(FORTUNE Magazine) – The bull improbably rages on--and nothing sizzles like the market for initial public offerings. Sometimes it may seem as if these IPOs are creating more instant millionaires than state lotteries do, as investors giddily snatch at the latest chance to make a killing. It's a phenomenon of late-cycle bull markets that IPOs become an easy-money game, with fast riches, hot tips, and plenty of "I told you so." But before you succumb to the temptation, take heed of an important warning that can be summed up in a single word: Viatel.

It's hardly news in most quarters that the market is overheated or--for that matter--that questionable outfits are coming down the IPO pike. What's revealing about this little company called Viatel is just how attractive the stock seemed to be when it was offered last October, how sure a winner it looked to be--and what it truly was.

Viatel is an international telecommunications outfit backed by some high-octane Wall Street types. Investing legend George Soros, the man who made $1 billion betting on the decline of the British pound, is the company's second-largest outside shareholder. The biggest outside stake is held by Comsat, the billion-dollar satellite outfit that presumably knows a thing or two about the communications business.

The company's founder is an impressive can-do kind of guy. Martin Varsavsky is a true "only in America" story--even if he is an Argentine native and now runs Viatel from Madrid. He came to the U.S. as a teenage political refugee of sorts, in tow with his brilliant astrophysicist father. In 1985, he co-founded a biotech outfit called Medicorp, which commercializes research bought from universities. Earlier, Varsavsky helped start a real estate firm, Urban Capital, that developed properties in New York and elsewhere. Both enterprises are apparently profitable.

Viatel had all the markings of similar success. As Viatel's managers pitched it, the explosive growth of global telephone traffic will gather momentum as economic globalization rolls on. At the same time, regulatory barriers are collapsing from Australia to Austria. Result: boundless opportunity for well-positioned players. Viatel appeared to have found its own enviable niche, having wired together a relatively cheap network of telephone lines in Europe. When deregulation strikes the Continent in 1998, the company promised, Viatel would be the price leader and make a bundle.

Wild numbers have been tossed about for years. In a memorandum for a proposed private placement, worked up for Viatel by Paine Webber in 1993, the company was projected to post a 1993 loss of $5.5 million on revenues of $29.1 million. The projections stated that would turn to a profit of $2.9 million on revenues of $106.6 million by 1994. And by 1996, the company was projected to post dazzling profits of $40.9 million on revenues of $471.4 million. Varsavsky calls the memorandum a draft and says, "I will not stand by that document."

Yet, a second set of financial documents, dated August 4, 1994, gives a more realistic but still upbeat view. These company forecasts show a projected loss of $8 million for 1994 on revenues of $27.7 million. Losses of $16.8 million on revenues of $58.2 million were projected for 1995. For 1996, the company forecast a smaller $9.4 million loss on a big jump in revenues to $148.2 million.

Here's what really happened. The company posted a far greater loss of $28.5 million on revenues of $32.3 million for 1995. Further, Viatel lost an estimated $39 million on revenues of just $51 million in 1996, giving it some of the fattest negative margins of any publicly traded non-biotech company. Such losses will continue, too. Currently the company is forecast by Salomon to post a loss of $41 million for 1997 on revenues of $85 million. CEO Varsavsky now doesn't expect profits until at least the year 2000. His biggest problem: Viatel's principal business is a system of routing long-distance phone calls through switches in the U.S. and London, taking advantage of dirt-cheap rates. In many countries, fierce competition has forced Viatel to price its service below its costs. But Varsavsky is absolutely unfazed. Says he: "If you're trying to find an example of market exuberance, this is not it."

Spoken like a true believer. But what of the stock? The company went public last October at $12 a share. Two weeks later, after its lead underwriter withdrew support--a normal event following such offerings--the price fell to $8.75. The stock has continued to slump, falling below $8 per share before a modest upturn. Given the company's problems, it may have even more to drop.

Nothing that has happened to Viatel, or to its unfortunate shareholders, is truly exceptional--disappointments are common currency on Wall Street. What is so disturbing, and should be a caution light to all who venture in young companies, is the way in which fine pedigree, prestigious backers, and hazy but alluring prospects got so many investors to overlook this company's worrisome condition.

Why would a Wall Street wizard like Soros think such a turkey could fly? Well, even great investors make mistakes. Soros's Quantum fund, for example, actually lost money in last year's bull market. And both Comsat and Soros bought their stakes in Viatel years ago: Even at today's price, they are still in the black.

As for those tony underwriters, would they really put their names on an offering likely to tank? You betcha. Underwriters collect their fees whether or not IPOs succeed, so even big names can get seduced by money in the rarefied world of new issues. Don't forget that the next time you see a renowned underwriter pushing a name you've never heard of.

But was there no clue that could have tipped investors off to the trouble that lay ahead? In fact, there were clues, but you would have to have been part sleuth to uncover them. Take management. By the time of the public offering, there had been a startling turnover of Viatel's top dogs. Of the ten most senior officers identified in that 1993 Paine Webber memorandum, only one--Varsavsky himself--is still with the company.

Here's another clue that largely went unnoticed: At the end of 1994, Morgan Stanley did a private placement for Viatel of $75 million with a group of institutional investors. It was an innovative deal, combining stock with junk bonds, the latter issued at a fat discount to face value, to begin paying interest in the year 2000.

But Morgan Stanley, the firm most familiar with Viatel because of the private placement, did not underwrite Viatel's IPO, Salomon did. Why? Varsavsky claims that he was taken with Salomon analyst Jack Grubman's coverage of the telecommunications industry. Says he: "He is the champion. He is the biggest advocate of our type of company." Morgan declined to comment, but Wall Street sources close to the situation give another explanation: Morgan refused to underwrite the stock at the price Varsavsky wanted because Viatel had repeatedly failed to meet the earnings projections that had been made prior to the private placement. Says one: "They missed their numbers after the deal."

And what about Varsavsky's impressive track record? Solid stuff, to be sure. But a little digging reveals that with both of those earlier companies, Varsavsky was backed up by a numbers-oriented, detail person who ran the shop while he played visionary and salesman. Until recently he hasn't enjoyed such support at Viatel because of the company's revolving senior staff.

There are also some troubling nuggets embedded deep in the IPO prospectus. A pair of lawsuits have been filed against the company by disgruntled former salesmen. More serious, Viatel has been thrown out of a number of countries that don't like its practice of bypassing local telephone monopolies. Indeed, as revealed in the prospectus, it may be in violation of the laws of some of the countries where it still operates.

So here we stand today. Viatel is losing big money, its executive suite has been a revolving door, and the legality of one of its businesses is in question. Morgan's private placement netted Viatel some $65 million in proceeds--yet by the time of the IPO, that had been largely exhausted. And the $95 million of proceeds from the IPO? Research director Irv DeGraw of IPO Insider, a newsletter, says that given Viatel's negative cash flow, it could run out of cash in as little as six months' time: "This company is burning through cash as if it were straw." In fact, buried in the prospectus, Viatel states it will likely have to gather more capital through a debt offering. And if Viatel can't find buyers for its debt? Well, the prospectus--in perfect legalese--says it may abandon "the scope of any potential future expansion."

That may be the kind of stuff that we've all come to ignore as some standard SEC-mandated humility. But what Viatel teaches, above all, is that nothing about an IPO in today's market is a sure thing--such issues are a treacherous place to make your mark as an investor. That's not to say that IPOs like Viatel don't have value--they are important markers for those who know what to look for. Says Gabelli & Co. vice president Geoff Johnson: "When you see companies like this come public, it's the sign of a market top."

A final moral to the story: Leave optimism to the entrepreneurs who run such outfits. Varsavsky, for one, used the recent drop in Viatel's stock price as a chance to buy one million more shares. Wish him luck--from a distance.

REPORTER ASSOCIATE Wilton Woods