The IPO was managed by Merrill Lynch / Bank of America (BAC) and Goldman Sachs (GS). With such a diverse retail and institutional platform, one would have expected the shares to be placed in the hands of long-term investors and priced at a discount to allow for an initial increase in the share price.  But the environment for retail stocks has been extremely difficult and institutional investors have been offloading risk at a steady pace this month.  At this point it seems that the selling shareholders got the better end of the deal – liquidating part of their position at $17.00 per share.

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According to the terms of the prospectus, there were roughly 16 million shares sold to the public of which 10.5 million were primary (sold by the company to raise  capital) and 5.5 million were sold by private shareholders.  However, when looking more carefully at the deal, this statistic is a little misleading…

Express essentially DID receive $170 million in proceeds from the deal which it used to reduce outstanding debt.  However, it should be noted that the outstanding debt is actually owed to several subsidiaries of the private equity firm that purchased the brand in 2007.  So after passing briefly through Express’s balance sheet, the funds will then be distributed to the selling shareholders in the form of a debt repayment.  Express will be left with $368 million in long-term debt and roughly $67 million in cash.  The pro-forma balance sheet has stockholders equity at $89 million – which implies a 413% debt to equity ratio – not exactly a solid balance sheet.

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But despite the shaky circumstances with which this stock began its publicly traded days, I expect EXPR to find a floor near $14 and begin to trade higher.  One of the primary reasons is because only a small portion of the stock was actually liquidated in the IPO transaction.  Sixteen million shares were sold to the public, but the number of shares outstanding is closer to 89 million.   That means Limited Brands and Golden Gate Private Equity still hold the majority of the stock and will see the market value of their investment rise and fall with the fortunes of the stock.

Once a private equity firm has begun to liquidate its position, they usually don’t wait too long to follow up by selling the remaining shares.  With the negative reaction to EXPR’s stock there is even more of an incentive for the company to find a “graceful” way of exiting this position.  So it may sound counter intuitive, but one of the best ways for Golden Gate to liquidate the rest of its position is for the company to step in and support the price of EXPR – and if they are going to take this action they need to act quickly!

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Supporting the stock at this time when the market is attempting to rebound will be key.  If EXPR begins to trade back towards the $17.00 IPO price and holds a stable pattern, then Golden Gate stands a better chance of selling its remaining shares in a secondary offering.  But if the stock is allowed to fall from here, there will likely be no market for quite some time.  So the stakes are high and the amount of capital at risk is not trivial.

It may be a little too cute on the trading side, but with retail names showing some relative strength over the past few days, I expect EXPR to be good for a trade higher.  The potential return is somewhere in the neighborhood of 10% to 12%.  But this can be painted against a relatively low-risk backdrop.  If I were to enter the trade later this week, I would place a stop just below $14.75 or so – exiting the trade if the rebound in EXPR doesn’t take place immediately.  Setting up a short-term trade in an improving market with capped risk is one of the better ways to play a short-term rebound and I think the general negative sentiment in the retail area could be temporarily lifted as the illusion of financial stability comes back into this market.

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

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This transaction seemed bound to be a poor deal for investors who were really just funding Apollo’s exit.  And sure enough, the stock dropped from the offering price of $21 down to Wednesday’s closing price of $14.80.  That means investors in the actual IPO lost nearly a third of their capital over just about six weeks.  Of course, the economic weakness and concern in Europe has helped to speed up the decline.

Market conditions continue to improve, as we see increases in customer inquiries and order volumes.  Raw material prices continue to rise and metal prices are following.  ~Lourenco Goncalves, CEO

Analysts are expecting the company to earn $1.16 per share this year compared to a loss of 52 cents last year.  In 2011, the expectations are for earnings of $1.94.  So at the current price below $15.00, investors can pick the stock up for 13 times this year’s earnings and less than 8 times next year’s expectations.  Of course those estimates aren’t a given, but at this point the risks seem more contained with the stock trading at such a discount to the IPO price.

The prospect for the company to be acquired shouldn’t be overlooked.  With MUSA’s market cap now approaching a half billion (from above) the company is well within the reach of larger metal conglomerates wishing to increase their business lines.  Heck, Apollo Group could step in and buy the company again pocketing about $250 million and still owning the same company it started with before the transaction.

Fears of deflation and weak demand cannot be simply overlooked.  But traders who bought on the IPO have likely pressured this stock down to a place where it makes fundamental sense to own.  Investors will have to be patient, but could see a significant return if they weather volatility and hold the stock for 6 to 12 months.

High debt levels may continue to cause concern, but this is standard operating procedure for the capital intensive metal industry.  The company has a healthy level of inventories, productive property and equipment, and has reduced costs to allow for healthy cahs flow into the business.  So despite the macro headwinds, I would cover shorts at this point and consider picking a few spots to add exposure cautiously.

FD: Author does not have a position in MUSA

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Despite the “alternative energy” name, Solarwinds is actually a network company which seeks to identify and solve network performance issues.  The company has a broad client base – boasting 93,000 customers at the end of the first quarter and offers a wide assortment of solutions:

• Network Monitoring
• Configuration Management
• Network Traffic Monitoring
• App & Server Monitoring
• IP Address Management
• IP SLA Monitoring
• Virtualization Monitoring
• Wireless Monitoring
• Network Mapping

I’m not a tech guy by any means, but I can tell you that investors were excited about this relatively new stock because of the broad number of services the company offers, and the potential to cross- sell these services to existing clients.  The idea is for the company to get their foot in the door by selling one service, and then quickly explain why the customer needs a full bundle of services to operate efficiently.

Up to this point, it looks like the company has been very effective in growing its revenue base.  The first quarter showed a revenue increase of 43% over the same quarter last year.  The business was nearly evenly split between license revenue and maintenance revenue.  The maintenance business is a bit more valuable to investors because this is largely recurring revenue with stability quarter after quarter.

But looking at management’s projections, it appears the growth rate is likely to contract considerably – which is a major concern for investors.  For the second quarter, management is guiding revenue of $36 to $37.8 million which is at best a 40% increase over the second quarter of 2009.  For the full year, revenue is expected to be $159-165 million.  This indicates that management is expecting a significant pickup in revenue for the third and fourth quarters in what is known as a “back end weighted” year.

Essentially, management is asking investors to take a “leap of faith” stating that revenues will be in the mid 30 million level for the first two quarters – and then the high 40 million range for the third and fourth quarter.  Unless there is a particular contract that management expects to land – and the timing is very specific, it would seem that the back-end weighted guidance is sketchy at best.

Despite the 15% drop in Tuesday trading, the stock still appears to be over-valued based on earnings expectations.  Management is guiding analysts to expect 72 to 75 cents per share this year which only represents an increase of 15%.  But at $20.50, the stock is trading at 27 times the high end of guidance.  This multiple might be reasonable for a stock in the middle of a strong growth period, but with heavy competition, disappointing growth projections, an extended and vulnerable market, and a technically broken stock chart; the risks seem to far outweigh the potential benefits of owning the stock.

Shorting SWI today may be a bit premature.  With the market likely to at least stage a rebound attempt from the sharply negative trade today, I wouldn’t be surprised to see SWI consolidate or even trade back to the $22-23 range.  But with the technical breakdown we have seen today and the potential for more selling as managers become less confident in the recovery, the stock will remain on my short list and could potentially trade back down to the IPO price of $13.

FD: Author does not have a position in SWI

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While at first blush the prospectus states that the shares are primary (with the shares being distributed to the company) further reading highlights the fact that private equity holders will actually retain the majority of funds from this transaction.  In no more than 60 days, the company is required to make an offer to purchase Payment In Kind (or PIK) notes which are held by the asset manager Apollo Group and some of its subsidiaries.  So while all the information is public, it appears this is a bit of a stealth deal to allow Apollo to cash out.

At this point there is still significant incentive for Apollo Group to support the stock and also provide MUSA with the necessary support to grow its business.  While 11.4 million shares were offered to the public, a full 37 million shares are outstanding with Apollo Group still owning a majority position.  I wouldn’t be surprised to see these additional shares hit the market later in the year – especially if equities markets continue to price in a recovery scenario.

Metals USA is an industrial company which is heavily dependent on sustained economic growth.  In the prospectus, management indicated that they expect demand for steel products to increase alongside improving general economic conditions.  The company believes that its customers are continuing to operate with low inventory levels which could bolster demand if these inventories are rebuilt.

To show how economic conditions affect this company, consider the wide swings of the last three years.  In 2007, the company collected $1.8 billion in revenues and produced 55 cents in earnings per share.  2008 was an even better year with revenues of $2.2 billion and earnings of $2.87 per share.  But 2009 was quite a challenge – revenues were cut in half to $1.1 billion and through cost cutting and managing expenses MUSA was able to generate just 14 cents per share.

Improving trends this year should push earnings higher but we are unlikely to see returns similar to 2008.  It is very difficult to forecast future growth because manufacturing and broad economic conditions are so unpredictable.  But lately the price of steel has been rising and competitors like US Steel (X) are expecting strength in 2010 and a much more profitable year in 2011.

MUSA operates three primary business segments

• Plates and Shapes accounted for 47% of 2009 sales
• Flat Rolled and Non-Ferrous commanded 45% of revenue
• Building Products is much smaller with 8% of revenues.

Looking through the prospectus materials, it is clear that the company has been slowly working both its inventory and its debt level lower.  This should provide a more stable fiscal foundation which is encouraging for shareholders.  But the failure of the IPO deal and the overhead resistance from Apollo’s shares which could eventually be dumped on the market will likely keep this stock lower.

As I write Thursday, the stock is trying to rally a bit and very well make a run back towards the IPO price.  If it reaches $20.50 or even $21, I will be interested in setting up a short position.  The position would not be entered until the stock began to fall again, but using a sell stop to get short and a tight stop above the IPO price, there is a good chance that traders could capture $2 to $3 in profits quickly, while only risking about $1.00.  Timing is critical and it might take more than one trade to get it right, but busted IPOs are some of my favorite short opportunities to pursue.

FD: Author does not have a position in MUSA

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Calix Networks is a provider of communications equipment to what the company calls CSPs or “Communication Service Providers.”  The equipment helps telecom companies make better use of their networks, be they copper or fiber.  In the offering prospectus, the company laid out several issues that the products are meant to assist with.

• Service Offerings – Calix products are able to help telecom companies offer a broader array of services to their customers.  Many networks were originally designed to only provide voice or limited data to customers.  The products offered by Calix helps to increase the number of services telecom companies can provide.
• Capacity and Efficiency – With the demand for data increasing an exponential rate (think streaming media, video conferencing and other feature rich applications) telecom companies are seeing their networks strain to handle the traffic.  Calix products can help with this – allowing customers to upgrade networks at a moderate pace when capital is available.
• Technology Flexibility – There are many different protocols and technological means by which voice and data flow.  Calix products allow networks to efficiently communicate with each other even when different or conflicting technologies are being utilized.
• Customer Value – The end goal is to provide a value for CSPs technology that will allow for flexibility, lower costs and better returns on their capital expenditures.

While the business model certainly sounds respectable (and the company has already shipped 6 million “ports” to roughly 500 customers) investors are being asked to take a leap of faith.  The fact that the company has yet to post a profitable year has raised concern and will likely be discussed more as CALX continues to trade above its offering price.

Typically, I would agree with this discussion except for the fact that CALX appears to have a good shot of generating strong earnings in the next two years – if management can grow its business responsibly.  On top of the potential for fundamental improvement, we are currently in a very speculative market where traders are looking past fundamental barriers.  So when speculative issues rise, expect CALX to be one of the go-to names for generating higher returns.

The Fundamental Picture

Looking at the financial data from 2009, the company generated a gross margin of 33%.  So before covering expenses like R&D, Sales and Marketing and the catch-all General and Administration category, CALX actually turned a $77 million dollar profit.

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Now assuming the company is able to generate 30-35% annualized revenue growth over the next two years, maintain a 33% gross margin, and keep operating expenses at a stable level, the company could come very close to reporting $1.00 per share in EPS for 2011.  If this were the case, CALX would likely see its stock trade at a multiple north of $20 – good for a 50% increase from today’s price.

I understand that this scenario may not play out perfectly.  Sales growth could be much higher or much lower.  Management will almost certainly increase operating expenses as the company grows.  But the company is at a very dynamic point where earnings are just beginning to turn positive (forth quarter EPS was positive $0.08 per share) and the actual dollar earnings per share could ramp up significantly in the next few years.

The stock is now trading just above the $13.00 IPO price and the reputations of Goldman Sachs (GS) and Morgan Stanley (MS) are on the line.  Trades could be initiated here with a tight stop below the IPO price as the brokerages will likely step in to support the deal if the stock gets close to this level.  Initiating a trade with a relatively small amount of risk and potentially large returns is a good way to initiate small trades at this time, and one could quickly increase position size as the trade moves into positive territory.

FD: Author does not have a position in CALX

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The ample liquidity has allowed new companies to raise capital to build their businesses, and has also allowed private equity investors to unload positions at a profit as the public market snaps up shares.  Last week Citigroup (C) took the position of a private equity player by selling a large portion of its position in Primerica Inc. (PRI).  The stock was issued to the public at a price of $15.00 and quickly began trading near $20.

Investors are likely very happy with their 30% plus gain in a single day and it looks like Citi may have sold itself short, as it could easily have collected $17 or $18 for the stock and still made investors very happy.  Fortunately for the company, it still owns roughly 40% of the company so it should be able to write up the value of its holdings.

The transaction has certainly benefited Citi as the company was able to raise roughly $300 million.  That number is actually very conservative because as part of the convoluted transaction, Citi issued warrants to Warburg Pincus LLC, and also was the lead underwriter for  the stock – meaning Citi was able to keep a large portion of the underwriting discount usually paid to brokers who place IPO stock.

Primerica could be considered a “low-tier” financial services company whose primary business is selling life insurance.  The target client includes middle income families with $30,000 to $100,000 in annual income.  The prospectus lists these client as:

• Having inadequate or no life insurance coverage
• Needing help saving for retirement
• Needing to reduce consumer debt
• Preferring face-to-face meetings for financial decisions.

While this target market covers a large percentage of households (Citi estimates the demographic at 50% of US households), the margins on this segment of customers is usually relatively low.  That is why Primerica was considered the perfect solution for Citi – allowing middle income households to be served by Primerica while the Citi financial professionals focused on the bigger and more profitable clients.

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The problem that I have with the Primerica business model is that the representatives often take a multi-level marketing approach to building their client base.  In the prospectus, Primerica speaks of “independent entrepreneurs” who are responsible for building and operating their own businesses.  These representatives are classified as independent contractors and are not official employees of Primerica.  Many of these “financial representatives” are part-time workers and Primerica actually encourages this aspect in order to attract more representatives.

The end result is that many of these representatives have little experience, a deficient knowledge base, and may not be giving the best advice to clients who need financial information.  While there are of course exceptions, Primerica has become known as the “Amway” of financial services – a reputation Citi would like to distance itself from.

I must say that I am a bit surprised at how well the IPO has been accepted by the market.  Financials are still a bit sketchy as it is difficult to understand the pro-forma numbers presented in the prospectus and account for the adjustments.  Below is a flowchart of the organizational structure which shows the convoluted state of the offering.

With this much complexity, I would avoid buying the IPO at this point as the market hates uncertainty and once the hype of the IPO wears off the stock could drop quickly.  Farther down the road, I expect Citi to unload the rest of its  shares and Warburg will likely exercise its warrants and liquidate the shares as well.

Aggressive traders might consider shorting below $19.60 but don’t get too greedy.  Citi will defend this stock vigorously as they still have a vested interest in the deal working.  So the stock could drop to $17 or even $16, but the IPO price is important for Citi to defend so I would expect them to start buying aggressively at the $16 level.

Typically an IPO that trades well out of the gate is likely to continue its positive trend.  But Primerica is a different animal and I wouldn’t put too much confidence in the positive initial reaction.

FD: Author does not have a position in PRI

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Today, I want to take a closer look at MaxLinear Inc. (MXL) which was priced Wednesday at $14.00.  The book was jointly managed by Morgan Stanley (MS) and Deutsche Bank Securities (DB) in a deal which provided underwriting commissions of $6.3 million.  The stock was well accepted by investors who immediately sent the stock up 33% in its first day of trading to close at $18.70.  The positive traction is likely giving private equity companies such as The Blackstone Group (BX) additional confidence as they prepare additional offerings which could quickly hit the US exchanges.

Part of the appeal for the MXL deal is that the majority of shares being sold to the public were primary shares.  This means that the proceeds went directly to the company which should be helpful in providing the financial ability to continue to generate growth.  According to the prospectus, MXL will use the cash for “working capital” and possibly for future acquisitions.  I would prefer to see a bit more information on how this capital could be put to work, but since the company has shown strong historical growth, I’m willing to give them the benefit of the doubt for the time being.

MaxLinear is a “fabless semiconductor company” which designs chips that allow devices to better receive wireless television signals.  The majority of the company’s sales have been in Japan where it appears that MXL has a lock on the mobile handset market.  In the last four quarters, the company has seen sales increase by 49%, 13%, 107% and 96% (using year over year comparisons).

In addition to the handset market, MXL is increasing its product offering to include chips that enable devices to receive wireless signals for more traditional television viewing.  These products are anticipated to go in cable boxes, digital televisions, PC’s and notebooks.  While the handset market continues to provide stable cash-flow, these new markets are expected to drive the growth in future quarters.

When we say that MaxLinear is “fabless” it simply means that the company does not have its own manufacturing facilities.  This can be both a business strength as well as a liability.  During the financial crisis, many firms struggled under the weight of the debt used to build large manufacturing plants.  For several solar companies, the decision to expand manufacturing capacity at the wrong time turned out to be fatal.  So MaxLinear’s decision to outsource the manufacturing process gives the company better financial flexibility to be able to focus on research and development and growing other parts of its business.

But the flip-side of this coin is that if the economy improves to the point where it becomes difficult to negotiate contracts with outside manufacturers, MXL could see its costs rise exponentially.  The laws of supply and demand can easily come back to bite the firm if it is not accurate in its long-term projections of customer demand and its need for manufacturing capacity.

After staging a positive IPO transaction, MXL has largely been biding its time and trading within a relatively close range.  This week we will begin to see some patterns developing and from a trading perspective, it will be interesting to see what opportunities set up.  Due to the success of the IPO transaction, it appears demand is in control at this point and I would recommend trading from the long side initially.  A pullback closer to the IPO price would provide a welcome entry point and risk can be carefully managed by placing a stop slightly below the $14.00 IPO price.

On the other hand, if MXL were to break higher – crossing $19.50 – a higher-risk breakout setup might be in order.  The risk is higher in this type of trade because there is less of a defined floor that would be supported by the underwriting team.  When buying above $19.50, traders should look to use a stop where they would exit the position if MXL trades back into its current range.

Fundamentally, it is very difficult to set a fair valuation for the stock.  This is because MXL is just crossing the line where its revenue overcomes fixed expenses and the company is starting to show a positive profit.  There are many variables which could cause MXL to ramp up its profitability sharply over the next two years, or possibly cause it to over-extend and lose value for investors.

So for today, it is important to determine who is trading this vehicle and what these traders are looking at.  Currently, MXL is being largely held by growth stock investors who currently appear willing to give the global economic rebound the benefit of the doubt.  As long as these investors continue to provide liquidity and are willing to pay speculative prices for future growth, MXL should stay in a positive trend.  But when the tide turns and growth investing falls out of favor, MXL will likely be hit with distribution – and at that time it might make sense for us to set up a short position.  The stock is dynamic – positive for now – and offers swing traders ample opportunity for profits.

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

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As the market trends higher and investors gain more confidence, business owners and private equity firms are increasingly tapping into the available market liquidity.  The opportunity at this point is for businesses to raise capital through an IPO transaction, selling shares of the company to the general public.  Private equity firms which own and manage individual companies are also cashing in.  A market of willing buyers allows the private equity managers to sell portions of these companies (or the entire company) and often realize healthy profits on their initial investment.

But how exactly does this process work?  As a fund manager who focuses on new issues, I have seen hundreds and participated in dozens of these transactions.  While there are often many moving parts and more than a little “slight of hand,” the IPO transaction is a fairly simple concept to grasp.  And whether you are a business owner or an investor, you should be aware of and understand the basic building blocks of this type of transaction.

The Cast of Participants

In order for a company to start trading on the public exchanges, there are basically three parties who are instrumental in the process.  The seller is the party distributing the shares and receiving the capital.  The underwriter facilitates the transaction much like a broker would facilitate a real estate transaction.  Finally, the buyers actually pay for the newly issued shares for the company.

So let’s look at each of these parties a bit more carefully.

Sellers Seeking to Raise Capital

When I look at an IPO transaction from an investor perspective, one of the most important questions I ask is who is selling the shares?

Usually, I am most excited about participating in the IPO when the shares are primary or being sold by the company.  This means that the capital that I pay for the stock goes largely back into the company which allows for growth.  The capital can be used to expand the sales force and pay their salaries, it can be used to expand a plant or facility that allows for better production, or it can be to pay down debt to make the financial foundation more stable.

The more specific a company can be about what they are doing with the capital, the more confident I can be that the money raised will be put to good work.  Too many times a selling firm will announce that the capital will be used “for general corporate purposes.”  That simply means the management team is asking for a blank check to spend however they see fit.  Not exactly a great way to instill confidence.

Other sellers can include the company’s founders, a private equity firm, or a wealthy individual or trust who has previously owned all or a large portion of the business.  While I understand that these parties need to sell at some point to monetize their investment, I’m instinctively uncomfortable with a current investor selling shares to the public.  Since in this case the seller knows more about the inner-workings of the company than I could hope to learn in a few weeks time, I’m curious whether he or she sees a problem and that is motivating them to liquidate.

Whether a private equity firm or an individual investor is selling shares in the transaction, there are a couple of things that can be done to make the deal a little more appealing.  If the seller retains a large portion of their investment, then I can feel confident that they still believe in the future of the business – but they just want to begin collecting capital from their success in building the company.  I understand this need and if they still stand to benefit or lose from the ongoing success or failure of the company, then I am a more willing buyer.

A second way for sellers to make the deal more appealing would be to issue a mix of primary and secondary shares.  This way the company is still receiving part of the money from the transaction and the sellers are liquidating a portion of their holdings as well.  This way there is still a reason to expect the company to benefit from my investment and the selling parties receive an opportunity to monetize their investment as well.

Underwriters Introduce Buyers and Sellers to Each Other

Underwriting firms are usually well known brokerages such as Goldman Sachs, Merrill Lynch (now a division of Bank of America), Morgan Stanley and similar firms.  In recent years, the number of top tiered underwriting firms have decreased as a result of the financial crisis.  But there are still plenty of niche boutiques which also have the ability to act as underwriters for IPO transactions.

The underwriter is responsible for putting together the prospectus which is an offering document with all of the pertinent information that investors need to make an educated decision as to whether to invest or not.  Typically, underwriters are part of a brokerage firm which will service a number of institutional and retail investment accounts – thus bringing the buyers into the picture.

After performing due diligence on the company, the underwriter will determine a “fair market” price range for the IPO.  This is based on their assessment of the profitability of the business, its risks and growth expectations, and the price at which similar investments are trading for in the open market.

Once an acceptable price range has been established, the underwriters will then turn to the buyers to place the stock with willing investors.

Usually there is more than one underwriter working on a deal.  The LEAD underwriter is usually the firm responsible for performing the due diligence and determining the acceptable price range.  Secondary underwriters are simply brought in to help place the deal.  Since it is important to have a broad number of investors in the stock, underwriters usually work in teams to distribute the stock to a wide assortment of investors.

The underwriting firms are typically paid very well for their assistance in getting the stock distributed to investors.  Typically the underwriting fees are between 6% and 10% of the stock price, so if a company is selling 30 million shares at $14.00 per share, the underwriters could split between $25 million and $38 million.  Underwriting fees can often make up a large portion of revenue for a company like Morgan Stanley.

Buyers Invest In an Unproven Vehicle

You’ve probably heard that the average investment return is highly correlated with the risk taken.  While I don’t think that’s an absolute truth, there is a certain amount of return an IPO investors should expect due to the risk he is taking.  After all, there has never been a market for this stock before and the buyer is being asked to trust the underwriter’s “fair market” valuation of the company.

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Since as a buyer, I am putting my investors capital at risk on an unproven stock, I expect the deal to be profitable immediately.  Underwriters understand this dynamic and so they are constantly trying to please both their buyers and sellers.  After all, they need both parties in order to generate their fees.

So IPO transactions are usually priced with the expectation of being a bit below the expected market price.  That way buyers are pleased with their transaction and are willing to come back the next time the underwriter has a new IPO to pitch.  But if the IPO pricing was TOO low and the stock jumps 50% or 100% from the pricing immediately, the sellers could become angry because they could have received a better price for their stock.  So there is a fine line, but the pricing of the transaction usually favors the buyer.

Buyers of IPOs are typically institutional investors, although it’s not impossible for retail accounts to participate in many of these transactions.  Underwriters typically approach the buyers with information about the stock, the expected price range, and maybe some color as to how much demand there is for the stock.  Buyers will then offer an IOI or Indication of Interest, stating how much stock they would like to buy when the transaction is completed.

When indicating for a particular stock, I am always interested to know how much stock the underwriter believes he can get for me.  There is a bit of reverse psychology at play here because if the underwriter says “this is a great stock and the best news is that I can get you all the shares you want!” then I quickly become nervous that the demand is very low.  However, if the story is “We don’t have much of this one available,” then I am much more interested because it is likely that demand will drive the price higher once the stock begins trading.

After the Process Is Complete

You might think that once the sellers have received their capital, the underwriters have collected their fees, and the buyers begin trading the stock, that the process is over.  However, just like a baby, the newly issued stock still needs some care to survive to maturity.

Underwriters have a definite incentive to make sure IPO transactions work and the stock remains a viable investment vehicle.  After all, they want to make sure that sellers look them up when they have a company to sell to the market, and the only way buyers will stay interested is if the IPO continues to trade in a positive manner.

So it’s a loosely guarded secret that many underwriting firms “support” the stock in the first few months of trading.  That simply means that when and if the stock trades back towards the offering price, the underwriter very well may place large buy orders in the market to keep the stock from falling below the IPO price.  If you look through the charts of a dozen recent IPOs, you will probably see 6 or 8 of these stocks which trade right down to the IPO price and then mysteriously find support.

Another issue is the research process.  Since many investors are hesitant to invest in a stock without receiving a few second opinions from analysts, it is important for these stocks to catch the eye of research departments in various investment firms.  Ironically, the underwriters usually know the most about these companies because of their due diligence process, and yet the underwriters are restricted from offering analysis for a period of time after the offering.

But once that “quiet period” is over, you will often see several underwriting firms issue reports on the newly issued stock.  More often than not, the analysts will have a “buy” rating on the stock which helps to attract more buying interest and once again beef up the stock.

A word of caution here:  If an IPO breaks below the offering price, the risk immediately becomes exponentially higher.  At this point every investor in the IPO transaction is now under water.  There are exceptions, but usually a break below the IPO price leads to massive distribution which can take days, weeks, or even months to run its course.  This is where the risk comes in and while it may be frustrating to sell an IPO at a loss within the first few days, there is a very real risk that the loss will get much worse.

Opportunities and Risk

So IPO transactions offer exceptional opportunities along with material risks.  As a primary buyer, it is important to have a strong relationship with an underwriting firm (or several underwriters if your account size is large enough).

There is opportunity to participate in many of the gains just by investing in IPOs after they have begun trading.  These stocks are usually very dynamic with wide swings and attractive trading opportunities.  But remember to keep your trades sized smaller than a typical established stock because of the large swings associated with unstable supply and demand dynamics.

IPO transactions can be an excellent way for traders to generate returns provided appropriate risk controls are in place.

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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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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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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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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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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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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 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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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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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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Macau is the only Chinese territory that explicitly allows gambling.  And the demand for gambling has been overwhelming.  Two of the major players in this market are Las Vegas Sands Corp (LVS) and Wynn Resorts Ltd. (WYNN), each of which have made significant investments in developing properties in Macau.  The debt level for each company has increased tremendously in order to fund these investments, but despite a near brush with death for LVS, both companies appear to be on the mend and should grow profits tremendously as their Macau properties come online.

The Chinese government has helped to create an enticing appeal for the region by restricting travel.  Originally, Chinese citizens were only allowed to visit Macau once every three months.  The restrictions helped to keep the region under control as the infrastructure simply wasn’t robust enough to handle the millions of visitors that would have otherwise visited.  Now that the region has beefed up its infrastructure the government allows citizens to visit the area once every month which should allow traffic to  increase more.  China is not immune to the global recession, but the limited supply of gaming should help businesses in Macau to continue to see heavy traffic.

Last week Wynn Resorts offered shares of its Macau subsidiary to investors on the Hong Kong exchange, raising roughly $1.6 billion in new capital.  The funding more than covers the capital needed to fund the $700 million dollar Macau hotel which is expected to open mid-year next year.  The new location should be a gold mine for new revenue with lodging, shopping and of course gaming available to visitors.  Investors are likely to see a sharp rebound in earnings which is why the stock has see such a tremendous gain since the March low.

Looking at the WYNN stock price in comparison to the current earnings, one could easily determine that the shares are over-priced at a listed PE of 129.  However, looking at the entire picture including the trough historical earnings due to economic decline, a significant new property coming online in the next several months, and a balance sheet that is quickly improving; you might come up with a very different opinion of the stock.

There is no doubt that investors are beginning to have a more optimistic view of this consumer driven company.  But despite my aversion to most retail driven investments, I believe WYNN could offer significant value for investors today.  Granted, I would like to buy the stock closer to $55 or $60 (and I may get that opportunity in the next few weeks), but I do believe the earnings power could be tremendous looking out to 2011 and 2012.  Keep in mind the stock price will likely discount an earnings recovery well before the fundamental numbers are actually reported.

In 2007 when consumers were still freely spending, the company reported earnings of $2.97 per share.  Now most of this revenue was from properties in the now depressed Las Vegas region.  However, the new location in Macau along with even a slight uptick in Las Vegas traffic could quickly put earnings at a new high level.  If this were to happen, investors would quickly be willing to pay 30 or even 40 times earnings due to the incredible growth.  That could result in a stock price of $120 or more and I could see this happening in the next 12 to 18 months.  The main question is whether Macau will continue to see healthy traffic and spending.

Since China is desperate to continue to show positive economic growth, I would expect restrictions on traveling to Macau to continue to be light – or even lifted altogether.  Wynn already has a strong foothold in the region and will likely increase its market share of a growing business region.  So it appears the stock may be fairly priced and I would suggest building a position over the next several weeks.

FD: Author does not have a position in WYNN

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Leading up to the deal, it appeared that the spin off was going to be a positive catalyst for the company.  A separately trading gaming ADS would allow investors to concentrate their capital in the fast-growing portion of Shanda’s business, and since the parent company retained 71% ownership in Shanda Games (and 96.08% voting rights), investors in SNDA still retained the ability to participate in the long-term growth.

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Unfortunately, it looks like the underwriters botched the deal which is unusual for Goldman Sachs (GS) who was the lead.  The number of shares offered to t he public increased by 20 million as the deal neared completion, and the underwriting discount may have been a bit too much for the current environment.  Goldman and the other underwriters received roughly 78 cents for each share they placed with investors – a tidy sum when you consider more than 83 million shares were placed.  Underwriting has typically been a very strong business for investment banks, but in today’s market we may eventually see margins on these transactions come under pressure.

Shares of GAME were offered to the public at $12.50 per share, but at the end of the first day of trading they closed at a disappointing $10.75.  Monday the shares made up a small bit of the loss and the stock is flat to positive in early trading on Tuesday.  But the bottom line is that the transaction was relatively disappointing and with a lower stock price on GAME, it will be more difficult for SNDA to sell more shares if it so chooses in the future.

The stock price in SNDA took a similar hit on Friday and we are likely seeing two forces at work here.  First, you have the lower market value for the gaming portion still owned by the parent company.  Fluctuations in GAME will have a very real affect on the value of SNDA because the parent company still owns 71% of the spin-off.  The second issue is that investors who want pure exposure to the gaming side of Shanda’s business are likely to be selling the parent company and buying GAME over the next several weeks.

Despite the negative initial action in GAME, I think that the stock will offer investors a great opportunity in the coming weeks and months.  Online role playing games are attracting a growing customer base and China is the epicenter of this movement.  Shanda Games has a strong pipeline of new features for existing games as well as completely new games which will likely drive future revenue.  The stock is not cheap based on historical earnings attributed to the spin-off, but the valuation is also not unreasonable.  Future growth even in a difficult economic environment should attract investor attention and lead to a higher multiple.

I think GAME is worth pursuing, but would wait for the stock to re-take the IPO price.  There is a chance that the stock could wash out a few more holders and if the selling gets extremely heavy, we may be able to pick up shares at a much better discount.  So for now it is a waiting game with the intention of buying when it breaks above the IPO price ($12.50) or starting a small position if the stock experiences heavy selling (likely down to $9.00 or so).  This is a risky name and will likely have plenty of volatility, but it is also an opportunity for very strong returns.

FD: Author has a position in SNDA in the ZachStocks Growth Model

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The IPO market (Initial Public Offerings) has been dormant for quite some time now.  While it used to be normal to have between 250 and 500 new offerings in any given year, 2008 saw just 43 deals priced.  So far this year there have been closer to 20 which indicates just how illiquid our equity markets have become.  When the market is in turmoil, it is very difficult to convince investors to take a shot on an untested, never been traded before, new public company.

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Many small and mid-cap companies rely on IPO transactions to provide much needed capital as they build their business to a sustainable size.  Often an entrepreneur will begin to build a business by putting up his own personal capital and then seek private funding along the way.  But when the company reaches a certain critical size, the best option for additional financing may be to sell a portion of the company to the public.  This type of transaction not only provides the company with an initial capital infusion, but often gives the brand name more recognition, and allows for future capital raises as the market is already established for the stock.

An IPO transaction benefits many different market participants as underwriters (usually well known brokerage firms) are able to collect very lucrative fees for assisting the company in placing the stock with investors.  Even the exchanges see a benefit as the NYSE or NASDAQ typically charge a listing fee and then also benefit from having the volume trade on their exchanges for years to come.  In late August, NYSE Euronext (NYX) announced that they would be reducing fees charged for new stock listings which will put the big board in a more competitive position with NASDAQ.  There are some that believe this move will cheapen the NYSE brand, but the chance certainly shows that NYSE has a desire to capture market share in what could be an interesting fall for IPOs.

Investors stand to reap potential windfall gains at least for the first few transactions that are brought to market.  This is because the general public is still a bit gun shy about buying untested stocks and will likely be hesitant until a few successful deals are made.  The underwriters know this and so it will be paramount for them to make the next few transactions work.  In order to do this, the underwriters will likely take a close look at what each equity should trade at and then apply a significant discount to the price.  So if based on earnings and the economic outlook, they believe that the market will pay $35 for a stock, it’s not unreasonable to think that they will offer the stock in the low $20’s just to make sure the deal works.

After a few IPOs that are offered at $22 and immediately trade to $33, investors will be a bit less skeptical and then the underwriters can begin commanding a price closer to true market values.  But for the next two to three months, the deals should be slanted in favor of investors.  Underwriters are desperate for the deal fees and many small companies have been waiting months for a chance to sell to the public.  So based simply on which parties are motivated, investors appear to have the upper hand.

Secondary offerings may also provide some attractive opportunities.  A secondary offering usually occurs when a public company sells additional shares to the market to raise capital for some purpose. Similarly, sometimes a large shareholder of the company will offer to sell a portion or the entirety of his holdings.  Either way, there is usually an announcement ahead of time stating that the stock will be sold to the public.  Then overnight, the underwriters determine an appropriate price and distribute the shares to buyers who have expressed an indication of interest or IOI.  The next morning when the stock begins trading these new shares are included in the mix and can be bought and sold.

There is often a unique opportunity to trade around these secondary offerings because the stock is often offered to investors at a discount to the closing price (this is how underwriters can garner enough interest to get the block of stock sold).  So an opportunity usually exists to hedge your expected position the afternoon before the deal comes out, and then pick up stock at a discount on the offering.  In this case, the key is to have a good relationship with your underwriter in order to make sure your hedge matches your allocation the next morning.

As we enter the last four months of the year, there should be some very interesting opportunities setting up from both the long and the short side.  If you would like help in crafting an investment approach to capitalize on unique opportunities such as IPO and secondary offerings, please send me an email and I will be happy to discuss some options with you.  Wishing you every success!

FD: Author has a position in NYX in the ZachStocks Growth Model

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I’m always puzzled as to why investors would get excited about buying such an offering on the IPO transaction.  Basically, when one of these securities is launched, there is an inherent dilution to investors which is much more pronounced than in a typical IPO.  Essentially, Starwood Property Trust is a brand new company and the capital put up by investors will be used to buy commercial mortgage loans and other commercial real estate debt investments.  In actuality, only 94% of the dollars raised in the IPO process will be available for the company to invest in these opportunities.  That’s because out of every $20 per  share that the company raised, $1.20 was paid out as an underwriting discount.  So in actuality, Bank of America (BAC), Deutsche Bank Securities (DBK), and Citigroup (C) were the primary beneficiaries of this deal.

Looking forward, investors who own STWD are expecting the firm to be able to buy these mortgage assets on the cheap and collect attractive interest payments while waiting for these loans to either mature, or be sold at a gain once the commercial real estate market improves.  And even though the stock is down 50 cents from the offering price, this still shows investor confidence, because remember STWD only received $18.80 per share on the offering.  And don’t forget that there are expenses such as office space, technology, and salaries which must also be paid out of the proceeds.

There will certainly be an opportunity for purchasing mortgage securities on the cheap during times of fear and making huge returns when they perform better than the drastic expectations.  But I believe we are pre-mature on that front for commercial real estate.  ZachStocks has continued to discuss how rising unemployment and weak consumer spending will characterize our economy for some time to come.  As these challenges continue to weigh on individuals and businesses alike, we should see more retail store closings, office leases broken or at a minimum not renewed, and general cost savings in place.

The commercial real estate opportunities are 6 to 18 months out.  There may be some opportunities now, but as we saw in the residential market, the real opportunities don’t become available until we have severe stress in the area.  In the fourth quarter we should see volume increase in residential bank transactions, and that volume is still some time off in the commercial market. ~Matthew J. Reidemann, President Ashford Capital Partners, Inc.

This type of environment could be devastating for all but the most liquid and capitalized commercial mortgages.  And the healthy securities will not be the ones with attractive prices which Starwood will want to purchase.  So as Starwood puts this new capital to work, management will have to be very careful to chase only the strongest opportunities which may very well hold the lowest returns for investors.  And as markets once again become volatile, there is a very strong possibility for STWD to trade at a discount to NAV.  Currently the premium to the $18.80 NAV actually implies significant risk.

So with REIT transactions which include hefty underwriting discounts, the smart money usually waits until the IPO hype has worn off before stepping in to buy.  Once that froth is taken off, the next move is to determine the long-term profit potential for the REIT.  In the case of Starwood, this looks risky.  Finally a wise investor will purchase at an appropriate time where he can put his dollars to work at a discount.  I believe we will see that opportunity when STWD hits the $14 to $16 range depending on how the market evolves.  Shorting the stock is likely to be a tedious and frustrating endeavor.  But for those interested in the investment, I would wait for a much more opportunistic period to buy.

FD: Author does not have a position in STWD

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On the block for a possible offering this week is LogMeIn, Inc. (LOGM) which is the primary provider of on-demand remote-connectivity solutions to small and medium sized businesses as well as individual consumers.  Essentially the technology allows users to log onto their home or office computers from any web browser, making sure that all data is easily accessable and yet still providing for secure connections in order to protect sensitive information.  There are several tiers of service offered including a basic free service all the way up to delux permium products.  As of March 31, the company boasted 188,000 premium accounts and continues to grow their subscriber base very quickly.

The LogMeIn IPO is expected to raise about $67 million for the company assuming the stock prices in the middle of the $14 to $16 expected range.  In addition to the 5 million shares being sold by the company, an additional 1,666,667 shares will be sold by existing shareholders which largely include private venture capital firms as well as company executives.  At this point it looks like the executives are selling a reasonably small portion of their holdings which helps investors maintain confidence that the executives have an incentive to continue to grow the business.

While the remote-connectivity concept is very useful and popular (especially for road warriors and those of us with dual home / business offices), only recently has LogMeIn been able to capitalize on its success and post a profit.  Looking into the financial statements it is amazing to see how much money the company spends on sales and marketing.  In 2006, the company spent 88 cents in marketing expenses for every dollar received in revenue.  But the efforts appear to have paid off with revenue growing by 139% in 2007, 91% in 2008, and 73% in the first quarter of 2009.  As revenues have caught up with high fixed costs, the company is inching closer to profitability with the first quarter actually posting pro-forma EPS of 0.10.

Although the growth is impressive, the price tag on the LogMeIn IPO may be a bit excessive.  Analyst expectations are still hard to come by, but annualizing the first quarter numbers, it is likely the company will earn 40 to 60 cents in 2009.  With the stock price likely to start near $15, the PE will be roughly 30.  When the market is healthy, multiples of 30 on growth stocks are commonplace and often expand to much higher levels.  But in an environment where consumer and business spending is constrained, it is likely that this multiple could prove a bit dangerous.

The company has relatively little debt, so the threat of default is not an issue for investors.  However, the expanded advertising budget could quickly burn through new cash if corresponding revenue does not continue to flow.  The technology sector is highly competitive and LogMeIn believes that it will face threats from similar services in the coming quarters.  There is no guarantee that the company will be able to maintain its leadership in this niche business, especially with companies like Citrix Systems, Inc. (CTXS) and and Cisco Systems, Inc. (CSCO) using deep pockets to develop and promote similar products.

The lead underwriters who handle the LogMeIn IPO are set to be JP Morgan and Barclays Capital which are relatively well respected firms.  Thomas Weisel Partners, Piper Jaffray, and RBC Capital Markets are also on the deal ensuring that there will be a relatively wide distribution for the new stock offering.  With the market starting out higher this week, I wouldn’t be surprised to see the deal come at or above the high end of the range ($16 or above) and possibly trade up from that level on the initial deal hype.  These underwriters often do a good job of creating a perceived shortage of stock on the deal which can lead to more buying pressure on the day the IPO is launched.  But once the hype wears off in the following few days, LOGM will likely be vulnerable to a quick negative move.  At that point, any additional weakness in consumer spending or in the broad markets could push the stock down to the low teens or even single digits.

So while the LogMeIn IPO may generate some near-term buzz and help to develop confidence in market liquidity, the deal appears a bit dangerous and I would not recommend holding deal stock beyond the first few days of trading.

FD Author does not have any positions in LOGM and does not have immediate plans to participate in the deal.

The last few months have been very dry for IPO investors.  As investors have shunned risk and the economy has faltered, it has been very difficult for new companies to find willing buyers regardless of the quality of operations or profits.

But with the rebound in the market has come renewed interest in new issues.  A few recent successful offerings may prime investors’ appetites.  At the same time, a number of companies have been waiting for a window in the market where they can go public and raise the necessary capital to grow their business.

So as the potential for new deals to price grows, investors need to be aware of the three most important dynamics surrounding every IPO.  These dynamics shape how the shares are distributed to investors and can give you a clue as to how the stock will trade following the offering.  Proper use of these clues could help you land a stock with the ability to post triple digit returns in a short period of time.  So let’s take a look at these dynamics and how you can claim your profits:   (Please request your full copy of this special report)

In this special report we cover:

• Who is Selling and What is Their Agenda?
• Who are the Underwriters and What is Their Role?
• What Pricing Dynamics Tell You About Future Trading.

A little homework can pay off with tremendous gains – Get your free report today!

Open Table is built on a business model that essentially brokers between diners and local restaurants.  The restaurant business has relied primarily on word-of-mouth referrals and print advertising.  Open Table, however, attempts to provide an online medium for diners to select where they want to eat, to review options within their community, and to book reservations even restaurants which are typically hard to get into.

The company collects revenue from three primary fee categories:

1. Installation Fee – Restaurants pay to install Open Table’s software and to train employees on the system
2. Monthly Subscription Fee – The restaurants also pay monthly to keep the system operating
3. Individual Diner Fee – Open Table also collects a fee for every diner that registers for a meal through the platform.

Something about this setup reminds me of the old “dot com” days when companies could come public with very little (or no) earnings and still collect a large premium for their stock.  While Open Table was posting a profit in 2007, the company actually lost money last year as the economic weakness caused weakness in the dine out business.  To its credit, OPEN has been able to grow revenues quarter after quarter, but profitability eventually is the key metric which determines the stock price.

Currently the company operates in Chicago, New York City, San Francisco, and Washington DC.  Adding new markets will be key to the company’s growth, and yet that will be difficult as consumer trends certainly aren’t favorable to the dine out business.  At ZachStocks, we have mentioned the growing trend in the US towards becoming a nation of savers.  That trend could make it very difficult for luxury businesses such as high-end restaurants, and companies like OPEN who support the industry.

Looking at the terms of the deal, the IPO priced at $20 while the underwriters were able to keep $1.40 of that price.  Merrill Lynch was the lead on the deal and while Merrill still has the largest base of retail clients, its status as a quality underwriter is less prominent than it was 18 months ago.  The shares were actually sold both by the company as well as private shareholders.  The 1.57 million shares sold by Open Table will raise roughly $26.3 million which will be used for “general corporate purposes.”  OPEN currently has no debt outstanding, which leaves it with plenty of options for financing growth.

Despite my respect for the innovation of this new business model, and the success OPEN has had in building a strong presence, I think the stock is very vulnerable to a decline.  There are still more than 19 million shares held by insiders and private investors, many of which will eventually find their way to the market creating selling pressure.  Macro economic issues create a strong headwind for the business, and earnings have yet to come anywhere close to fundamentally supporting the stock price.

It may be difficult to borrow shares today, but in the near future I expect OPEN to offer a great short opportunity.  If the stock fell to a price of $12, short sellers would make more than 50% on their trade.  And at a price of $12, the stock would still carry a 20 multiple compared to 2007 – its most successful year.  Please treat this position with caution as volatility will be high.

FD: Author has no position in OPEN