NEW YORK (CNNfn) - Michael Strong can't get enough initial public stock offerings.
Strong, an assistant director for a think tank at the University of Pennsylvania and a graduate student working on his dissertation on Finnegans Wake, hadn't invested at all until April 1. That was the day he found out about Wit Capital and investing in IPOs online.
He opened an account soon after. Following a failed attempt to get in on Web-site designer iTurf (TURF)'s first sale of shares to the public, he bought into software developer Net Perceptions' (NETP) IPO at $14 on April 22. When it started trading the next day, he saw it more than double, hitting $34.38 its first trade.
Strong held the Net Perceptions shares for 60 days, to avoid Wit shutting him out of future IPOs for flipping the stock. But he sold it as soon as that holding period was up, at $19.
Not the huge bucks of the opening day, sure, but still a return of just over 35 percent in two months. He hasn't looked back. Strong has since invested in 21 IPOs through the accounts he has opened with Wit Capital, FBR.com and E*Trade.
When Charles Schwab, TD Waterhouse and Ameritrade open their online investment bank - expected to happen in the first half of 2000 - he will likely sign up there too.
"What I am doing is not investing, and I understand that very clearly. I am not an investor. I am a speculator," he said. "And I'm doing it all to pay my student loan."
IPOs for all
Welcome to the world of Everyman IPOs. Once off-limits to all but the biggest and best clients of the top investment banks, many brokerages now tout the access they give to retail investors online, sometimes to all comers.
The problem isn't touting access, it's getting it. More often than not, online brokerages only get enough shares to satisfy a few hundred customers.
Despite all the fervor over IPOs already, Strong said he thinks many more Main Street investors will start subscribing, realizing a lot of offerings amount to free money.
But there are already enough retail investors to sop up the entire float of shares in the majority of IPOs. And large mutual-fund companies could absorb most issues.
"For many of these IPOs, if you offered them all to Fidelity, Fidelity could just buy them without blinking," said Ivo Welch, a professor of finance at UCLA's Anderson Graduate School of Management who studies IPOs and runs a Web site that tracks them.
So demand is tough to satisfy. Many online brokerages such as DLJ Direct and Morgan Stanley Dean Witter Online still limit access to preferred customers, with high balances -- $100,000 at both brokerages. The options for investors with smaller balances are limited.
It's not surprising then that Strong's success ratio in applying for IPOs has been spotty. He estimates that he gets shares in around 1 in 4 of the offerings he has tried for through Wit. But that's good compared with the access at E*Trade, where he's been successful on only 1 in every 20 offerings he's submitted.
Strong opened the FBR.com account to get Red Hat (RHAT), but he wasn't quick enough on the draw and the brokerage too few shares to go around. He figures he had five minutes at most to get in on that extremely popular offering.
He was about to cancel his FBR.com account because he felt he wasn't getting decent-quality IPOs. But the brokerage, which is owned by the small investment bank Friedman Billings Ramsey & Co., won him back with NetCreations (NTCR), which closed up 54 percent from its $13 opening Nov. 12. That was the first deal he got out of 12 he had tried for.
FBR was the lead manager on that offering, meaning it distributed 20 percent of the shares, which the brokerage believes is the biggest share of an IPO to go to online customers so far. Almost all customers got some shares, the brokerage said.
It may not hold the title of the "most-online offering" for long. Brokerages continue their push to appeal to individual investors, luring them to open online accounts to get access to IPOs, and using that clout to clamor for bigger blocks of shares in deals.
New online bank may force door open
When the as-yet-unnamed Schwab-Waterhouse-Ameritrade investment bank debuts, it will be a gorilla. It will have access to 41 percent of the 10.9 million online accounts that U.S. Bancorp Piper Jaffray recorded at the end of the third quarter.
What's more, says Scott Ryles, a 15-year veteran of Merrill Lynch who is president and CEO of the new bank, those investors build sizable positions in IPOs already. Only for the moment they do it in the aftermarket.
"As a group, they're the single-largest shareholders of all the technology IPOs this year, and in some cases they own more than all the institutions combined," Ryles said from his car phone in Silicon Valley, where he was looking for office space for the bank to call home.
But those investors got less than 1 percent of the shares in the IPOs they had access to. Of a typical 3 million share float in an IPO, they were lucky to get their hands on 30,000 shares, Ryles said.
In fact, it's because the brokerages were unhappy with the number of shares they were getting from existing deals each had set up with investment banks such as CS First Boston, J.P. Morgan and Hambrecht & Quist, that they're forming the bank.
A new day for online IPOs?
So is a new day of IPOs for all upon us?
Not quite, though Wit and FBR.com have cracked the door, and the new bank may force it a little more. But the Schwab-led investment bank will still distribute shares to preferred customers, as well as to investors that match a profile an issuer is looking to target - think widget makers looking to sell shares to widget buyers.
The three brokerages will decide how to distribute their allocations. Ameritrade will give its shares to its largest and most active accounts, for instance, though "those practices will be reviewed from time to time," President and COO Jack McDonnell said.
"In the past we've had such a meager allocation that it wasn't practical [to distribute shares widely]" McDonnell continued. But the new bank, which will focus on the high-tech stocks that online investors prefer, will increase the number of shares that go straight into retail hands.
Coupled with more egalitarian online distributors such as Wit and FBR.com, that suggests a change in the way IPOs will operate.
"That's going to be a very interesting dynamic that's going to play out there," Welch, the finance professor, said. "There will be some serious strategizing in the corporate suites of the best investment banks in how to deal with this venture." They'll have to decide, do we join them or do we compete, try to starve them of deals, he said.
Until the past two to three years, the average leap for an IPO on the first day of trading was 10 percent, Welch said. Lately it is not unusual to see average appreciations of 50 percent, more in hot periods for IPOs.
Not every IPO Strong has got has performed well. 1-800-Flowers.com (FLWS), for instance, closed below its offering price of $21 on its first day of trading, a "broken deal" that didn't get a first-day pop.
"That was a big fat bummer for me," he says. "The thing I'm proudest of is that I've been able to distinguish between the deals that are good and are bad." He passed on Rubio's Restaurants (RUBO) and Edison Schools (EDSN), companies whose businesses he didn't like.
But his voice rises and speeds up when he talks about IPOs, which he will admit have become something of an obsession for him. To Strong, IPOs are partly a lot of fun, mostly a lot of money.
HeH rattles off his winners like a proud father -- Internet Capital Group (ICGE), Kana Communications (KANA), NaviSite (NAVI), Bsquare (BSQR). They're the kind of tech-related companies that have seen price leaps the first day - those four averaged a 141 percent jump the first day - and make investors' mouths water.
The theory used to be that after an IPO, the market would adjust the deliberately low offering price to match the discounted present value of cash flows, Welch said. An investment bank would price the offering lower than it was worth so that the issuing company could "give" shares to favorite customers, suppliers and other business partners. And, of course, the investment bank itself got a very good deal on its shares too and offered them to preferred clients.
Now, realizing that IPO prices are often a bargain, retail investors have been bidding up their favorite offerings, particularly high-tech stocks. They hit levels well beyond traditional cash-flow valuation methods, Welch said. And IPOs have been seeing bigger leaps when they open as a result.
But giving more retail customers access to IPOs may turn that trend of bigger first-day "pops" around. The selling point for investment banks such as the Schwab-led new venture and other online investment banks is that they can give issuers wider distribution and a higher price for their stock in the IPO as a result. The new bank also has two venture-capital partners to ensure it has development-stage companies looking to go public in its fold.
"We should be able to offer the issuer the opportunity to have more demand for their stocks, and when they price that deal, the demand would be reflected," Ryles said. From their lead manager, issuers have good information on institutional interest and price sensitivity there. "But they don't have any idea how much demand there is out there from the online investor."
Already Ryles has seen significant interest from companies looking to go public calling him up, he said. Issuers are realizing how much money they leave on the table in IPOs that are underpriced - even, Welch said, 30-something entrepreneurs who can't exactly fathom how much money they're making from fledgling high-tech issues going public anyway.
Greater access likely, at a price
They may start looking to sell them to retail customers to get a better deal. And that would mean the shares start out more realistically priced.
"It's not going to be this bonanza for retail investors that retail investors believe it is, because the underpricing discount is going to change," Welch said. "When you have a party for 10 wealthy people, you may serve caviar. If you have a party for 1,000 people on your lawn, you're not going to serve caviar anymore. You're going to serve hot dogs."
Still, within three to four years, 30 percent to 40 percent of IPO shares will go to retail customers, according to FBR.com's president, Suzanne Richardson. That's up from a tenth of that now, she estimates. The estimate varies, and companies aren't required to reveal how many shares they sell to retail investors.
But pricing will change as a result. "I don't think retail customers, that demand, is being priced into offerings to date," she agreed.
So giving retail investors what they want - more IPO shares - will actually mean they get less of what they're looking for - a big leap in price. But retail investors will demand even greater supply than 40 percent of most issues, Richardson thinks. So getting access will still be the big issue that drives a brokerage's success.
Being the lead manager or a strong co-manager, with the heft to deliver a decent allocation of shares, will be the key. Just being in the syndicate isn't enough, online brokerages have found through experience. "When you're an e-manager, you're not in that position. You're low man on the totem pole," she said.
Investors like Strong track that. He has made it his specialty to know all there is to know about IPOs - how to get in, when to get out, who gives the best access, which brokerage has the best customer service, Web site, phone help, system capacity.
"I am basically new to the investing world. I have learned as much as I can about this extremely narrow part of the investing world, online IPOs and what they do in the first two months. That's what I know about."
He scours online message boards such as Yahoo's IPOStation, chatting with fellow IPO fanatics about upcoming offerings and keeping tabs on the new listings he's trying to get in on, and which other investors has got in on various offerings. "To me, it's all about the size of the allocation," he said. He goes where the shares are.
Richardson thinks success will come to investment banks such as hers and the new Schwab-led bank, which has a similar business model, she said. That involves guaranteeing research for issuers and online distribution that doesn't compete with a large offline brokerage presence, a problem traditional investment banks have to wrestle with.
Those banks are working on ironing out their online distribution kinks. Welch, the professor, expects all investment banks to develop online distribution. But how generous they'll be in doling out shares to all comers is still a very good question.
"Most likely, in the future there will be more retail access, even though one doesn't need them," Welch said, adding that institutional clients also complain they don't get as many shares as they'd like. Still, investment banking will get more competitive on pricing deals by offering retail access, a kind of IPO inflation.
The more chances Strong gets to buy into a hot offering, the merrier, and he'll take greater access for a little less pop in price.
Ultimately, he thinks the demand is driven by fundamentals. "If the company is Cobalt Networks (COBT) or Sycamore (SCMR) [two recent hot IPOs], I don't think it matters who gets the shares." Juniper Networks (JNPR) "you could have bought in the aftermarket at $90," he pointed out. Now it's near $300.
He can't say enough about the world he discovered in April. People who don't get the Web might be put off by the constant e-mailing back and forth, the risk, the site crashes, the variable customer service and the rejection on a lot of offerings.
But to him it's worth it, literally. If the new online investment bank gets him on new deals, he welcomes it. He's worried, though, that too many people will catch on. In fact, one of his main concerns with being interviewed about investing in IPOs is that others will cotton on and make it more difficult for him to buy in.
"It's just like the saying, 'if it was easy to do, everybody would do it.' Everybody's going to do it," Strong said.