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First Day Pop Doesn't Spell Long-Term Success for IPOs

Recent tech IPOs have had great first days, but performance has lagged since then, says Morningstar's James Krapfel.

Jeremy Glaser: From Morningstar, I'm Jeremy Glaser. Facebook has been dominating the IPO headlines, but how is the health of the rest of the IPO market? I am here today with IPO strategist James Krapfel to take a pulse of that market. James thanks for joining me.

James Krapfel: Thanks for having me, Jeremy.

Glaser: Outside of Facebook, how has the rest of the IPO market been performing?

Krapfel: The IPO market this year has actually been pretty strong. There has been a lot of weak pricings this year which has led to pretty outsized gains in terms of post-IPO trading. We've seen the average company that's IPOed in the last 12 months basically double the average return of the S&P 500. So it's been pretty strong. Then within tech, it's actually been even stronger. The average first-day return for a technology IPO is 30% versus 16% for all IPOs this year. Then the return from the first-day close actually outperformed the market, as well, up 11% versus 3% for the average company going public in 2012. Then the total return from the IPO price is up 40% for technology IPOs versus 18% for all companies that have gone public this year.

Glaser: So what's driving some of that weak pricing? Is that keeping some companies from entering the market? Why aren't people that excited at least when they're getting those initial allocations?

Krapfel: I think in general, the quality of the IPOs this year is down a little bit from last year, so you're seeing some weakened activity. Also the supply of companies going public this year is higher, so that's kind of brought down IPO prices, as well. Then I think it's just general risk aversion among investors. Even though the market has been fairly strong up until few weeks ago, investors still want a higher degree of safety when it comes to IPO investing

Glaser: So if Facebook has a successful IPO, what impact do you think that's going to have on the IPO market? Do you think that's going to cause a lot of other companies to kind of rush into the marketplace or do you think it would be more measured impact?

Krapfel: I think the expectations for Facebook are very high already. So if it does very well, I don't think it will have a huge impact on the IPO market. However, if it does less than spectacular, that could be a negative for companies that have not gone public yet because if Facebook can't do well, then very few companies will be able to do so.

Glaser: You mentioned that you have all these good returns coming from these IPOs, but does that mean that it's a great time for individual investors to be looking at the IPO market to be buying shares of IPOs in the secondary market after they start trading? What do the numbers look like there?

Krapfel: Well, looking at Facebook we kind of compare Facebook to some other high profile technology IPOs of maybe the last year or so, and we have come up with seven companies that kind of it fit that list being LinkedIn, Pandora, Groupon, Zynga, Yelp, and Millennial Media. These companies on average went up 46% in the first day, so they all have done very well. As to be expected, we think for Facebook all signs are that that it could do very well on the first day. But in the ensuing month these companies tend to pull back a decent amount on average. These seven companies are down 11% from the first month after they went public, and there was instant correlation where the more it went up on the first day, the more it was down in the ensuing month. We saw that especially with LinkedIn and Groupon and a few others.

Then these companies are actually down an average 23% from their first day close until now. So buyer beaware with Facebook. If it spikes a lot we wouldn't rush to take it in.

Glaser: Certainly it sounds like a lot of that excess return has been captured by investors who are able to get some of that initial allocation at that offering price and not so much by the people who are buying it after it starts trading and the price has already risen so much.

Krapfel: That's right.

Glaser: So if the market is getting a little bit healthier, and we are just trying to see more companies enter the marketplace, what needs to happen for the IPO market to really take off again, to really see the kind of equity offerings we had prerecession? Or is that kind of level of offering never going to return?

Krapfel: Well I think you need to see the market really strengthen. There is a lot of macroeconomic concerns certainly somewhat with the U.S. but more so in Europe and slowing China. So the overall market is a little uncertain especially in the last few weeks with the market being down here in a number of days in a row. So we would need to see some of those concerns abate a bit and for the overall market return to healthy levels. That's when you start to see more speculative activity, and that's usually the marks of when the IPO market does the best and when the most companies become public.

Glaser: Well James thank you for your thoughts today.

Krapfel: Thanks for having me.

Glaser: From Morningstar, I am Jeremy Glaser.

Jeremy Glaser does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.