The Pain and Potential Gain from a Dead IPO Market


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The initial public offering ( IPO ) market is now in lockdown. Frozen. Shuttered. Throw away the key. With all the turmoil roiling the markets, more than 30 companies have had to step away from the IPO starting line in the last six weeks. Even if the market turned up sharply right away, it would take some time for bankers to prime the pump to get these deals back on the docket. And if the market remains a bit nerve-wracking, these still-private companies may stay that way for an extended time.

Bankers Lament

The IPO shutdown comes as a real disappointment for investment banks, as these deals, with their 7% commissions, generate boatloads of profits.  That's often how these banks justify carrying teams of research analysts, who otherwise would not pull their weight in an era when many clients trade through electronic networks for almost nothing. In the past, these active clients would send large trades at five cents a share -- known as "the nickel business" -- to firms in exchange for analyst research and a cut of promising IPOs.

These days, analyst research doesn't hold the same respect with clients, and without the IPO activity to at least provide some value, the relationship between sell-side departments (analyst teams at investment banks) and buy-side firms (the hedge funds and mutual funds that serve as clients) is even further frayed.

The timing is unfortunate. A number of investment banks have just been getting back on their feet in recent quarters, and analysts will likely need to start lowering their profit forecasts if the IPO market remains depressed. For the big banks like Goldman Sachs ( GS ) or JP Morgan ( JPM ) , investment banking fees and research trading commissions are only a small part of their overall business. But for smaller firms such as Jefferies ( JEF ) , Stifel Financial ( SF ) , Oppenheimer ( OPY ) and Raymond James ( RJF ) , investors may need to brace for weaker-than-expected results.

Good News for Buyers

Companies that are pushed away from the IPO gate can stay away only so long. Many times they are funded with the notion that their original investors will soon be able to recoup their investment. And if these backers, such as venture capital (VCs) firms, are on the hook to keep these companies going, they may look for alternatives. When this has happened in the past, these VCs have reached out to private equity firms like KKR Financial ( KFN ) or the Blackstone Group ( BX ) to take the private companies off of their hands.

But if these stalled IPOs are in the high-tech field, then the cash-rich large public players also field phone calls. In past cycles, when the IPO market was closed, Cisco Systems (Nasdaq: CSCO) , Oracle (Nasdaq: ORCL) , Intel (Nasdaq: INTC) , EMC ( EMC ) and others have pounced on small private names, often at fire-sale prices.

Action to Take --> There is so much to like about tech stocks like these right now. Many have very strong balance sheets, which can be used to buy back stock while the market is slumping, or used to acquire these almost-IPOs. Moreover, tech spending is now solidly rising, if recent earnings reports are any indication. I am a big fan of Dell Inc. (Nasdaq: DELL) , thanks to its balance sheet-led downside support, but all of the above-noted tech names hold appeal. Conversely, look to trim positions in investment banks if the IPO market doesn't re-open before the next earnings season in July.

-- David Sterman
Staff Writer

Disclosure: David Sterman owns shares of Neither StreetAuthority and LCC nor the editor hold positions in any securities mentioned in this report..

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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This article appears in: Investing , Investing Ideas

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