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Lawyers for Facebook and its founder and CEO Mark Zuckerberg, seen here, say a lawsuit claiming he developed the social media website with Paul Ceglia is fraudulent. (Craig Ruttle/Associated Press/Craig Ruttle/Associated Press)
Lawyers for Facebook and its founder and CEO Mark Zuckerberg, seen here, say a lawsuit claiming he developed the social media website with Paul Ceglia is fraudulent. (Craig Ruttle/Associated Press/Craig Ruttle/Associated Press)

Strategy

Why IPO investors should look for friends beyond Facebook Add to ...

After a dismal 2011, the market for initial public offerings in the United States is roaring back to life, producing double-digit gains for investors.

Share prices for companies that went public in the U.S. over the prior two years soared nearly 20 per cent in the first quarter, a trend that bodes well for Facebook Inc.’s whopper IPO, expected next month.

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But analysts say the best opportunities for investors may lie beyond Facebook, in smaller companies that are pricing their deals at attractive levels to entice investors.

The tempting valuations are the result of an unusually crowded IPO market. After waiting out tough conditions in 2011, when a choppy economy forced many companies to pull back from planned IPOs, a large number of companies are trying to get their deals done in 2012. The candidates range from specialty manufacturers such as Tumi Holdings Inc., which makes high-end suitcases, to the private equity giant Carlyle Group.

“We have the biggest backlog of companies in over a decade,” says Kathleen Smith, a principal with Renaissance Capital LLC, an IPO research and investment firm. “They are lined up, in registration, so there is a lot of inventory.”

The plentiful supply means lower than average valuations as companies give up some cash in return for finally getting their deals done.

“In order to get the investor to step up to look, the deals had to be priced down,” Ms. Smith says. “We are seeing the biggest discounting in years, and it’s continuing.”

Weak pricing for issuers in the first quarter translated into solid gains for investors. Those who were able to get stocks at offering prices on average made a 19-per-cent gain in the first day of trading, followed by an additional 10 per cent gain in aftermarket trading through the quarter, says James Krapfel, equity analyst with Morningstar Inc.

Another force that could aid IPO investors is the market’s growing willingness to pay up for growth potential. At a time when profit growth is slowing among larger companies, a newly public firm with fast-growing revenue can be especially attractive.

“There’s a belief by investors that a large company paying a large dividend may not get you the returns you want,” Ms. Smith says.

“Investors are willing to pay a big premium for growth,” Mr. Krapfel said. This sentiment has been evident in the technology sector, where the stock price of the average tech IPO surged 60 per cent above its offering price and 20 per cent above its initial trading price, according to Morningstar.

Mr. Krapfel warns that valuations for companies connected to the red-hot area of cloud computing have become “frothy.” Guidewire Software Inc. , Brightcove Inc. , Demandware Inc. and Bazaarvoice Inc. have seen their stocks climb more than 50 per cent since their debuts last quarter.

Most IPO prices, though, remain far from bubble territory, with the average post-IPO stock trading at only 15.8 times trailing earnings, according to Renaissance Capital.

Facebook, which has chosen to list on the Nasdaq, has yet to put a price on its offering. Early indications are that the deal will price the entire company at as much as $100-billion (U.S.).

“We would not put all our eggs in one basket,” says Ms. Smith. “However, there is something about Facebook that could make us look conservative if we advise people not to chase this one.”

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