The Rise and Fall of Net IPOs: How It Happens

Look, no one's to blame. It's just that the company, the underwriters and the Net traders all want different things.
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Let's not make it personal. Let's talk National Gift Wrap.com, a mythical dot-com that sells giftwrap, ribbons, stretch bands and gift boxes online. The business is a year old and losing money hand over fist but is owned by a successful old-line bricks-and-mortar provider of packaging products in the Philadelphia area.

Parent National Gift Wrap & Box set up this dot-com in response to a red hot market that was willing to pay through the nose six months ago for dot-coms. It has finally gotten through the road show and the

SEC

clearance, and

Ben Holmes

says it has good buzz, but not as good as it would have had National Gift moved in the early spring.

The filing range is $12 to $15, but the underwriters see strong demand at the $19 to $20 level, so the stock gets bumped to that over a couple of days.

The underwriter -- let's call it Remarc Brothers, a typical large Wall Street house -- has close connections with the mutual funds and hedge funds and has done this business forever. It won't put its name on overpriced merchandise. It wants to make money for National Gift and for the people who buy National Gift Wrap.com. It doesn't want to value the sub, National Gift Wrap.com, north of the whole entity, National Gift Wrap & Box, which will still own 80% of National Gift Wrap.com after the deal. There has to be some integrity to the process.

Now, unbeknownst to Remarc Brothers, the individual online investors, those aggressive dot-com IPO buyers, are salivating for National Gift Wrap.com. They have purchased gift wrap through it and love the prices and the service. They know that this company always has a strong fourth quarter because of the Christmas holidays. They are insensitive to price.

Remarc knows that the institutions won't pay more than $30 in the aftermarket for National Giftwrap.com. But Remarc has no way of knowing what the retail demand is. These people trade through e-blah blah blah and Remarc has no e-Remarc to gauge things.

So what happens? On the morning of the deal, Remarc signals that it has people willing to pay up to $30. But the e-blah blah blah guys have market orders to buy it at any price. Remarc doesn't want to lose control of the deal. The e-blah guys don't give a darn -- they have anxious buyers and they want it at all costs.

So, Remarc goes back to its institutions and says, "Look, we think this dot-com is going to open up north of $50." The institutions think that is nuts, even though they like National Gift Wrap.com. But instead of buying more to bring their National Gift Wrap.com positions to a reasonable size (they only get a few thousand shares on the now-low offering price), they boot it to the individuals from e-Blah. Why bother to build a new position at an unsustainable price?

So National Gift Wrap.com opens where e-blah's people want it to open, maybe as high as 55, say, and the institutions take the quick capital gain.

Of course, the collective demand from e-blah is as overinflated as the offering price is underinflated. Once the stock opens at $50 e-blah's clients don't have the firepower and the stock begins its long descent to where the institutions cared about it in the first place. The stock wanders waiflike, down 10 or even 20 points, to where the institutions were in the first place.

National GiftWrap.com's managers never wanted to anger anybody -- the institutions or the individuals. Instead, National Gift has pissed off everybody with that sky-high opening. Remarc didn't mean badly, either. It priced the deal at what it thought the company was worth. It's not e-blah's fault, either. It was just following orders.

But it sure does sting.

My take? Until the e-blahs and the Remarcs can work things out, that's just the way it is.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund had no positions in any stocks mentioned. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

letters@thestreet.com.