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IPOs attract higher prices
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March 16, 1998: 2:51 p.m. ET
New issues may benefit as Russel 2000 beats other indexes, hits record
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NEW YORK (CNNfn) - Small-cap stocks are beginning to show signs of life after the Russell 2000, an index of small-cap issues, posted a better than 1 percent gain last week, a sign that may portend higher IPO premiums and first-day pops.
Perhaps it's a sign of more tolerance to liquidity-risk. Small caps have been lagging the market for months, but last Wednesday the Russell 2000, a basket of small cap stocks, hit its first record in more than four months.
For the week, the Russell's 1.09 percent gain actually beat both the Nasdaq Composite and the Dow Jones industrials.
In the past decade, IPOs have outperformed the overall market only in the years the Russell 2000 posted better returns than the Standard & Poor's 500 index. Some attribute the phenomenon to an optimism factor: When the Russell does well, it's a reflection of rising investor optimism and willingness to take more risk.
Another recent trend in IPOs is the improving pricing environment. According to Michael Moe, NationsBanc Montgomery Growth stock strategist, companies increasingly are raising more capital than they originally sought, with 50 percent of new issues pricing above the range in the first week of March. Year-to-date, 27 percent of IPOs have been priced above expectations, compared with 22 percent for all of 1996 and 1997.
"Investors are bidding up IPOs aggressively because they're paying for the future value of growth," says Moe. "Liquidity is no longer a big risk because it's a compelling case when small caps are growing at 50 percent versus the S&P 500 of 9 percent." says Moe.
The widening disparity has dumbfounded many. "The market is in denial about earnings," says Chuck Hill, director of research at First Call. "The story about small caps is that the Russell has consistently outpaced the growth rate for big caps since the second quarter '97, and the margin is widening."
Hill notes that analysts project small-cap stocks to grow by 10.2 percent in the first quarter of 1998 versus only 2.1 percent for the S&P 500; it will be the fourth straight quarter earnings growth for the Russell has beat out the S&P 500.
Moe also believes investors will continue to bid up prices for IPOs and uses the NMSGI, which is NationsBanc Montgomery's 500 fastest projected growing companies in America, as his leading indicator. The NMSGI is up 12 percent for the year, far better than the 8.8 percent return for the DJIA. And according to Moe, a better performing growth index leads to a favorable pricing environment for IPOs.
One caveat for small investors: Most of the gains for IPOs are realized on the first day. According to CommScan Equidesk, while IPOs are up 20.22 percent on average this year, they're up only 3.4 percent when first-day gains are excluded. And first-day gains are accelerating, hitting an average 13.72 percent in March.
This compares with an average first-day gain of 12.12 percent in February and just over 5 percent in December and November of last year. In fact, the top ten performing IPOs of 1997 are up 76.77 percent on average, but anyone who got in on the second day is looking at only a 22 percent return.
That may give some investors caution before diving into this week's batch of IPOs. With only eight deals raising $197 million on the calendar, it's a relatively light week compared with last week's 17 IPOs that raised $922 million.
Goldman Sachs leads the most notable deal this week: four million shares of Internet hosting company Exodus Communications between $9 and $10. Exodus is a provider of Internet systems management. The company operates six Internet Data Centers across the country and monitors and supports overall Internet operations for companies.
For instance, Exodus's newly announced product: MutliPath Net acts as a back-up website. Companies that rely on the Internet can't afford downtime, and in the event of a software or hardware failure on-line traffic is routed onto a duplicate site. Among its 200 customers are well-known Fortune 500 firms such as Hewlett Packard and Computer Associates.
The company began hosting servers three years ago and opened its first data center in the fall of 1996. Still in its emerging state, Exodus has a debt load of $31 million and has been accruing losses faster than it has generated sales. For all of last year, Exodus lost $25 million on revenue of $12.4 million. And the company doesn't expect a profit any time soon, in part due to plans to open more data centers.
But the market for Internet outsourcing is promising as the number of websites increases exponentially. Exodus believes companies will increasingly prefer Internet outsourcing because it eliminates substantial up-front investment. The cost for a typical corporate website is about $350,000 a year, and that figure is expected to reach $2 million by the year 2000. Additionally, many companies don't have the financial resources to keep up with the swiftly changing Internet technology.
Online retailing has yet to take off. By some estimates, items purchased on the Internet totaled $296 million three years ago and are expected to explode to $220 billion two years from now. Getting a piece of that growing pie is certainly the intention behind the IPO of Cybershop. The online retailer offers over 40,000 products from more than 400 manufacturers. Its online stores are accessed at CYBERSHOP.COM on the Internet and on the AOL Shopping Channel. Cybershop is offering its shares between $6 and $8, raising $7 million.
In the biotech field, CuraGen, is set to price this week at a mid-point of $11, raising $30 million. CuraGen is a genomics company whose technology has been supported in part by the Advanced Technology Program at the National Institute of Standards and Technology. Currently, the company has entered into research collaborations with Pioneer Hi-Bred International, Biogen and Genentech.
And in what must be the first-ever rollerblading pure-play stock, Rollerball is set to float 1.2 million shares at $5.50 each under the ticker symbol ROLL. The four-year-old company offers 17 models of its Radial Skateball in-line skates. Most of its sales have been outside the U.S. and on the Home Shopping Network. 
-- by Bambi Francisco for CNNfn Interactive
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