Internet and Telecom Companies Top Today's IPO Market

After two years of hovering near death, the market for initial public offerings is finally healthy. That means you may soon get a chance to invest in such hot properties as LinkedIn and Skype, though you’ll have to wait a while longer to buy into Facebook.

IPOs are stocks sold to the public for the first time. Through mid February, 24 new stock offerings have hit the market, 11 more than in the same period in 2010, according to Renaissance Capital, an IPO research and investment firm in Greenwich, Conn.

Investors try to get in on IPOs before the stocks actually begin to trade because the shares are often underpriced relative to what they’re expected to trade for on the open market. This discount entices investors to pony up cash to buy the shares. However, IPOs sometimes rise only briefly -- or don’t rise at all. They may even flame out.

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Overall, it's a good time to be an IPO investor. During the financial crisis and its aftermath, companies found it difficult to obtain financing. Now, there's a large backlog of firms that seek to raise capital. Moreover, shares of companies that have gone public recently are selling at reasonable prices. "Buyers remain in the driver’s seat," says Kathleen Smith, a chairman of Renaissance Capital. "If the company is offered at too high a price, the buyers go on strike until the price comes down."

So far, big deals, as opposed to big first-day pops in the share price, have dominated the headlines. The $2.9 billion IPO of energy company Kinder Morgan (symbol KMI) on February 11, coming just weeks after Nielsen Holdings (NSLN), the TV-ratings company, raised $1.9 billion, shows that investors have an appetite for large deals as well as for the hot, young companies that usually make up the bulk of the IPO buzz.

The Kinder Morgan offering was the largest private-equity-backed IPO in history. In 2007, private-equity firms used debt to purchase the company and take it private, intending to later sell it at a profit. This kind of IPO offers the private-equity investors a way to cash out of their investment, while bringing to the market a company loaded with debt. The stock came public at $30 and closed at $31.05 on its first day. But it has done little since -- it recently traded at $30.72 -- and so it might be worth considering (all prices and related data are through February 22). The Houston-based company gets most of its cash from the publicly traded pipeline operator Kinder Morgan Energy Partners (KMP). It's expected to pay a dividend that results in the stock yielding about 4%.

The question is, can you get in on the ground floor of a good IPO deal? Brokers typically offer shares to their best clients. These are usually institutional investors and individuals with substantial assets at the firm. Actually, if your broker offers you shares in an IPO, you might want to stay away -- it may mean the big investors passed on the deal and the broker needs to dump them. Or to paraphrase Groucho Marx: "I wouldn’t want to buy into an IPO that would have me as a member."

However, there are exceptions. For example, Fidelity clients who have at least $100,000 in assets at the firm or who trade at least 36 times a year, can get in on deals led by private-equity firm Kohlberg Kravis Roberts. Ask your broker if it has similar programs.

If you can't get in on the IPO, avoid the temptation to buy shares the day they go public. IPOs often shoot up initially on the hype, only to quickly fall back to the initial offering price or below.

So how is the current IPO market shaking out? Investors may be feeling a bit of déjà vu because the current IPO scene is starting to resemble that of the late 1990s, when Internet and telecom companies ruled. Two of the major themes in the current IPO market are Internet companies, such as LinkedIn and Skype, and telecommunications firms that send data to mobile devices, such as Epocrates (EPOC), which has already gone public.

One big difference: Most of the U.S. firms on the IPO track today are profitable; most of the 1990s vintage dot.coms never saw a drop of black ink. However, some froth is forming among Chinese Internet companies, some of which are going public in the U.S. under a cloud of questionable accounting practices.

The IPO calendar is filled with big companies that had previously been purchased by private-equity firms. Topping the list is hospital operator HCA. The company is expected to bring a $4.6 billion offering to the market in early March. Also expected later this year are Toys 'R' Us; AMC Entertainment, the movie-theater chain; and American International Group, the poster child for the financial crisis.

The biggest topic in the IPO market is Facebook, the social-networking company, which, ironically, refuses to publicly discuss the subject of going public. (See How to Buy into Facebook Before It Goes Public.) But Facebook’s spectacular growth has sparked interest in other social-networking companies, a budding sector of the Internet economy that has become the latest and potentially greatest, dare we say it, killer app.

The most widely anticipated deal is LinkedIn, the largest social-networking site for the professional class. The Mountain View, Cal., company has 90 million members in more than 200 countries and makes most of its money from advertising and services for recruiters. In the first nine months of 2010, LinkedIn’s revenues doubled, to $161 million, from the same period in 2009. During that period, LinkedIn posted a $10 million profit, compared with a loss of $3.3 million in the first nine months of 2009.

Another company with a lot of pre-IPO hype is Skype, which offers telecommunications services over the Internet. Sales at the Luxembourg-based company grew 25%, to $406 million, for the six months that ended June 30, 2010. However, net income fell 42%, to $13 million, from the first six months of 2009. Skype filed to go public last summer, but the IPO has been delayed until later this year because of turmoil at the company, including the hiring of a new chief executive in October.

Taking advantage of the enthusiasm for Internet stocks, online radio company Pandora Media created excitement when it filed for its own IPO in mid February. The Oakland, Cal., company streams online personalized music "stations" based on an individual's favorite songs, artists or genres. For the first nine months of 2010, Pandora saw revenues nearly triple, to $90 million. Its net loss narrowed to $328,000, from $18.6 million the previous year.

Among the small companies that have gone public in 2011, a few are worth a second look. NeoPhotonics (NPTN) makes products to facilitate high-speed data transmissions of large Internet content, such as video conferencing, over telecom networks. Shares of NeoPhotonics, whose clients include Cisco Systems (CSCO), have surged 45%, to $20.34, since they debuted at $11. Epocrates, which sends reference information about drugs to doctors' mobile devices, launched at $16. It now trades at $23.71.

Also, Demand Media (DMD), a provider of online content for its Web site, ehow.com, has leapt to $22.88 since it hit the market at $17. "Valuations are still low for these companies, so this is the start of another bull leg for IPOS," says David Menlow, president of IPOfinancial.com, a research firm in Millburn, N.J.