Gambling With Ipos -- Initial Public Offerings Can Be Risky, But Payoffs Can Be Handsome

Had you bought stock in every new company that went public in Washington, Oregon and Idaho since the end of 1986, your portfolio would be up a robust 114 percent.

Sounds pretty good, doesn't it?

Well, it isn't. If you had bought the 30 blue-chip stocks in the conservative Dow Jones industrial average, you'd be ahead 143 percent. And if you had purchased all the stocks in the Nasdaq composite index, which better reflects new issues, your gain would be 192 percent.

In spite of the sudden and highly publicized success of Seattle-based Redhook Ale Brewery's recent stock issue, initial public offerings can be hazardous to your wealth.

"The typical IPO outperforms the first three months, then underperforms the general market," said Robert Natale, research director for new issues at Standard & Poor's Corp. in New York.

Eagle Hardware & Garden is a good example. It was priced in July 1992 at $9.33, and adjusting for a split, zoomed as high as $40. Today, it trades at 14 percent discount to the original price and 80 percent below the high. But that's an improvement over the 1993 offering of MicroProbe, or the '91 offerings of Nendels and Oesi Power, or the '88 sale of Hughes Homes. They're all virtually worthless, either no longer traded or trading as penny stocks.

Investors will be able to test Natale's theory again soon. The same week Redhook went public, Cutter & Buck, a men's sportswear designer in Seattle, and Mackie Designs, a Woodinville maker of audio mixers, also issued stock.

Since then, Redhook has consistently traded in the low to mid $30s after the $17-a-share offering. Mackie, offered at $12, ended last week at $15.25. Cutter & Buck has been up 50 cents to $1 over its $7 offering. By Thanksgiving, if Natale's theory holds true, the general market should be outperforming them.

The best chance to make money on new issues, market veterans say, is by buying shares during the initial offering rather than after trading starts and prices tend to skyrocket.

That's as easy as saying if you want to go to the moon, start by being an astronaut.

The sale and marketing of new stock offerings is a bundle of contradictions and complexities.

"There's an old saying about IPOs: If the stock is available, you don't want it. If it's not available, you want it," said Yale Hirsch, an investment newsletter writer in Old Tappan, N.J., a 34-year industry veteran.

Stocks such as Netscape, which was initially priced at $28 but started trading at $71, and Redhook, priced at $17 and traded for $25, are eagerly sought. But getting them at the initial price is nearly impossible.

A prime reason for a company to sell stock is to create a ready market for shares already held by management and employees and by outside investors. Those often are shares originally valued at just a few cents, when the company was young and the risk great.

When Redhook's sale occurred, the lead manager, or underwriter, was Smith Barney, a New York-based brokerage.

Underwriters consult with the companies to determine the terms for an offering and see that the shares get sold. They use valuations of other companies within an industry, potential profit growth and other financial factors to set a price range. For Redhook, that was $13 to $15. Then, brokerages participating in the offering solicit orders to determine demand. High demand will send the price range higher. For their work, underwriters collect 7 percent to 10 percent commissions.

Piper Jaffray and Montgomery Securities were co-managers of the Redhook offering. Fifteen other brokerages were in what is known as the selling syndicate.

Among those was Merrill Lynch, the largest brokerage in the country. Merrill Lynch customers might have imagined getting a shot at Redhook stock at $17. But because of the way allocations work, the entire Merrill Lynch system received just 4,000 shares.

Syndicates are set up to achieve a balance between national and regional brokerages and between brokerages that specialize in institutional business (mutual funds, pension and trust funds and others who move large blocks of money in and out of the market every day), and those specializing in individual accounts. How many shares which brokerages get usually is left to the lead underwriter.

In Merrill Lynch's case, the 4,000 shares it got - because of the small number available and the familiar regional name on the stock - were distributed by brokerage offices in its Northwest region. Requests by Merrill Lynch customers exceeded 100,000 shares.

Investors with accounts at Smith Barney might have had a better chance. But just because you're a customer doesn't mean eagerly sought shares will come your way.

"You have to cultivate relationships," Natale said. "You have to open accounts in several places," worth $10,000 to $20,000.

It won't help to open an account at the last minute. Brokerages generally won't favor new clients with hot deals. They don't know you, and they have enough long-term clients to take the shares. When it comes to longtime clients, brokerages tend to favor those who buy and sell stocks frequently.

"The broker will reward their clients who have worked with them for years with the good deals," said Len Cereghino, a former stock broker who now provides financial advice to companies through his Len Cereghino & Co. in Seattle.

In an initial public offering, at least half the shares go to institutional investors instead of individual clients.

Some companies selling stock would prefer 90 percent of the shares going to institutions, said Cereghino.

"Institutions typically will pay more," he said, because they can see the value and potential growth better. "But most companies would prefer to see 50 percent institutions, 50 percent retail."

People running the sale would love to sell as much as they can to institutional investors.

"If you can place it with 100 institutions or 10,000 retail customers, which is easier?" Cereghino said. "Face it, institutions do the lion's share of business."

On a hot issue, when the stock gets to a broker, it is tough decision time.

Brokers with lots of good clients and not much stock to hand out will rotate the hot deals among their customers. Individuals who use discount brokers who never participate in such deals won't get in on the new issues until after trading starts.

Market observers advise individuals generally to avoid new issues unless they can get the benefit of the lower offering price. (By buying at the offering, customers get another boon: no commission.)

For those assessing new issues, Natale advises checking the reputation of the underwriter and making sure a company's senior management owns a piece of the company.

Read the prospectus, the selling brochure for the stock. Look not only at sales and earnings, but also at trends. Also see if there are any one-time benefits that caused earnings to be inflated.

"Check the size of the market. Unless the company is No. 1 or No. 2 in a field that can go to $1 billion in revenues in two to three years, you don't want to own it," Natale says.

When markets are hot, and a hot stock emerges, investors sometimes lose their heads.

"Fear of missing out becomes more important than fear of a loss," said Robert Farrell, a senior investment adviser at Merrill Lynch.

Leaps like those that Netscape and Redhook experienced can prompt visions of a 100 percent move overnight.

Amid such thoughts, no wonder Farrell says, "Despite recent experience, IPO does not stand for `instant profit opportunity.' "

------------------------- History of Northwest IPOs -------------------------

These are Northwest initial public offerings, the Nasdaq Composite index and the Dow Jones industrial average since Jan. 1, 1987, plus for comparative purposes three other well-known IPOs from earlier periods - Microsoft, Nordstrom and Price/Costco. The average gain for all IPOs in the 1987-1995 period was 114 percent.

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: Went : First : 8/25/95 : % : Stock : public : price : price : chg : ------------------------------------------------------------------. Microsoft : 3/13/86 : $1.167 : $94.375 : 7989% : ------------------------------------------------------------------. Nordstrom : 7/29/71 : $1.021 : $40.125 : 3831% : ------------------------------------------------------------------. Cellular Tech. Services : 1991 : $1.750 : $24.000 : 1271% : ------------------------------------------------------------------. Sierra On-Line : 1988 : $3.000 : $39.750 : 1225% : ------------------------------------------------------------------. Lattice Semiconductor : 1989 : $2.667 : $31.375 : 1077% : ------------------------------------------------------------------. Hollywood Entertainment : 1993 : $2.333 : $27.000 : 1057% : ------------------------------------------------------------------. Quality Food Centers : 1987 : $3.250 : $24.875 : 665% : ------------------------------------------------------------------. Ride Snowboard : 1994 : $2.250 : $16.625 : 639% : ------------------------------------------------------------------. Cascade Financial : 1992 : $3.072 : $17.000 : 453% : ------------------------------------------------------------------. Price/Costco : 12/5/85 : $3.333 : $17.375 : 421% : ------------------------------------------------------------------. Starbucks : 1992 : $8.500 : $39.875 : 369% : ------------------------------------------------------------------. Jackson Co. Fed. SB : 1990 : $3.250 : $15.000 : 362% : ------------------------------------------------------------------. Wholesome & Hearty Foods : 1992 : $3.000 : $13.500 : 350% : ------------------------------------------------------------------. Pioneer Bank (1) : 1989 : $6.178 : $26.300 : 326% : ------------------------------------------------------------------. Barrett Business Systems : 1993 : $3.500 : $14.750 : 321% : ------------------------------------------------------------------. Merix : 1994 : $9.000 : $34.250 : 281% : ------------------------------------------------------------------. Plum Creek Timber L.P. : 1989 : $6.667 : $24.625 : 269% : ------------------------------------------------------------------. GNW Financial (1) : 1988 : $6.625 : $24.000 : 262% : ------------------------------------------------------------------. In Focus Systems : 1990 : $9.500 : $30.375 : 220% : ------------------------------------------------------------------. VanFed Bancorp (1) : 1989 : $6.250 : $19.000 : 204% : ------------------------------------------------------------------. Nasdaq Comp. since 1/1/87 : 348.83 : 1019.98 : 192% : ------------------------------------------------------------------. BMC West : 1991 : $5.333 : $15.250 : 186% : ------------------------------------------------------------------. Planar Systems : 1993 : $7.000 : $20.000 : 186% : ------------------------------------------------------------------. Sequent Computer Systems : 1987 : $8.500 : $24.000 : 182% : ------------------------------------------------------------------. Omega Environmental : 1991 : $1.500 : $4.063 : 171% : ------------------------------------------------------------------. Receptech (1) : 1989 : $9.750 : $25.750 : 164% : ------------------------------------------------------------------. McCaw Cellular Comm. : 1987 : $21.750 : $54.125 : 149% : ------------------------------------------------------------------. TriQuint Semiconductor : 1993 : $11.000 : $26.750 : 143% : ------------------------------------------------------------------. Dow Jones since 1/1/87 :1895.95 : 4601.40 : 143% : ------------------------------------------------------------------. Phamis : 1994 : $12.000 : $27.750 : 131% : ------------------------------------------------------------------. Microfield Graphics : 6/23/95 : $6.000 : $13.375 : 123% : ------------------------------------------------------------------. US West NewVector (1) : 1988 : $20.000 : $44.000 : 120% : ------------------------------------------------------------------. NeoPath : 1/26/95 : $11.000 : $23.750 : 116% : ------------------------------------------------------------------. Redhook Ale Brewery : 8/17/95 : $17.000 : $34.750 : 104% : ------------------------------------------------------------------. Ostex International : 1/25/95 : $9.500 : $18.875 : 99% : ------------------------------------------------------------------. InterWest Savings : 1991 : $7.826 : $15.500 : 98% : ------------------------------------------------------------------. Active Voice : 1993 : $15.000 : $29.250 : 95% : ------------------------------------------------------------------. Midisoft : 1993 : $3.500 : $6.563 : 88% : ------------------------------------------------------------------. Itron : 1993 : $13.500 : $24.250 : 80% : ------------------------------------------------------------------. Sterling Financial : 1991 : $6.818 : $12.000 : 76% : ------------------------------------------------------------------. Cascade Bancorp : 1994 : $8.264 : $14.500 : 75% : ------------------------------------------------------------------. Acres Gaming : 1993 : $5.000 : $8.625 : 73% : ------------------------------------------------------------------. Percon : 7/28/95 : $6.750 : $11.250 : 67% : ------------------------------------------------------------------. Riverview Savings Bank : 1993 : $8.658 : $14.000 : 62% : ------------------------------------------------------------------. Aldus (1) : 1987 : $20.000 : $31.500 : 57% : ------------------------------------------------------------------. CFI ProServices : 1993 : $9.750 : $15.000 : 54% : ------------------------------------------------------------------. CellPro : 1991 : $11.000 : $16.500 : 50% : ------------------------------------------------------------------. FEI Co. : 6/1/95 : $9.500 : $14.250 : 50% : ------------------------------------------------------------------. Key Technology : 1993 : $9.000 : $13.500 : 50% : ------------------------------------------------------------------. Metropolitan Bancorp : 1990 : $7.273 : $10.875 : 50% : ------------------------------------------------------------------. Timeline : 1/9/95 : $4.375 : $6.500 : 49% : ------------------------------------------------------------------. Midcom Communications : 7/7/95 : $11.000 : $16.000 : 45% : ------------------------------------------------------------------. Heart Technology : 1992 : $18.000 : $25.875 : 44% : ------------------------------------------------------------------. United Security Bancorp. : 5/5/95 : $6.818 : $9.750 : 43% : ------------------------------------------------------------------. Schnitzer Steel : 1993 : $19.000 : $26.250 : 38% : ------------------------------------------------------------------. Columbia Banking System : 1992 : $8.875 : $11.938 : 35% : ------------------------------------------------------------------. Ambassadors Int. : 8/3/95 : $9.000 : $11.625 : 29% : ------------------------------------------------------------------. Shurgard Storage Centers : 1994 : $18.900 : $23.875 : 26% : ------------------------------------------------------------------. Phoenix Gold International : 5/4/95 : $6.750 : $8.500 : 26% : ------------------------------------------------------------------. Pacific Rehabilitation : 1994 : $6.000 : $7.500 : 25% : ------------------------------------------------------------------. Red Lion Hotels : 7/27/95 : $19.000 : $23.250 : 22% : ------------------------------------------------------------------. Adaptive Solutions : 1993 : $6.000 : $7.250 : 21% : ------------------------------------------------------------------. R-B Rubber Products : 5/11/95 : $4.250 : $5.125 : 21% : ------------------------------------------------------------------. Red Lion Inns : 1987 : $20.000 : $23.875 : 19% : ------------------------------------------------------------------. Applied Voice Technology : 1994 : $13.000 : $15.250 : 17% : ------------------------------------------------------------------. ThrustMaster : 2/24/95 : $6.500 : $7.500 : 15% : ------------------------------------------------------------------. SMC : 1/20/95 : $7.750 : $8.875 : 15% : ------------------------------------------------------------------. Flir Systems : 1993 : $12.000 : $12.875 : 7% : ------------------------------------------------------------------. Protocol Systems : 1992 : $11.000 : $11.750 : 7% : ------------------------------------------------------------------. Cutter & Buck : 8/15/95 : $7.000 : $7.469 : 7% : ------------------------------------------------------------------. Monaco Coach : 1993 : $13.000 : $13.250 : 2% : ------------------------------------------------------------------. Arctic Alaska Fisheries (1): 1988 : $13.000 : $12.750 : -2% : ------------------------------------------------------------------. Wall Data : 1993 : $20.000 : $19.000 : -5% : ------------------------------------------------------------------. Crown Pacific L.P. : 1994 : $21.500 : $20.375 : -5% : ------------------------------------------------------------------. Applied Laser Systems : 1992 : $3.000 : $2.813 : -6% : ------------------------------------------------------------------. Targeted Genetics : 1994 : $6.000 : $5.563 : -7% : ------------------------------------------------------------------. Greenbrier : 1994 : $14.000 : $12.625 : -10% : ------------------------------------------------------------------. InControl : 1994 : $11.000 : $9.875 : -10% : ------------------------------------------------------------------. Macheezmo Mouse : 1994 : $6.000 : $5.375 : -10% : ------------------------------------------------------------------. Icos : 1991 : $8.000 : $7.000 : -13% : ------------------------------------------------------------------. Western Power & Equipment : 6/14/95 : $6.500 : $5.625 : -13% : ------------------------------------------------------------------. Eagle Hardware : 1992 : $9.333 : $8.000 : -14% : ------------------------------------------------------------------. TRM Copy Centers : 1991 : $8.500 : $7.125 : -16% : ------------------------------------------------------------------. Paragon Trade Brands : 1993 : $19.000 : $14.750 : -22% : ------------------------------------------------------------------. Egghead : 1988 : $17.000 : $12.563 : -26% : ------------------------------------------------------------------. Holly Residential Properties 1993 : $23.000 : $14.500 : -37% : ------------------------------------------------------------------. Digital Systems Int. : 1990 : $18.000 : $10.875 : -40% : ------------------------------------------------------------------. MK Gold : 1993 : $6.000 : $3.625 : -40% : ------------------------------------------------------------------. Saliva Diagnostic Systems : 1993 : $6.250 : $3.750 : -40% : ------------------------------------------------------------------. Consep : 1994 : $6.000 : $3.250 : -46% : ------------------------------------------------------------------. Arrow Transportation : 1993 : $5.000 : $2.500 : -50% : ------------------------------------------------------------------. Interlinq : 1993 : $8.000 : $3.625 : -55% : ------------------------------------------------------------------. Sun Sportswear : 1989 : $10.500 : $4.250 : -60% : ------------------------------------------------------------------. ProCyte : 1989 : $8.000 : $3.000 : -63% : ------------------------------------------------------------------. Ernst Home Center : 1994 : $16.000 : $6.000 : -63% : ------------------------------------------------------------------. Utilx : 1988 : $8.500 : $2.875 : -66% : ------------------------------------------------------------------. Jay Jacobs : 1987 : $12.000 : $3.000 : -75% : ------------------------------------------------------------------. NeoRx : 1988 : $28.000 : $6.875 : -75% : ------------------------------------------------------------------. Industrial Funding : 1989 : $12.250 : $1.750 : -86% : ------------------------------------------------------------------. Renaissance GRX (1) : 1987 : $4.500 : $0.500 : -89% : ------------------------------------------------------------------. MicroProbe : 1993 : $6.500 : $0.438 : -93% : ------------------------------------------------------------------. Oesi Power : 1991 : $14.000 : $0.003 : -100% : ------------------------------------------------------------------. Hughes Homes : 1988 : $4.091 : NV : -100% : ------------------------------------------------------------------. Nendels : 1991 : $5.750 : NV : -100% : ------------------------------------------------------------------.

(1) - No longer public. NV - No meaningful value available.