Amid Alibaba fever, reasons for caution in IPO market

The highly anticipated debut of Alibaba Group Holding, the Chinese e-commerce group, will come amid the busiest year for initial public offerings since the technology bubble burst in 2000.

Alibaba's IPO, which could come as soon as Sept. 19, could raise more than $21 billion and claim Facebook's title of biggest tech IPO. It will usher in a fall season when plenty of new names sell shares for the first time in the U.S. market.

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Returns from IPOs so far this year have been mixed. Some analysts say large swaths of the market, especially biotechnology stocks, are frothy.

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The percentage of IPOs coming from money-losing companies has jumped to a 14-year high, according to Jay Ritter, a professor of finance and leading scholar of IPOs at the University of Florida.

The mixed financial results could dim enthusiasm for some of the hot names coming later this year, including web hosting company GoDaddy, airline Virgin America, and possibly burger chain Shake Shack, which has been exploring an IPO.

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Roughly one-third of the 188 stocks that debuted this year are selling below their IPO price. New stocks have risen an average of 19 percent over the first three months of trading, compared with 36 percent in 2013, and 23 percent in 2012, according to research firm Dealogic in New York.

"With the exception of mature companies like Alibaba, a lot of the companies that have all the hype around them tend to underperform beyond the first day. They just get squeezed to valuations that are beyond what they can absorb," said Kathleen Smith, who manages Greenwich, Connecticut-based Renaissance Capital's IPO ETF (IPO.A).

MediWound, a biopharmaceutical company, serves as a cautionary tale. Its shares down 60 percent from the first closing price.

In perhaps the year's biggest flop, shares of King Digital Entertainment, the maker of mobile game "Candy Crush Saga," have tumbled more than 29 percent since going public in March.

"Remember how a few years ago, everyone had Angry Birds? That seems so 1998 now. These things run on a life cycle, and you need new things in the content pipeline all the time," said Jim O'Donnell, chief investment officer at San Francisco-based Forward, which has $5 billion in assets under management.

Some of the IPOs from late last year, including casual dining chain Potbelly, have also sunk. Potbelly is down 60 percent from its first-day close.

Given the underwhelming performance of several high-profile IPOs in recent months, some analysts worry investor appetite for risk is reaching unsustainable levels.

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Much of the influx of money-losing companies comes from one sector, biotechnology, where investors tolerate spotty track records in hopes of cashing in on lucrative payouts.

While some investors find their bets rewarded, as in the case of UltraGenyx Pharmaceutical, which is up 176 percent from its IPO price, others are disappointed. Three of the five worst performing IPOs of 2014 are in biotechnology.

"They're essentially looking at companies that don't have much in the way of revenue or profit and hoping to see that one big blockbuster drug approval or pharma company buyout," said Jeff Reeves, editor of InvestorPlace.com in Rockville, Maryland.

Yet even excluding biotech, IPOs look rich. Offer prices have been about 50 percent higher this year than the average from 2001 to 2013, even as median sales declined to $136.2 million from $187.3 million in the year before the companies go public, according to Ritter.

Experts say the stock market's gains, with the S&P 500 topping 2,000 for the first time last month, are somewhat responsible for the appetite for risk. And with the U.S. Federal Reserve keeping rates low, investors seeking growth are attracted to more untested companies.

Alibaba IPO buzz heats up
Alibaba IPO buzz heats up   

"Individual investors' appetite for risk will be predicated on the economic backdrop. If they think the Fed will continue to be accommodating, they'll be more apt to want to take risks on IPOs," said Joel Guth, chief executive officer of Gryphon Financial Partners, a member of the HighTower Network.

Still, there are some indications investors are becoming cautious. In the second quarter, stocks rose an average of 9.2 percent on their first day of trading. In each of the three quarters before that, stocks popped about 20 percent.

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That could mean the torrent of companies slated for IPOS in the next few months, like restaurant-arcade chain Dave & Buster's Entertainment and peer-to-peer banker LendingClub, will be met with more skepticism.

"When valuations are at their highest level in years, at some point, there's going to be a correction," Ritter said.

By Reuters