There are several reasons for regular mortals to dislike Martha Stewart, the domestic goddess and one-woman conglomerate. You might resent the irritating ease with which she whips up gourmet meals. Perhaps her nifty craft suggestions, or her simpering motto, “And that’s a good thing,” stick in your craw. But the best reason to take umbrage with Ms. Stewart is the deceptive facility of her recent initial public offering of stock in Martha Stewart Living Omnimedia Inc. On Oct. 19, it went public on the New York Stock Exchange at $ 18 (U.S.) a share. Within minutes, it was trading at a 160per-cent premium.
Although this may be a more dangerous grudge to express, the World Wrestling Federation Entertainment Inc. also went public the same day. Like Martha Stewart’s, the WWF issue soared because of strong brand-name recognition and and consumer appeal.
But the remarkable performance of these recent floats is far from representative of the typical IPO experience. According to money manager David Driscoll of Toronto Capital Markets Inc. in Toronto, about 80 per cent of all new stock issues quickly shed up to 50 per cent of their value. In fact, a recent survey indicated that of 74 IPOs launched since the start of 1998—each worth $10 million or more—fewer than one in four had risen in price by the time the study was concluded on Oct. 25. “It’s best to give IPOs at least a year to shake out their market value,” Driscoll advises, “especially for the individual investor.”
That advice is particularly relevant as year-end approaches: a host of companies are scrambling to go public before Y2K jitters rock the market and before investors tire, in particular, of technology stocks. This week, the largest IPO ever is slated to take place in the United States when United Parcel Services of America Inc. issues more than 109.4 million shares and raises an expected $6 billion in new capital. At least 70 other new issues are also expected to hit U.S. markets in November.
Although retail investors may not be aware of it, the dynamics of these deals work against them from the outset. There is a widespread assumption that the Internet is a great equalizer in capital markets, providing more and varied information to the average shareholder. But when it comes to IPOs, even the most progressive companies retreat into anachronistic, backroom relationships with investment bankers.
That relationship comes at a steep price. Although new issues can be bought from a broker without a sales commission, the corporate finance fee of two to 10 per cent of the issue’s value is included in the share price. Then, there is the
increasingly controversial tradition of the “road show,” where managers of the company meet privately with institutional investors. At these meetings, senior executives often provide detailed performance targets and other material information not contained in the prospectus. That information often creates a buzz in the investment community which allows the investment dealer to price the issue higher than it might otherwise—even though retail investors can’t judge the information firsthand.
The practice of selling new stocks also deserves close scrutiny. To demonstrate good faith in the client, underwriters typically acquire at least five to 10 per cent of an issue, which they then resell to their clients as quickly as possible. The pressure to move inventory through the retail network is often accompanied by recommendations by in-house research analysts—a conflict of interest currently under study by the Toronto Stock Exchange.
There are also other agendas at play that work against small shareholders. As in the case of Martha Stewart or the McMahon family, which controls the WWF, IPOs come to market so that private owners can attain some liquidity for their assets. In other cases, the issue may be a way to realize value for insiders who hold various options. Although there is supposed to be a 180-day waiting period in American markets, there is still an inherent risk that significant blocks of equity may be dumped on the market in relatively short order, depressing the value of the shares held by others.
Yet another consideration with IPO investments, especially when several stocks in the same sector come to market in short sequence, is that many mutual fund managers are “indexers.” That means they try to replicate the various weightings of the TSE 300 composite index or the Dow Jones industrial average within their portfolios. That forces new issues—one example is life insurance companies—to compete with one another for limited space within a prescribed sectoral niche.
The final mark against IPOs is that, with a few exceptions, they tend to be deployed by small companies that trade in a more volatile manner, especially given the current market obsession with well-capitalized blue-chip stocks.
Some traditions may die hard, but an overturn of the inefficient and unfair process surrounding IPOs is long overdue. It’s about time that the interests of small investors and Bay Street were a little more closely aligned. After all, if Martha Stewart and the bone-crushing behemoths of the WWF can learn to use the same tactics, so can the potential buyers who make ’em—or break ’em.
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