Talecris Biotherapeutics (TLCR) is one of the more recent successful IPO stories as the company raised capital and began trading on October 1.  The IPO was priced at $19.00 per share and underwritten by an all-star cast of investment bankers including Morgan Stanley (MS), Goldman Sachs (GS), Citigroup (C) and JPMorgan Chase (JPM).  On the first day of trading, investors were rewarded with an 11% return as the stock bolted out of the gate.

Over the next month, the stock began to cool off as is often the case with new issues.  In early December, TLCR breached the all important IPO price of $19, but within two weeks the stock began to mount a recovery.  This is a perfect example of how underwriters and IPO investors can often be counted on to support a new issue very close to the IPO price.  It’s important for the underwriters to have the issues trade above the offering price, because it makes their job easier when peddling the next IPO to investors.  So often for quality IPOs, it is a good strategy to buy additional shares when the stock tests the initial price point.

The business model for Talecris appears to be very sound, as the company is experiencing strong revenue growth and generating impressive strength in earnings.  The company is a world leader in plasma based therapies and has strong command over its niche of the medical business.  One concern could be that the company receives 70% of its revenue from its two main products (Gamunex IVIG and Prolastin A1PI).  I’m not extremely experienced when it comes to the medical industry, but it appears based on market share and revenue trends that the company is very successful in its product lines. The third quarter was a strong period for TLCR with revenue growth of 12.9% and EPS of $0.38 which represents an increase of 72.7% over last year.  It appears that the company has been able to reduce expenses through vertically integrating its supply chain which has led to stronger gross margins.  The IPO transaction allowed the company to pay down a portion of its debt leading to lower interest expense which further helps to bolster earnings.

Our third quarter results reflect the continued demand for Gamunex, our brand of IGIV, as well our success in building a vertically integrated plasma supply chain to ensure a continual supply of Gamunex. ~Lawrence D. Stern, CEO

As far as debt is concerned, the company still has long-term liabilities north of $1 billion.  The liabilities are offset by $630 million in inventory and a healthy balance of accounts receivables, but the high level of debt could still become a concern should there be any unexpected changes in the revenue stream.  While it is still too soon after the IPO, I would not be surprised if the company issued additional equity in the first few quarters of 2010 in order to pay down debt.  This would dilute current shareholders, but would also lead to a more stable capital structure.

Analysts are expecting the company to earn $1.52 per share in 2010 which is probably reasonable given the strong management team, growing revenue base, and cost cutting initiatives.  At the current price near $21, the stock is trading at a multiple of 14 which seems a bit conservative considering the earnings growth.  Some caution is in order due to the debt level, but a multiple of 20 would not be unreasonable.  If we see medical stocks rebound in the aftermath of health care reform (as I expect we will), TLCR could ride the trend and see a much higher multiple.

So at this point it looks like the risk/reward ratio is very good.  $19.00 remains an important level to watch as a breach of this level would cause me to stop out my position.  On the other hand, the stock has the potential to trade through $30 and yield a 40% plus return.  The next six months should be a positive period for TLCR and its investors and I look forward to seeing what kind of growth management can generate.

FD: Author does not have a position in TLCR

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Shares of Fortress Investment Group (FIG) are trading higher today after comments made at the Goldman Sachs (GS) US Financial Services conference. The private equity company has benefited from the equity market rebound and the return of liquidity to the global investment universe. As I write, the stock is up more than 7% after CEO Daniel Mudd spoke at the conference this morning and told investors that they are seeing more demand for their private investment funds.

Fortress has seen its stock plummet over the past year as funds that the company managed took on losses while at the same time, investors pulled capital out due to the poor returns. This is the nature of private equity – it can often be a boom and bust business model even though funds are usually structured to be absolute return vehicles. When a fund or family of funds are performing well, the company recognizes very attractive incentive allocations (FIG gets to keep a portion of it’s investor’s profits) and at the same time, new capital comes pouring in.

However, when these funds face a few months of poor performance, investors pull capital out resulting in a smaller pool of capital available to generate gains. At the same time, the poor performance puts the funds below their “high water mark” and that level must be reached again before the fund can charge any incentive fees on investors who are simply making their money back. So even in a rebounding market environment, companies like FIG will see their profitability lag because it takes time to make up past losses on their investments.

But we are likely in the early stages of another boom in the private equity market and for Fortress particularly. There are two factors feeding this new wave of profitability which could quickly lead to a sharply higher stock price. First, the company isseeing new investment capital come in the door. Keep in mind that this capital does not have a high water mark. Gains on these new investments will immediately lead to FIG taking a portion of the returns as their own profit. In the past few months, FIG raised $500 million in a portfolio designed to invest in the Japanese real estate market. Other new fund launches will likely allow the company to substantially increase their Assets Under Management (AUM)

The second factor is that existing funds are nearing their high water marks. So while the funds have been struggling to make up past losses, these assets have basically been adding very little to FIG’s profits. But once the magical high water mark is hit, immediately new gains will tie directly to increased profits. As expectations ramp higher, the stock price will likely get a lift and potentially run several hundred percent higher.

Currently, analysts are expecting FIG to earn 28 cents in 2009 and 45 cents in 2010. This means that the stock is currently trading below 10 times next year’s expected earnings. To be fair, these earnings estimates are not very reliable. It’s extremely difficult to handicap exactly how well the company’s funds will do and what type of incentive allocations will be generated. But I do think that the Wall-Street analysts are excessively conservative given the difficulty we have experienced over the last year.

FIG is not an investment that you should make with your “safe” capital. In many ways, this is a risky bet that could go bust, or could pay off big. If the market experiences another decline (which I think is possible) its likely that the funds will be better prepared to handle the turbulence. But there’s no guarantee that they won’t lose money in the funds resulting in much lower revenue. However, there is a good chance that FIG will have some of its funds make wise investment decisions (short or long) which will yield significant profits and push earnings up significantly. A little confidence could go a long way and if FIG realized a multiple of 20 on earnings of 75 cents we would have a return of roughly 275%.

So consider taking a shot at FIG – buy a few speculative shares and tuck them away for 6 to 12 months. The potential is great and you are only risking roughly $4.20 per share.

FD: Author does not have a position in FIG

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The IPO market has become more active as underwriters try to push through deals before we hit the holiday doldrums.  There are only a couple of actionable weeks left until portfolio managers and traders close up shop for the year and liquidity dries up.

One of the most recent companies to take advantage of the liquidity is Archipelago Learning (ARCL) which was offered to investors at $16.50 on November 20.  The Underwriters (Bank of America / Merrill Lynch and William Blair) did a good job of pricing the deal attractively for investors and developing interest in the company.  On the first day of trading, the stock closed at $18.77, good for an initial gain of 13.75%.  Since that time, the stock has pulled back to just above the IPO price, an important level that  BAC will likely defend.

Looking at the company, Archipelago has built a line of subscription based online educational products which are predominantly sold to the Kindergarten through 12th grade schools.  During the 2008/09 school year, the products were used by 8.9 million students through a relationship with 21,000 different schools in all 50 states.  While the company has already penetrated a very large geographical footprint, management estimates that they only represent 17% of the available schools with 94,000 public and 24,000 private schools as potential clients.

As a growth strategy, the company is not only looking to expand into new schools, but also to increase the revenue within its existing client base.  The products used by high-school students typically carries a higher price point and stronger margins than lower grade products, and there is potential to develop new products which could assist with the company’s existing initiatives to expand into the college and post-graduate markets.

According to the terms of the IPO prospectus, the company sold 3.1 million shares with selling stockholders also selling 3.2 million shares.  As it turned out, another 937,500 shares were sold by the selling shareholders to meet the strong demand for the deal.  The primary selling shareholder was Providence Equity Partners which still retains a 54.9% position in the company.  Over the next several months, investors are likely to worry that Providence will liquidate its position.  But for today, there is a lockup on these shares and so the overhang should not play heavily into the price of the stock. The company indicated that it would use the proceeds from the sale for “general corporate purposes” which means very little to us as investors.  Given management’s desire to grow the company and expand its client base, I would expect much of this capital to be used for marketing and promotional initiatives.  The company has $61 million in debt, so the additional capital could theoretically be used to create more financial stability.

Archipelago is at a critical spot where revenues are just barely covering fixed costs and beginning to provide the company with a profit.  The pro-forma model for the year ended 12/31/2008 shows that the company would have earned 3 cents a share, and with the lower interest expense this year, the company was able to clear 17 cents per share in the first three quarters.  If management is successful at integrating its programs in a wider base of schools, the earnings growth could expand exponentially.

Most IPOs are heavily influenced by the underwriters in the first few weeks of their existence.  It’s important to the underwriters that the deals are profitable to investors because that will allow them to efficiently market the next deal and investors will have confidence in the company’s ability to price the IPOs attractively.  With that in mind, ARCL is now trading just above the $16.50 IPO price and is likely being supported by Bank of America.  This offers us as traders a great risk/reward spot to buy on the expectation that the stock will be bid higher by IPO investors and the underwriters.

If we are wrong and the stock breaks below $16.50, we will quickly sell and realize a small loss.  (I would give the stock 20 or 30 cents below the IPO price but not much more room than that).  On the other hand, the potential for the stock to trade back up to $18.50 or even its high at $19.50 is fairly good.  I would welcome a trade that allows me to risk 50 cents with the potential for a 2 dollar or 3 dollar gain.

One caveat is that there is very little volume in this new issue.  That means it is much easier for large blocks of stock to push around the price – and so we will have to endure more volatility.  If the stock breaks $16.50, it could very quickly continue lower before you exit the stock.  But by the same token, if it is bought by a large institutional investor, there is a good chance the order would push the stock significantly higher.  So consider putting a small amount into this position and maintaining a close stop.

FD: Author does not have a position in ARCL

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For the past several years, investors have only had one choice when it comes to a major technology investment serving the China telecom market.  AsiaInfo Holdings (ASIA) has been the only major technology provider in the sector trading on US markets, and the stock has had a tremendous run over the last several quarters.   Investors are betting that the emerging middle class in China will drive growth in both  land line and mobile telecommunications and in turn increase the business available to ASIA.

AsiaInfo is actually broken into two separate divisions which meet different needs of institutional clients.  The first division is AsiaInfo Technologies which provides software and solutions to voice and data carriers.  The Chinese government recently combined the six major telecom players into three and has implemented measures designed to inspire competition and in turn drive demand for their services.  ASIA stands to benefit from the rapid integration as these three firms consolidate operations and struggle to create an efficient technology framework.

The second division is Lenovo-AsiaInfo which specializes in IT security, antivirus and network protection technologies.  Similar to Mcafee (MFE) or Symantec (SYMC), the division offers subscription based services to protect against malware.  The division has several government contracts which not only provide stable revenue, but also gives the company credibility and helps prove the legitimacy of their products.

But while ASIA has been a strong competitor, there is a new player which will likely issue a US based IPO in the next couple of weeks.  Lincage Technologies is expected to offer shares between $13 and $15 sometime near December 9th.  The ticker, ironically, will be BOSS and the shares will be sold through the underwriting branches of Citigroup and Barclays Capital.  Linkage receives most of its revenue through software development, and the software helps clients properly manage customer accounts, manage network issues, and generate helpful data for future planning.

Unlike many of the technology IPOs in the US over the past decade, Linkage is actually a profitable company with revenue of $66.6 million during the first half of the year and net income of $15.1 million.  Despite hefty competition in the market (including domestic rivals that are not traded on US exchanges), the company appears to be growing rapidly and winning significant contracts from the three major telecom providers.

The IPO transaction is expected to net the company roughly $129 million although this could vary depending on what price is received for the shares.  Linkage will set aside $30 million for research and development and use the remainder for “general corporate purposes.”  It’s encouraging that the company will actually be receiving capital from the transaction instead of the capital going to a private investment firm or directly to previous shareholders.  The additional capital should be able to fund growth and allow the Linkage to compete against rivals in this attractive growth market.

For the time being, ASIA still looks like an attractive investment although possibly a bit pricey.  The company is expected to earn $1.20 per share in 2010 which means that the stock is trading at roughly 20 times forward earnings.  That is a reasonable multiple given the growth assumptions, but does imply a bit of risk as any disappointment would likely cause the stock to drop quite a bit.

Buying BOSS on the IPO could be very profitable but also encompasses a decent amount of risk.  It is too early to tell how the deal is shaping up and whether there is sufficient buying interest to support the share price.  Usually when an IPO begins trading, the first few months are driven much more by perceived value and the supply and demand is centered around how much interest the underwriters are able to generate.  After that time, the stock will settle into a more predictable pattern based on the fundamentals of the company and the opportunities within the sector.

I would be willing to take a small position in BOSS and participate in the IPO unless there is a significant dislocation in the market between now and the actual transaction.  It appears equity markets are shrugging off the Dubai news and liquidity still continues to be strong.  While this can quickly change, under the current environment the prospects for this IPO remain very strong.

FD: Author does not have a position in ASIA

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Over the summer and into the fall, growth stocks have seen their share prices rise sharply as a violent shift from pessimism to optimism encouraged risk taking.  Arguably, many of these growth companies had been unfairly punished as the economic crisis created opportunity for some, and was simply not as bad as expected for others.  However, the unbridled buying of the last few months has pushed quite a number of growth stocks into excessively over-valued territory and many are vulnerable to sharp drops.

Netsuite Inc. (N) could be one of the next victims of the flight to quality.  The stock has recently fallen 22% from it’s recovery high, and that could simply be the start.  While Netsuite came public at a price of $26 in December of 2007, the company has failed to show any meaningful profitability and investors are losing patience as profit projections continue to be extended to later dates.

Management recently bragged that Netsuite logged its fourth consecutive profitable quarter, pointing to the company’s $0.01 earnings for the third quarter.  The earnings were on an “adjusted” basis while true GAAP earnings showed a loss of 13 cents per share for the quarter.  Adjusted earnings are certainly important for investors to consider, since many intangible items are included in the GAAP numbers.  However, even the adjusted earnings show a company that is clinging to marginal profitability instead of growing rapidly.

Earnings are a bit easier to manipulate than revenues.  While management can defer expenses and play around with the adjustments a bit, it is difficult to hide a lack of revenue growth.  So while the press release stated that the company experienced the highest number of Netsute One World (its flagship product) wins, the actual revenue came in at $41.7 million which is only 3% higher than the same level in 2008.  The decline in revenue growth has become a trend as 2008 saw the majority of quarters with 40% plus revenue growth, but the last four quarters have shown 30%, 22%, 10% and 3% growth respectively.

Our customer wins and new SuiteCloud partnerships indicate customers are running from legacy applications like SAP and Microsoft Great Plains to NetSuite’s cloud computing offerings. ~Zach Nelson, CEO

Another concerning statistic is a decline in the deferred revenue.  Companies like Netsuite usually sell annual subscriptions and often collect payment for a full years worth of service.  The company cannot book the full payment as revenue, because the service will actually be delivered in future quarters.  So the payment usually goes into the “deferred revenue” category and is realized as revenue in future quarters when the company performs the service.  If the level of deferred revenue declines, this can be ominous for revenue growth in future quarters.

The cloud computing service is certainly a growth industry, and has helped many companies save resources during a time when it is important to keep expenses low.  However, competition is heating up in this industry and the  majority of publicly traded companies are trading at extraordinary multiples.  It’s easy to see how investors could quickly begin selling shares at the first hint of trouble in the industry.

Most analysts are expecting Netsuite to earn $0.06 in 2009 and $0.14 in 2010.  This is a strong growth rate, but simply represents the huge percentage change from “near zero” to any positive earnings growth.  It is unlikely that the company will experience any significant earnings growth with revenue trends in such dismal shape.

The stock is currently trading north of $13.50, so even if the 2010 estimates are correct, the price/earnings multiple is roughly 98.  Unless the company continues to see its earnings double or more for several years, investors are likely paying too much for the hope of future growth.

To its credit, Netsuite does appear to offer a very attractive product, the company is being run with no debt, and technology advances continue to make it more relevant with new features such as an app for the iPhone.  However, as an investor, I am not willing to pay the current price for this growth story, and would be much more interested in shorting the stock and looking to cover somewhere south of $10.00.  Concern is beginning to creep back into the market, and we are seeing speculative issues get hit the hardest.  For now, Netsuite appears to be a poor place to invest your hard earned capital.

FD: Author does not have a position in N

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One of the more successful IPOs over the past few weeks has come from Vitamin Shoppe Inc. (VSI).  The stock was offered to investors at $17.00 and began trading on October 28.  Underwriters included JPMorgan Chase (JPM), Bank of America (BAC) / Merrill Lynch, and Barclays Plc. (BCS).  The stock traded sharply higher out of the gate, closing its first day of trading at $17.95 which was good for a 5.6% initial return.

Since the IPO, investors have gained more confidence in the stock, pushing it as high as $21.39 during the day on Tuesday.  That’s a potential 26% increase over the IPO price.  It’s encouraging to see additional strength in the open market for a growth opportunity in its early days of trading.  The positive movement points to liquidity which continues to show up in pockets of the market despite the economic uncertainty.

Investors were particularly pleased with the third quarter earnings release which came out last Wednesday, just a week after the IPO.  During the quarter, VSI reported sales of $168.4 million which represents an 11.3% increase over last year.  The company has opened 60 retail stores over the last year, brining their total locations to 434.  Comparable store sales were up 4.4% which is impressive given weakness in consumer spending.  Of concern was an increase in cost of good sold which were higher due to increased product costs and occupancy costs.

While there are certainly challenges in operating a retail shop in today’s market, VSI used the proceeds from its IPO to pay off debt, giving the company a better financial presence.  Of the $121.2 million received in the transaction, $72.5 million was used to redeem preferred stock, and $45.2  million was used to repurchase senior secured notes.  Now the preferred stock was essentially a way for the early investors in the company to get paid, but the lower value on the senior notes should help with long-term interest expenses.

The dynamics on this IPO are very positive for the time being.  A well managed deal has led to a higher stock price which will likely be supported for the next several months.  Aggressive traders could pick up stock on any dips into the high-teens with an absolute stop below $17.  If the stock breaks below this level, all bets are off and the picture could get ugly very quickly.  But as long as the stock remains above this level, the trading opportunities will be best from the long side.

Down the road, it will be important for the company to demonstrate superior growth characteristics.  Over the last 10 quarters, Sales have grown very steadily by roughly 10 to 12% but that number will need to pick up in order to justify the current stock price.  It appears that the first quarter is typically a strong earnings quarter for the company so that will be the first major data point for investors to analyze.

It is often a major challenge for management teams to transition to publicly traded dynamics.  Transparency is extremely important and the reporting issues can be burdensome.  Currently, the company does not appear to have an extremely transparent setup with balance sheet information less than accessible.  As management becomes more talented at disclosure and keeping the necessary systems and processes in place, they will need to refocus on driving growth in order to create value for shareholders.  I believe the long-term prospects are good, but challenges must be overcome quickly in order to maintain a premium stock price.

FD: Author does not have a position in VSI

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The company that allows you to “start learning a new language in less than 5 minutes” is having trouble communicating its message to Wall Street.  During the third quarter Rosetta Stone Inc. (RST) booked revenue of $67.2 million and earnings of $0.29 per share.  The result showed growth over the same quarter last year, but failed to revive investor confidence which had been falling for several months.

In August, ZachStocks discussed marketing expenses at Rosetta, explaining that the company was “purchasing sales” by exorbitant spending on sales and marketing in order to reach target revenue rates.  While the targets were being hit, profit margins suffered and the stock took a significant hit when third quarter guidance was issued on August 17th.  Last week when the company issued the  actual third quarter report along with guidance for the fourth quarter, the stock once again gapped lower, this time violating the $18 IPO price.

Once again, management tried to paint a positive light on the numbers, stating that the company saw strength in institutional and international markets while acknowledging that there were challenges with the US consumer.  While the press release did not break out the international versus domestic sales figures, it did lay out the fact that 76% of sales come from consumers while only 24% are institutional.  So it appears that the major portion of the company’s business is under pressure and unlikely to generate meaningful growth in the next few quarters.

While we resolved our Internet marketing issues during the quarter, we feel that the current economic environment is having an effect on our US consumer business, resulting in greater variability in our operating results as we head into the holiday season. ~Tom Adams, CEO

With Friday’s payroll report showing a worse than expected number of jobs lost and the unemployment level reaching 10.2%, it is unlikely the US consumer will add to sales for Rosetta.  While the company was able to land a meaningful contract from the military this month, it is still an uphill battle to generate meaningful sales growth.  International sales could pick up, but there is not significant strength in the global economy.  One positive could be a weak dollar which makes international sales cheaper, but Rosetta has yet to prove that this source of revenue can add meaningful growth.

Initial investors who bought on the IPO have to be extremely frustrated at this point.  After experiencing more than a 75% increase within a few weeks of the offering, positive returns have now evaporated.  As RST probes new lows and slides below the IPO price, there are now no investors who actually have a profit in the stock.  Ironically, this is taking place at the same time the Dow is hitting new highs.  As we mentioned in the ZachStocks Newsletter this week, investors are quickly fleeing risky assets and putting capital into blue chip investments.  This doesn’t bode well for investors in RST.

When discussing the stock in August, I mentioned that I would not be interested in buying the stock unless it reached $15.  I stand by that statement but want to add a caveat.  As we approach that level (which represents a 16% decline from the IPO price), I do not want to buy Rosetta simply because it reached that price level.  In order to buy this name, I want to see a clear picture for how the company will grow revenue and translate that to significant earnings growth.  Until the picture for the consumer picks up, or the company proves it can ramp up its institutional business quickly, there is too much risk to own this under performing stock.

FD: Author does not have a position in RST

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The market melt-down caused a significant decline in the number of IPO transactions over the past two years.  While a typical year used to include more than 200 major offerings, there were less than 50 such offerings in 2008 and so far I count 44 major transactions for 2009.  However, the pace of deals has picked up as markets once again offer liquidity and private equity investors and corporations are using that liquidity to cash out and raise capital.

The health of the most recent deals will have a major affect on both the pricing and frequency of upcoming deals.  If investors are willing to take on risk and the market has a speculative tone, then underwriters will likely have little trouble in pricing deals and getting top dollar for the selling shareholders.  But as we start to see a shift to more caution on the street, underwriters will have to adjust terms in order to get shares sold.  This doesn’t necessarily mean the rate of deals will decline, but it may mean that sellers will have to settle for lower prices and for selling smaller allocations in order to match market demand.

Dole Food Company Inc. (DOLE) was able to raise $419 million in its most recent transaction, netting the underwriters more than $26 million in fees.  The stock met selling its first day of trading with the IPO price of $12.50 quickly shunned by investors.  The majority of the capital is expected to be used to pay down the company’s debt which is likely to be a wise move given the uncertainty surrounding capital markets and the company’s interest expense.  However, investors appear to be worried that a faltering economy could still pressure shares and without earnings growth, the debt repayment will do little to add to shareholder value.

On a more positive note, Verisk Analytics Inc. (VRSK) was offered to the public at $22.00 and has quickly traded higher offering the IPO investors a handsome profit.  The risk management and analytics company is broadening its customer base to extend beyond its roots with insurance companies.  Essentially, the company will be able to offer internal credit reports for customers in many industries and should be able to grow revenue and earnings steadily in future quarters.  While the stock has pulled back a bit in the last week of trading, it is still 24% above the IPO price which is encouraging for the IPO market.

The most anticipated upcoming IPO is undoubtedly Hyatt Hotels.  Barron’s had a scorching article on the company this week including information surrounding the family squabbles which have plagued this closely held company for years.  The company is expected to offer 38 million shares to the public between $23 and $26 per share, valuing the entire firm near $4.1 billion.

Investors could justified in concern over the Pritzkers dysfunctional management of the company, especially considering that the family will retain voting control over the company through the use of two classes of shares representing ownership of the company.  The public will be issued class A shares, while the family will retain class B shares for their continued ownership.  The class B shares have 10 votes for every vote class A shares have which means that for the foreseeable future, the family will retain control over Hyatt.  Institutional investors will likely bulk at such a stipulation, which will likely lead to a lower share price than would be reasonable if the company were controlled equally by investors.

Although there are negative issues surrounding the deal, Hyatt has a strong brand, a full portfolio of attractive properties, and a top tier underwriting firm.  Goldman Sachs (GS) will likely pull out all the stops in order to get this deal priced and trading attractively.  I would not be surprised to see the company buying shares heavily after the deal to prop up the price and maintain that the deal was positive.  This would give the Pritzker family more confidence in the investment bank so that when it is time for round two of selling (a secondary offering) Goldman will get the deal and collect the fees.

I would keep indications low if you intend to participate in the IPO.  While profits could be substantial if Goldman does a good job, the risk in this offering is higher than normal.  I would prefer to allow the stock to start trading and establishing a pattern before committing capital.

FD: Author does not have a position in any stocks mentioned.

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Over the past two months, the IPO market has heated up, allowing companies and private investors to access liquidity by selling new shares to the public.  While the performance of these deals have varied from company to company, Verisk Analytics (VRSK) turned out to be one of the better managed, more profitable transactions for investors.  The stock was offered to the public on October 7th at $22 per share and closed above $28.50 on Tuesday for an attractive gain of nearly 30%

The deal was underwritten by Bank of America (BAC) and Morgan Stanley (MS) along with a syndicate of supporting cast.  Although Bank of America was not considered one of the top tier underwriters for the majority of this decade, their acquisition of Merrill Lynch during the financial meltdown has given them access to a large pool of retail and institutional investors which makes placing IPOs and secondary offerings a bit easier.

It is interesting to watch the trend in underwriting fees which used to be incredibly lucrative for these introducing firms.  While the profit margins are still relatively fat, Verisk Analytics only offered the underwriters 88 cents per share for the offering which represents a 4% haircut.  A few years ago, this underwriting discount could easily have topped 8 to even 10% of the offering price.

Looking at the details of the transaction, it immediately becomes clear that the entire amount of the $1.8 billion raised in the offering goes to selling shareholders with no capital actually flowing to Verisk as a company.  This would usually be considered a black mark against the deal, but Verisk is a different animal.  The company was actually owned by a broad assortment of top tier insurance companies including American International Group (AIG), Berkshire Hathaway (BRK.A), CNA Financial (CNA), Hartford Financial Services Group (HIG) and Travelers.

Verisk was created by these insurance companies as a third party risk analysis and decision support vehicle.  Verisk has built a well-recognized skill base in determining risks associated with a number of different industries, and providing decision support tools allowing clients to properly price, manage, and avoid risks associated with their individual businesses.  The decision to spin off the company appears to be an important liquidity event for these insurance companies, many of which could use some additional stability in their balance sheets.

Earnings have been relatively stable over the past five years with Verisk growing pro-forma EPS from 79 cents per share in 2004 to $1.26 per share in 2008.  The first two quarters of 2009 showed attractive growth with revenue increasing by 14% and 16% respectively and earnings up 9% to 16%.  So far there have been no official consensus estimates for the full year or for 2010 due to the fact that so many underwriters were assisting on the deal and they are barred from issuing an opinion on the stock for about 30 days.  Over the next several weeks we should see these research firms quickly initiate coverage and offer guidance for earnings.

The risk assessment business will likely face significant demand over the next several years as Wall Street and Main Street adjust to the new dynamics of a (hopefully) post recession world.  With VRSK now operating as its own independent business apart from the founding insurance companies, the firm should be able to diversify its client base and expand into promising industries.  In fact, the company recently hired Vince McCarthy who has extensive experience in corporate finance and M&A (Mergers and Acquisitions).  The title of Sr. VP – Corporate Development and Strategy indicates that the company is exploring opportunities to broaden its reach and develop new business lines.

Investors in VRSK are paying a relatively high premium for the potential growth.  Currently, the published PE for VRSK is 21 which is in line with Risk Metrics Group (RMG) which operates in a similar field.  I would expect a bit of a pullback in the stock over the next two weeks as the 30 day restriction on trading is lifted and a few investors cash in on their profitable position.  However, the long-term prospects for this industry are very good and I expect VRSK to begin a steady climb once the IPO trading dynamics have played out.  Investors may want to try to accumulate shares near $24 if they have the opportunity with the intent of holding into the $30’s over the next 12 months.

FD: Author does not have a position in VRSK

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The housing market may be dead in the US, but in China there is still significant activity.  As a massive population continues its transition to a higher standard of living, millions of rural Chinese citizens are moving to large cities and are in need of housing.  A real estate bubble may be in the works, but it is certainly a long way from popping.

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E-House Holdings (EJ) is a leading real-estate company serving this growing need.  The firm currently operates a large real estate agency with brokerage services.  It also has a consulting and information services business which allows clients to have access to a huge database of information.  This information will be spun off to investors in a complicated transaction this week.  The new IPO will be China Real Estate Information Corp (CRIC).

Over the past year, CRIC has partnered with Sina Corp (SINA) which is a leading web portal in China.  The strategic alliance has allowed the information division to reach a very wide audience and has developed a strong revenue base.  This joint venture will be merged into the new IPO which means that Sina will be a large shareholder in the newly issued company.

Currently it looks like the deal will raise somewhere between $210 million and $242 million depending on whether the underwriters exercise their options to sell excess stock.  It is difficult to determine just how popular the deal will be with investors as we have conflicting trends to deal with.  On the negative side, the most recent IPO out of China was a big disappointment.  Shanda Games saw its IPO flop with the stock offered to investors at $12.50, but the stock (GAME) is now trading close to $10 – or 20% below its offering.  If investors see that previous IPOs are having a tough time generating profits, they will be more hesitant to buy the next deal.  Underwriters may have to price CRIC at the low end of estimates in order to get the deal done which would be a red flag and also provide less capital to the company and selling shareholders.

On the other hand, investor sentiment appears very robust with the Dow crossing 10,000 for the first time since our financial collapse.  Now the rally may be suspect and I understand that there are serious fundamental flaws, but for short-term trades like IPO issues, healthy investor sentiment is much more important than macro fundamental issues.

Investors in CRIC should certainly hold the IPO with a traders perspective.  At this point there is very limited operating information available, and it wouldn’t surprise me to see some hiccups in the first year as a stand alone company.  I expect that the real estate market will remain firm in China for three to five years, which will provide some support for the company as it begins operating on its own.

If you have a relationship with Credit Suisse, UBS, or Bank of America / Merrill Lynch, you may consider taking stock on the deal.  There will likely be a small pop as the underwriters need to price this one attractively to make up for investor concern following GAME.  However, a week after the deal is priced, I think the best option will be to sit back and let CRIC begin to form a trading pattern and watch for the fundamental picture to mature.  I would rather miss out on a good opportunity today, than commit capital to a risky situation that has the potential for disappointing losses.

FD: Author does not have a position in EJ

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