Last year was a strange year for medical companies seeking to go public, and 2005 is looking like a replay in which the dominant theme is, again, many deals drenched amid discounted offering prices.

"What you have is hopeful bankers and venture capitalists trying to bring overpriced deals to the market -- and investors are having none of it," says Linda Killian, portfolio manager of the IPO Plus Aftermarket Fund.

Medical initial public offerings account for 14% of the 57 IPOs that have come to market through May 26. The eight medical IPOs place second behind financial IPOs (11 offerings), according to Renaissance Capital, of Greenwich, Conn., which analyzes public offerings and is the adviser to Killian's fund.

But many medical IPOs have been disappointing. Through May 26, all but one went public at prices marked down from underwriters' original estimates. Three were trading below their offering prices.

"Investors won't pay a premium for companies that have products in phase I or phase II trials," says Killian, referring to early clinical trials. There are three stages of clinical trials before a drug is submitted to the Food and Drug Administration. "Many companies don't have a clue when their products will come to market because they are still in early clinical trials," she says.

Finding Believers

Investors are much more willing to place their money in companies whose products are nearing FDA approval or those with financial backing from well-heeled partners, she adds.

Killian says she sees many drug and biotech companies seeking to go public even though their research doesn't distinguish them from the rest of the crowd.

"Many of these companies have uncompetitive products," she says. "They are reformulations of existing drugs. They seem to add little value. It's hard to sell this concept to investors."

A lot of investors aren't buying the sales pitches even at discounted prices. In the last five months, eight medical IPOs have been withdrawn or postponed; most of the companies filed applications with the

Securities and Exchange Commission

last year.

If an IPO hasn't come to market within 10 to 12 weeks of its filing with the SEC, "something is wrong," Killian says. "You know there are problems ... . Some biotech companies sit there waiting for the window of opportunity to open up, and the window doesn't open."

Discounted Deals

Given the pressure to bring an IPO to market, some underwriters take what they can get.

"There was a flurry of activity last year and part of 2005," says Richard Peterson, market strategist at Thomson Financial. "Last year, many venture capitalists wanted to bring their portfolio companies public to get some gains on their investment." The result was a lot of discounted deals in 2004, and the trend is continuing this year.

Last year, Renaissance Capital says 60% of medical IPOs had offering prices below the figures initially recommended by their underwriters. Some had multiple markdowns. For all other IPOs, this rate was 29.5%.

This year, seven of the eight medical IPOs had offering prices below the price ranges initially set by their underwriters, while one IPO matched its initial range. Most companies falling short of underwriters' dreams are biotech or drug companies.

Like last year, the medical IPO performance in 2005 is worse than other IPOs. Among non-medical IPOs this year, seven were priced above their initial range, 30 were priced within their range and 12 were priced below their range. Renaissance Capital's analysis compares the offering price to the midpoint of the range initially set by underwriters.

Three of the worst six performers this year are medical companies, including

Threshold Pharmaceuticals

(THLD)

whose $7 offering price fell 53% below the initial $15 midpoint between $14 and $16. Other heavily discounted companies include

Favrille

( FVRL), whose $7 offering price was 46% below its original midpoint, and

Icagen

( ICGN), whose offering price of $8 was 27% below its midpoint.

Even worse, shares of these three companies were trading below the discounted offering price as of May 26.

Ignoring the Past, Investing in the Future

The tough economic climate, the weak performances and the discounted offering prices don't seem to have affected underwriters' efforts to make deals.

Six medical IPOs are expected to come to market by mid-June, including two biotech companies, three device makers and a health care services firm.

And that's not all. Renaissance Capital says 15 other medical companies have filed with the SEC during 2005, excluding the eight companies that postponed or cancelled IPOs this year. Five other medical companies have had applications pending from last year.

Although "this is a tough industry," says Peterson of Thomson Financial, "there's still an appetite for these deals -- for knowledgeable investors who can be selective."

To avoid indigestion or choking on a medical IPO that sours quickly, experts offer some hints that combine a large amount of common sense with a small amount of research into the business of science.

Investors must do their homework about company's management and the underwriter, says Peterson. One red flag: an underwriter shepherding an IPO for the first time.

Killian says beware of young companies whose top management lacks experience in commercializing products. Companies run by researchers should provoke caution.

Management's track record in bringing products to market is a key recommendation from Amit Bhatia, managing partner of Actus Partners, of Greenbrae, Calif., a firm that specializes in arranging licensing deals among pharmaceutical and biotech companies. "Investors aren't willing to wait a decade to potentially see revenues from a product," he says.

Look for companies with products in late-stage clinical trials or products already on the market, says Bhatia. And you don't need a medical degree or doctorate to do some fundamental research on clinical trial data.

Even if a startup lacks a marketed product, check its other sources of revenue -- such as grants, licensing deals and partnerships, Bhatia says. And make sure you understand the company's burn rate, that is, how fast it's spending on research and development and how it plans to bolster its cash position.

Good luck, Bhatia adds, because right now the IPO market for life sciences companies is "miserable."