he also knows that few investors are tight enough with investment bankers to get a piece of a hot IPO. So he looked at how these stocks did from the second day of trading on. He was surprised by what he found.

"About a third of the overall Internet IPO performance comes from eBay and priceline," says Peterson. "And if you're not part of the privileged class buying in on the first day, you're not doing any better than the Dow Jones."

Net IPOs between Sept. 24 and May 4 returned, on average, 130% after the first day of trading. Without eBay and priceline.com, these new issues returned 34%. The Dow in the same period returned 36% -- with significantly less heartburn and risk.

What gives? "The quality and the premium of the recent IPOs has been dreadful," says hedge fund manager Seth Tobias of Circle-T Partners. "You're seeing less and less of a premium to the offering price because the quality of the businesses going public is going down. It really worries me."

Last Wednesday, Comps.com (CDOT Quote) made headlines for not surging on its first day. Other new offerings have been hovering near their initial price. Tobias says such companies are being poorly served by second-rate investment bankers piling onto the Net IPO bandwagon. "I've seen more and more third-tier firms coming out with lower-quality issues and they don't have the firepower to defend them," he says. "For example, Comps.com was a Volpe [Brown Whelan] deal."

Nine of Volpe's last 10 IPOs are now trading below their offering price, according to Thomson. Volpe's chief operating officer, James Feuille, says, "People have gotten so accustomed to these things doubling and tripling, and if they aren't going to go up that much, they slam them."

But investors, it seems, are starting to separate the good deals from the bad. "Now you're reaching a point where there are an abundance of Internet IPOs," says Peterson. "There's going to be this pecking order, where investors' dollars are going to be allocated to the better deals. The rest will be left by the roadside."

Is this, finally, the long-predicted bursting of the Internet bubble? Not quite. To veteran Wall Streeters, the tepid response to recent IPOs suggests that there will be no popping of an Internet bubble. Rather, some overblown stocks will find themselves deflated.

"Everyone is just yearning to jump on the notion that it's all over," says Howard Love Jr. of the Love Capital Management hedge fund. But "just because crap doesn't fly doesn't mean the bubble has burst. I don't doubt that some of these stocks can drop some -- but I don't think the market will accommodate all those people who want Amazon.com (AMZN Quote) to go to $50." The stock closed Monday at 146 7/8.

Tobias, for one, is looking for signs that some newly issued Internet stocks will actually start falling. "It will be very interesting to see how the higher-quality names will fare, particularly barnesandnoble.com," he says. "If the market can't support that one, you'll see what we've all been waiting for." In other words, the wheat being separated from the chaff.

And what of that ubiquitous notion of the Internet IPO as quick money and the newly minted millionaires fresh from the IPO trough, featured in ads from The Wall Street Journal to AT&T (T Quote)? In the phone giant's ad a young black woman ponders her struggling furniture line, opining, "Maybe going public isn't so crazy after all."

As long as there is a perception that someone is getting rich, someone else will dream of joining that lucky SOB. The notion of the Internet IPO taps into a democratic idea no different than that of the Internet itself: If those guys can do it, why can't I? Just like in the stories of lotto winners and Jed Clampett ...

Well, the first thing ya know, Jed's a millionaire.
Kin-folk said, "Jed, move away from there." Said
Californy is the place y'oughta be, so they
loaded up the truck, and they moved to Beverly.
Hills that is! Swimmin' pools. Movie stars!