To be sure, it’s been a big year for initial public offerings (better known as IPOs). All told, year-to-date IPO announcements are up more than 86% versus last year, with 631 firms filing to make their shares publicly traded as of this morning’s open. But that positive trend in IPOs is hardly the whole story…

In case you’ve been living under a rock this year, you already know how gut-wrenching stock performance has been so far this year. Historically, bad market conditions mean lower values for IPOs, so companies and their underwriters avoid going public when stocks are under pressure as much as possible. As a result, withdrawn IPOs are up 66% versus last year, as financially sound firms pull the plug on their offerings until Mr. Market looks a bit friendlier.

Those who haven’t — the Groupons, LinkedIns, and Zillows — have gotten absolutely shellacked this year since they started trading. And so have their shareholders…

Yes, it’s true that IPOs can hold the keys to truly outsized gains (imagine buying Google back when it cost $85 — now it’s $628 as of this morning’s open), but they’re clearly also fraught with risk right now. Should you avoid IPOs altogether in 2012?

No. But you’ll have to sift out the wheat from the chaff to find gains in newly public stocks in the new year.

While the most-hyped IPO names of 2011 have seen their share prices summarily whacked, smaller IPO names have fared a whole lot better this year. Take nutritional supplement retailer GNC Holdings (NYSE:GNC) for example; this stock was a small-cap when it went public, and investors who bought early have seen their positions rally nearly 68% since March.

Taking a look at the names below, there’s clearly a trend in what’s make an IPO successful in 2011:

Looking at the table above, a few common threads become very clear. For starters, each of the top gaining IPOs of 2011 have been small-cap stocks. Contrast that with the hyped-up names like Groupon, which is down double-digits and went public with a $16.7 billion, or Renren, which is down nearly 82% on the year after offering at a $5.5 billion market cap. Without the hype and over-analysis of Wall Street, smaller firms had more upside to offer investors this year.

Another important trend is the industry that the winners are operating in…

While most of the attention has been on high-tech social media names such as LinkedIn or Thursday’s Zynga IPO, most of the top performers of 2011 are actually in comparatively boring businesses. It’s not that boring is inherently better for investors — instead, the key is that investors are more competent at valuing the fundamentals of a retailer or an energy firm than they are at valuing a tech firm with no profits and lots of intangible assets.

From a due diligence standpoint, it makes sense to focus on industries that we can get reasonable assurance over rather than the high-risk, low-reward tradeoff being offered up by tech names right now.

Despite all appearances, there are clearly still opportunities to be found in IPOs. With 2012 on the horizon, it’s going to be crucial to focus on IPO names that meet the criteria of the recent winners, not the hype that the media is focusing on. Stick with small-cap names in boring industries on your next IPO hunt, and you’ll be better off.

Cheers,

Jonas Elmerraji
for The Penny Sleuth

The Secret to Raking in IPO Gains in 2012 was originally featured in the Penny Sleuth.

Many members of the financial media have declared the flurry of activity in the social media market to be the next Internet bubble. Considering the current state of initial public offerings, these statements might not be too far from the truth. After all, even the savviest Internet businesses have stumbled when it comes to social media investments…

Google famously overpaid for YouTube when it bought the site in 2006 for more than $1.6 billion in stock. The great minds at Google were never able to squeeze enough profits out of the free video-sharing site, which, to this day, remains more popular than profitable. In short, millions of lost dollars across the social media landscape have proven that it is difficult to adequately monetize even the best technology ideas.

But recently, two intriguing startups sporting a mix of social media and financial know-how have attracted my attention. These two companies are looking to change the way small businesses and consumers interact by removing cash from the equation and streamlining transactions. Each offers unique, potentially profitable ideas, and I consider both companies to be compelling buyout candidates or potential future IPOs.

The first company is Square, which is the brainchild of Twitter co-founder Jack Dorsey. Square is a mobile payment company. It targets small businesses and consumers by offering free apps and a small credit card reader to process credit cards on a smartphone or iPad. The company has already caught the eyes of private equity, raising approximately $100 million back in June. Now Square is expanding its consumer offerings with unique payment features…

Earlier this month, Square launched a mobile app called Card Case. The app allows customers to pay for an item by just telling the cashier their name. The customer’s phone (which doesn’t have to leave his pocket) automatically opens a particular store’s tab when he enters and the cashier can confirm the customer’s identity with a photo that pops up on the store’s Card Case app display.

The technology removes many of the barriers of starting a small business — mainly, the expense of credit card processing equipment. “The technology is a boon for many fledgling entrepreneurs,” reports the SFGate.com, “particularly small and mobile food businesses — who found the traditional way of processing credit cards either cost prohibitive or unfeasible.”

As intriguing as Square might be, it still relies on traditional means — the credit card industry — to transfer funds. This next startup has found a way to skirt the entire Visa and MasterCard network by building its own platform.

Enter Dwolla, a tiny, Iowa-based startup looking to compete with PayPal and major credit card networks.

“With Dwolla, payments are made directly from your bank account. No credit or debit cards are allowed. And because they don’t exist in the system, we don’t have to bring the fees into the system,” founder Ben Milne told Business Insider.

“You can spend any amount of money, and when you do that, the person on the other end doesn’t have to pay 1, 2, 3 or 4%. They pay only 25 cents a transaction, which is especially helpful when it’s $1,000, $2,000 or $5,000 transactions. Obviously, PayPal becomes very cost prohibitive with those larger transactions.”

It’s an amazing concept — yet it has also been a difficult journey for Milne and Dwolla. The company spent a majority of its developmental months focusing on legal issues surrounding its business. The consumer banking and credit card industries are highly regulated, and Dwolla had to find the legal know-how — and financial backing — to navigate its business plan.

So far, everything has fallen into place for this Midwestern company. Despite having only 12 employees and a 20-something CEO, Dwolla is now processing close to $1 million in transactions every day.

While Square and Dwolla are approaching their high-tech banking businesses in very different ways, I see each finding success in one form or another in the coming months and years. Keep both of these names on your radar as potential investment opportunities.

Sincerely,

Greg Guenthner
for The Penny Sleuth

Two “Cash Killing” Startups to Watch was originally featured in the Penny Sleuth.

Yesterday the market’s latest IPO, Pandora Media (NYSE:P) rallied double digits. Back in May, LinkedIn’s IPO (NYSE:LNKD) rallied 47% in its first day of trading.

Again, to most people, double-digit gains in a day seem pretty impressive.

But I recommend you stay out of the IPO market… until it flashes the “buy signal” that I’ll show you in this alert. I’ll show you the buy signal in a moment.

But first, here’s why I recommend you stay out…

Despite the red hot start, if you bought shares of LinkedIn the day it started trading, you could be down more than 38% on the year – shares have been moving lower steadily since.

Likewise, if you bought Pandora at the height of Wednesday’s trading, you could be sitting on losses of 30%. Here’s another chart:

So much for buying a “hot IPO,” eh?

You see, the current slew of IPOs (and yes, there are many more in the pipeline) is predicated on hype and promise, not cold hard numbers. While that may fly in a more buoyant market, it’s a toxic situation given the weakness stocks have seen since the beginning of June. It’s something that I wrote about following LinkedIn’s IPO – hopefully you weren’t suckered into the new, hyped names that have started trading since.

All of that said, there is a way to profit in spite of weakness in the IPO market…

In fact, as I see it, the key is finding technically relevant levels on newly-public names. Let me show you a real-world example:

Trading IPO Names For Fun and Profit

Back in late 2010, Tesla Motors (NASDAQ:TSLA) was a lot like LNKD. Shares had gone public in late June of last year, only to peak on their first trading week and move lower over the next few months. But on October 20, 2011, my Penny Stock Fortunes colleague Greg Guenthner and I recommended buying shares – since then the position has rallied more than 40%.

So, what was the key to cashing in IPO gains on Tesla?

The first factor was quality. Even though Tesla’s fundamentals were nascent, the stock was offering a muted valuation relative to its potential. Still, investor exuberance can overpower a stock’s “story” any day of the week – to get the timing right, the stock still had to be a technically relevant buy. Take a look at its chart:

Source: Bloomberg

Even though shares of Tesla had only been public for a few months, the company’s chart told us a wealth about how the market was pricing this stock. After peaking, shares sold off to the $15 level, setting ultimate support. After that, shares carved out two more significant support levels (the thick white and red horizontal lines in the chart above) that offered us a good buying target and stop loss target respectively.

Simply put, support can be thought of as a “price floor” for shares of a stock. They’re levels where shares have found an intermediate bottom – that low point indicates that there’s a glut of demand for shares at that price.

In practical terms, a support level is the price where investors start to think, “Hey… that stock looks cheap!”

Support levels are often the lowest price a stock trades at (at least for a while) not surprisingly, then, investors want to buy shares close to support.

In short, a bounce off of support lines is the “buy signal” you should wait for when looking at these IPOs.

Even though buying Tesla was a long-term position, the factor that made this trade successful was the fact that we picked up shares when probabilities highly favored the demand side of the equation. That’s exactly the scenario that you should be shooting for on any IPO trade regardless of your time horizon.

From a technical analysis standpoint, LinkedIn is starting to look like Tesla did – but it’s still too soon to tell whether it will make a good buy. Shares still have yet to set a meaningful support level.

My recommendation: give the latest batch of IPOs a few months… wait for the “buy signal” to flash… and then look for a chance to buy just above support.

Sincerely,

Jonas Elmerraji
Penny Sleuth

Chart Smarts: Squeezing Gains From This Toxic IPO Market was originally featured in the Penny Sleuth.

LinkedIn is just the latest in the slew of high profile IPOs and private equity deals that are trading for insanely high valuations. At the end of April, my colleague Greg Guenthner wrote to you about the similarly lofty valuation that was being put on social media giant Facebook – a company that the private equity markets have valued at $72 billion. That enormous price tag puts Facebook at four to five times the premium that’s being seen by the likes of Apple (NASDAQ: AAPL) or Google (NASDAQ: GOOG) on the public markets.

There’s clearly a valuation bubble in the private equity markets right now – one that you should avoid at all costs as a penny stock investor.

I’ll be the first to admit the fact that initial public offerings (IPOs) hold a special place in the hearts of small-cap stock investors. After all, the vast majority of all new stock offerings are for small companies that don’t see the same fanfare that social media stocks are seeing right now.

But for all but the wealthiest, most connected investors, it’s impossible to get a “good value” on any of these new firms in the current environment.

The trend doesn’t look like it’s slowing either. On Monday, Russian web search firm Yandex (NASDAQ: YNDX) opened for trading with an $11 billion market capitalization. Other prominent tech firms, like real estate data site Zillow have listings pending. And right now, I’d suggest avoiding all of them.

The fact remains that private equity firms are paying outrageous valuations for these growing web companies – and while their businesses may be attractive, the prices that private equity investors need to get to stage a successful exit make the possibility of making long-term gains incredibly difficult. There are a bevy of reasons why it doesn’t make sense for upstart names to claim massive premiums over mature, entrenched companies like Google or Apple – so, while enamored amateurs may sink their cash into these fundamentally queasy IPOs, you’d do well to avoid them.

That doesn’t mean that you should sit out the IPO game completely. While private equity backed internet IPOs are generating overpriced valuations, there are still quite a few upcoming public offerings in other industries that investors should be watching.

Some of the more interesting names include computer storage firm Fusion-io (expected to price on June 8), solar energy utility Brightsource Energy (pricing date to be announced), and private label retailer Bluestem Brands (pricing date to be announced). With more value opportunities in these lower profile names, investors actually stand a chance at getting in on the ground floor.

We’ll keep you updated on these IPOs as more details become available.

Cheers,
Jonas Elmerraji
Managing Editor, Penny Sleuth

May 26, 2011

Don’t Fall for the IPO Feeding Frenzy was originally featured in the Penny Sleuth.

To many market watchers, Goldman’s hefty bet signaled a new market era of legitimized social media investments. However, Facebook’s success is not easily repeated. In fact, I am finding it incredibly difficult to find any significant value in most social media small-caps and perspective IPOs. These stocks can be great trade candidates, but nearly all of them lack business models that will allow them to consistently compete in cyberspace, one of the investing world’s harshest climates.

Facebook has several key factors working in its favor. It has the eyeballs of the Western world, with more than 500 million registered users. It recently surpassed Google as the most-visited site on the web. And most importantly, the folks running Facebook have access to the personal information, likes and dislikes of a majority of the consumers in the United States and beyond. To say this information is valuable is a gross understatement. Targeted advertising is king on the internet, and Facebook’s platform is perfectly designed for businesses to strengthen their bonds with new and loyal customers alike.

With annual revenue reportedly in the billions, Facebook is the dominant social media force even though its IPO is potentially more than a year away. We don’t have any detailed numbers yet, but it’s safe to say there will be real value in this company when shares become available to the public.

After Facebook comes a long line of coattail riders, eager to cash in on the social media trend. Yet unlike Facebook, I can’t envision scenarios where most of these companies can maintain significant  market shares and sustained profitability:

• Social Media Games – I’ve heard that social media games — such as the infamous time-waster Farmville — can be fun and addictive. Yet I’m not seeing any small-cap game developers that are positioning themselves at a true competitive advantage. Games are fads, and frankly, so are many of the penny stock gaming companies out there. Most are far from profitable, and probably even fewer will show investors significant returns.

• The Daily Deals – Groupon is the king of this category, where subscribers are emailed daily coupons to local restaurants and shops. It’s a popular service, but I don’t think it has the barrier to entry similar to Facebook. Several Groupon copycats have emerged, and I doubt consumers will immediately declare loyalty to one particular provider. Shoppers love bargains, so they will flock to the best deal. The source is irrelevant.

Groupon’s IPO is tentatively scheduled for later this year, and could raise more than $1 billion, according to Reuters. I expect we will continue to see increasingly ridiculous numbers tossed around as the company gets closer to its IPO date, since news outlets have already rumored valuations of $15-$20 billion.

• Twitter – Telling the world what’s happening in 140 characters or less might have sounded like a silly idea five years ago. But it’s become insanely popular — and probably the best social media company following Facebook in the social media sphere. Twitter is actually a profitable company that has rebuffed buyout and investment rumors, with co-founder Biz Stone claiming that the company is profitable and needs no additional funds to grow its business. The strongest argument for Twitter is that it invented a social media genre and monopolized it from day-one. Unfortunately, you probably won’t get the chance to invest in this phenomenon anytime soon.

Sincerely,
Greg Guenthner
Penny Sleuth

April 27, 2011

Don’t Fall for the Social Media Hype was originally featured in the Penny Sleuth.

TeleNav (NASDAQ: TNAV) provides location based services (LBS) through software that runs on mobile phones. The company’s flagship product, accounting for 94% of revenue, is GPS Navigator, a voice-guided navigation program.

The company earns practically all of its revenue through distribution deals with major U.S. telecom carriers, who pre-install TeleNav’s software onto mobile phones where it can be easily activated by consumers. Users pay a monthly subscription fee to the carrier, and the carrier pays TeleNav either through a fixed fee per user or revenue sharing arrangement. TeleNav went public through an IPO on May 13, 2010, at $8 a share, raising $56 million in capital.

A Growth Industry

Location based services is a huge growth market. As GPS-enabled smartphones increasingly replace older featured phones, the addressable market for navigation products expands. These phones are expected to comprise 96% of all mobile phone shipments in the U.S. by 2012, according to Gartner. Mobile carriers are interested in driving uptake of these services as a way to grow revenue to offset ever-declining voice plan prices. TeleNav has seen its subscriber base grow 70% in the most recent quarter, a testament to this growth potential.

Even with this, only about 7% of cell subscribers pay for navigation services, creating a penetrative growth opportunity. Additionally, the company is looking to expand to more carrier partners from a current base of Sprint and AT&T Wireless, recently signing #6 U.S. carrier U.S. Cellular and inking a deal with Ford to be their in-dash GPS software partner for the SYNC system. Clearly, there are significant growth avenues here.

That growth doesn’t come without competition…

GPS-based navigation services are an intensely competitive field. TeleNav faces direct competition in the software-based smartphone market from competitors such as Navigon (MobileNavigator), TomTom, Magellan, and others. Google even provides a voice-based navigation package for free on its Android phones, as do Nokia and Microsoft on their respective phone platforms.

Stand-alone personal navigation devices and in-dash systems from dedicated firms like Garmin also offer similar functionality. Such heavy and in some cases free competition causes prices to forever be in a free fall, threatening margins and profitability for all entrants – after all, it is impossible to compete with free.

Average revenue per user (ARPU) has consistently been declining in the low double digit percentages year-over-year. Competition is a major concern for this investment over the long term.

A Strong Management Team

TeleNav has a solid, experienced, and quite well-vested management team. The CEO, President, and Chairman is 46-year old H.P. Jin, a co-founder of the company and a leader since its founding in 1999. Three other co-founders – Y.C. Chao, Salman Dhanani, and Robert Rennard – still serve in executive positions.

Compensations are reasonable, and insiders own a whopping 62% of the shares, directly aligning their financial interests with those of common shareholders. More impressively, insiders sold no significant amounts of stock in the IPO, a sign that they believe in the future earnings potential of the company instead of just “cashing out” to the public. While there is little public performance record to judge this group on, it appears to be a core team of leaders who believe in the company.

Solid Financial Health

TeleNav has a solid balance sheet, with close to $113 million in cash and no debt. Free cash flow generation is robust, with 23% of sales converted to free cash in fiscal 2010. Returns on invested capital come in at above 100%. The business model is also attractive, as it relies on recurring revenues, which are usually predictable and are collected ahead of services rendered. Financially, the firm is solid.

TeleNav is ultimately a cheap stock, with a P/E ratio of 5.3 and an adjusted earnings yield of 64.1%. Against free cash flows, the current valuation yields 36.8%. Clearly, investors are betting on the worst happening with the Sprint negotiations, and presumably negotiations with AT&T as well.

This is probably a prudent course to take. Those two contracts, accounting for nearly 90% of business, are immensely important to the company. Unfortunately, there are hordes of competitors lining up at the door to take TeleNav’s place as preferred GPS navigation services provider. Many of these competitors have advantages over TeleNav. TomTom and Magellan both can boast of brand awareness. Google, Nokia, and Microsoft can offer cost advantages. Invariably, TeleNav will face declining revenues per user – the law of competition and the company’s complete lack of structural competitive advantages will make it difficult to grow profitably.

The immense uncertainty surrounding the carrier contracts means that only the truly risk-seeking should consider TeleNav. The best case is that the company is able to consolidate the market some to bring down competition, or is swept up by one of the telecoms or smartphone platform makers to provide built-in value added services.

Sincerely,
Steve Alexander
MagicDiligence.com
Penny Sleuth

September 10, 2010

[Independence Note: Unlike scores of other penny stock resources, we’re 100% independent from the companies we talk about in the Sleuth – that means that we never accept compensation in exchange for profiling a company, and our editors never own a position in any stocks they talk about.]

The Summer IPO to Watch in 2010 was originally featured in the Penny Sleuth.

Like I mentioned on Monday, Agora Financial’s small-cap team was at the New York Stock Exchange on Friday, attending an IPO conference to hear the latest updates on what’s going on in the new issue market right now. And given Tesla Motors’ (NASDAQ: TSLA) high profile IPO earlier this week, I thought now would be a particularly timely opportunity to talk about this niche of the market…

For small-cap investors, IPOs hold a special role; after all, with more than 82% of IPOs valued at $300 million or less – 80% percent of which sit right between $50 and $150 million – most stocks that go public are still small enough to offer exciting growth potential.

The past couple of years have been anything but auspicious for the IPO market. According to Renaissance Capital, 2008 saw only 43 public offerings, a far cry from the 273 back in 2007 before the market tumbled. 2009 wasn’t much better with 63 IPOs, but the tides are beginning to change…

We’re only halfway through the year, and already 64 companies have gone public and another 130 have filed with the SEC to go public. That suggests more than 100% growth in the IPO market over what we’ve become accustomed to – a definitively strong sign for investors.

That’s because the IPO market is largely indicative of the broad market. When times are good, investors usually get excited about the growth prospects of IPOs, bidding up their prices in the process.

But when the market is bearish, IPOs historically generate smaller returns for the companies, investment banks, and private equity owners involved – that means that the only companies who go public in bear markets are the ones that are either impressive enough to get investors’ attention regardless – think Visa’s (NYSE:V) IPO back in 2008 – or the ones that are really hurting for cash.

As a result, stronger investor sentiment generally means that higher-quality IPOs are headed your way.

Stronger investor sentiment is exactly what we’re seeing right now. Despite the increased market volatility of the past few months, the Consensus Index is reporting that bullish sentiment has risen from 39% to 49% bullish in the past three weeks. Likewise, since IPO activity usually trails market activity, and because 2009 was such a banner year for stocks, we’re seeing many of last year’s IPO filing start to hit the market now.

Ultimately, that means we’re feeling pretty bullish about IPOs right now. There are some truly exciting new companies going public in 2010 – and you’re going to be among the first to learn about them. This summer, we’ll be publishing recurring IPO watch issues of the Penny Sleuth with all the details you want to know about the hottest small-cap IPOs to hit Wall Street. Stay tuned…

Sincerely,
Jonas Elmerraji
Managing Editor, Penny Sleuth

July 1, 2010

An Exclusive Update on the IPO Market was originally featured in the Penny Sleuth.

For the uninitiated, an IPO – or initial public offering – is the most well known method of taking a company public. Because IPOs give investors their first taste of companies that are new to hit the stock market, they’ve long been touted as one of the most exciting investments available; after all, it’s not uncommon to see IPOs rocket in price in the months following their first trading days.

And because most IPOs are firms that are still relatively nascent, these stocks are of particular interest to small-cap investors like us.

In the tech boom of the late 1990s, IPOs entered the mainstream as a slew of tiny technology firms went public to capitalize on the bubble. And though the subsequent burst and recession of the early 2000s slowed the pace of initial public offerings, they continued to get priced at breakneck pace until 2008’s market malaise came to bear on stocks. 

Why Did IPOs Slow Down in 2008?

When a private company decides to go public, it’s no small decision, and the company’s owners (typically a combination of venture capitalists, private equity firms, angel investors, and company founders) are strongly incentivized to get the biggest returns possible.

For professional investors – like VCs and other private equity firms – going public is one of two main ways to exit an investment (the other being third-party acquisitions). So they’ve paid a great deal of attention to how to get the most bang for their IPO dollar. One way they do that is by staying away from the stock market when times are tough…

Studies have shown that IPOs dry up when stocks are under fire. That’s little surprise for most people – when equities are in a bull market, owners can get higher valuations for their IPOs and investment banks can get higher underwriting spreads. In a bear market, however, more cost-conscious investors are less likely to overpay for growth potential, and companies that can afford to stay private opt to more often than not.

That’s not to say that there’s absolutely no IPO activity in bad markets, but barring a good timely reason to go public, there’s a bad stigma attached to stocks that need the capital bad enough to IPO among the bears. That’s about to change.

IPOs Are Back on in 2010

While the increased market volatility investors have seen since May has impacted sentiment toward stocks right now, it hasn’t halted the increased interest in IPOs that’s currently taking place…

So far this year, IPOs have raised $75.9 billion internationally – a 1,586% increase over last year’s paltry proceeds. That’s a pretty staggering improvement in a market that’s largely thought of as a bellwether for the overall economy.

And there’s plenty more growth available to today’s small-cap investors. Of the 113 IPOs that were filed for 2010, only 52 have been priced (i.e. launched) already. That leaves plenty of upcoming initial public offerings for the rest of the year.

Even though foreign stocks have taken some hits in recent months, overseas companies continue to lead the IPO pack. That’s especially true in Asia, a region that’s contributed 64.4% of the world’s IPOs in 2010. Of the region, the biggest country for new stock offerings was not surprisingly China.

We’ve long been fans of investing overseas for the business and currency diversification it can provide – and some of Agora Financial’s best minds have been spending some serious time in China to that end. (We will fill you in on this latest trip soon.)

Hopefully you understand the potential of this exciting market a bit better now. There’s plenty of activity going on in the IPO market at present, and we want to make sure that you’re part of it – keep a look out for the Penny Sleuth’s recurring IPO watch later this month…

Sincerely,
Jonas Elmerraji
Managing Editor, Penny Sleuth

June 9, 2010

The Small-Cap IPO Market Is Worth Watching in 2010 was originally featured in the Penny Sleuth.

Earlier this week, battery maker A123 Systems (NASDAQ: AONE) commenced public trading of its shares, raising more than $340 million in the largest IPO of 2009. Those who got into the stock early have been rewarded handsomely – shares are up nearly 70% right now. But AONE is only the latest in a string of initial public offerings that capped off the biggest week in IPOs since 2007.

To be fair, that hasn’t been a difficult benchmark to beat. Since the fallout from the credit crunch began, the IPO market has deteriorated to the point where only a single U.S. company went public in both the last quarter of 2008 and the first quarter of 2009. Things heated up again last quarter with 13 public offerings, but those numbers still paled in comparison to the 95 stocks that traded for the first time in the last quarter of 2007. Now, with murmurings of the recession’s end upon us, the bullish signals from an IPO resurgence shouldn’t be ignored.

Not everyone agrees with that prognosis…

“The fact that the many in the media are classifying three IPOs as a resurgence is evidence of how low our expectations have become,” National Venture Capital Association President Mark Heesen said in a statement picked up by Reuters.

“[This] not the direction we hoped to see. While the psychology of the market is trending positive, our original forecast of a true recovery not beginning until 2010 still unfortunately holds true,” he continued.

And while Heesen’s concerns about the IPO market’s recovery have been echoed throughout Wall Street this week, it’s inaccurate to say that a recovery in public offerings isn’t happening right before us. At the start of this week there had been 11 new public offerings in the third quarter of 2009. That’s a huge departure from the nearly post-mortem IPO market that we were in the midst of six months ago.

IPO bears lost more credibility on Wednesday when Talecris Biotherapeutics (NASDAQ: TLCR) went public, breaking the year’s domestic IPO record for the second time this week. The biopharma stock raised $950 million in its offering, the biggest IPO for the sector since 2006. The Talecris offering comes after China State Construction Engineering Corp’s record-breaking $7.34 billion IPO on the Shanghai Stock Exchange, and a week ahead of Banco Santander’s public offering next week, which at $7.25 billion will once again bust the year’s record for the biggest American-traded IPO.

What were the “experts” saying about a dead IPO market until 2010?

And with some exciting companies filing to go public in the coming months – including NewEgg.com and Dollar General – things aren’t slowing down yet. To be clear, a strong IPO market doesn’t necessarily say much about stocks in general. The S&P 500 has already slumped 2% this week despite all of the offering activity that’s happening before us. It does bode well for small-cap stocks, however…

There’s a big argument going on right now among the vast majority of investors: some are claiming that the market is perfectly primed for a 10 year bull rally, while others are bracing for the next market correction. But in the small-cap world, things move very differently. Every single U.S. IPO this year has been a small-cap stock, which tells me that the investment banking syndicates – which have some of the most advanced market data available – are bullish on small-caps.

Why does IPO activity suggest where the big investment banks are putting their money? Studies by Nobel Prize winning economists Franco Modigliani and Merton Miller showed that, historically, investment banking syndicates and venture capital firms will not push companies to go public in a down market. That phenomenon actually makes a lot of sense, because in a bear market, investors are willing to contribute far less money to a stock’s underwriting premium – the “commission” that an investment bank gets by selling an IPO’s shares for more than they paid.

By unleashing primarily small-cap IPOs so far this year, evidence points to growth opportunities in the small-cap space.

So, how do you make a play off the potential of penny stocks? Look for small-cap plays that remain deeply undervalued to capitalize on the buying that’s going on right now. That’s a more difficult prescription than it was six months ago before the market rally, but ignored penny stocks still remain one of the last vestiges of value right now.

It’s also important to keep in mind that sentiment is prone to change. While small-caps might be a favored market space right now, a huge drop in the rest of the market will undoubtedly take penny stocks with it. We’ll continue to watch broad moves with our Small-Cap Recovery Index for that very reason.

There’s little question that IPOs are having a fantastic quarter, one that will break records for the year once all of the numbers are crunched. And as long as the industry’s experts continue to be disappointed in the wake of unrealistic expectations, most investors will miss the growth sentiment in small-caps. That makes right now a perfect time to position your portfolio.

Cheers,
Jonas Elmerraji

October 2, 2009

Why the Latest Trend in IPOs Is Great for Penny Stock Investors was originally featured in the Penny Sleuth.