Some scholars say there is no way to tell if the economy or stock market is in a bubble. Wrong. The telltale signs are maniacal initial public offerings (IPOs) -- young companies taking their stocks public for the first time. The early investors usually sell a small percentage of their shares to the public. If the new stocks rise wildly -- as inevitably happens in an overheated market -- the insiders find themselves very rich. When the IPO market is sizzling, the overall stock market is almost always in a bubble, and the economy could be in one too.
This year, emerging tech companies have been rushing initial public offerings to market, but the game may slow sharply or possibly halt for a spell. "It was terrific for tech" until early November, says Bud Leedom of California Stock Report. But now tech stocks and the overall market have taken a pounding. "Techs trade at high valuations anyway, so it looks like they will take a pause," or perhaps a pratfall. And "this tech market casts a pall over the IPO market. I think a lot of planned issues will be delayed."
The high-tech/dot-com bubble of the late 1990s ended in the 2000 crash and economic woes. History is replete with other examples. Over the years, the standards for going public have weakened. Several decades ago, a company making an initial public offering would likely be profitable or at least close to profitability. No longer. Companies that don't even see profits on the far horizon hurry to peddle their shares to a greedy and giddy public.
China is flashing warning signs. In early November, an initial public offering of Alibaba.com, an Internet company, tripled in price the first day of trading. Among the many others that have gone public this year are Qiao Xing Mobile, Acorn International, Simcere Pharmaceutical, Xinhua Finance Media, Tongjitang Chinese Medicine, and JA Solar. The Chinese economy and stock market have been roaring for several years. Both could be bubbles: the hot market for new stock issues is a clue. Here's a warning, though: some people were saying that the Chinese market was in a bubble a couple of years ago.
In 1999 and 2000, our IPO market was insane -- nationally and particularly in San Diego. Many stocks were blatantly manipulated. The dot-com craze was only part of the story. In San Diego, a company named Wireless Facilities went public on November 5, 1999, at $15. It closed the first day at $62, up 313 percent, and in early 2000 hit $163.50. This fall, it changed its name to Kratos Defense and Security Solutions. It now sells for around $2. Then there was Diversa, an enzyme developer. On February 14, 2000, it went public at $24. It closed that day at $75, up 212 percent. It shot up to $169.19. Now it has changed its name to Verenium and sells for under $4.
Some tales became infamous: Padres majority owner John Moores, angling for a $350 million subsidy from the City, cut former councilmember Valerie Stallings in on stock of a Texas IPO, Neon Systems, at the lowball "friends and family" price of $15. It zoomed, and Stallings, acting on a tip from Moores, sold at $49.15, within a hair of the all-time high. It fell back down to $20, and Moores told her it would go back to $40. It did. Moores got his ballpark and Stallings got a wrist slap. Neon has since been purchased by another company.
So where do local IPOs, and potential IPOs, stand in today's new environment?
One local success has been biotech Genoptix, the diagnostic laboratory service provider, which went public the day before Halloween, raising $85 million. The shares came out at $17 and leapt 49 percent the first day to $25.35. Subsequently, they got as high as $27.16 and have held around $25. The company sports one thing many other IPOs don't have: profits. For the three months ended June 30, Genoptix earned $3.7 million on revenues of $13.9 million. However, the company writhed in red ink until that quarter; the cumulative deficit is $50.3 million, and Genoptix warns that losses may resume.
At the time of the offering, the net asset value per share was only 84 cents, so an investor paying $17 to $27 was taking a big risk. One comfort: with techs and biotechs, net assets aren't as meaningful as some other measurements of a company's worth.
There is another positive about this company: the insiders paid $5.23 a share for their stock. In many offerings, the insiders have paid pennies a share. Tina Nova, whose Las Vegas antics were reported in the Reader March 1, is chief executive. She owns 3.6 percent of the shares and didn't sell any in the offering.
San Diego's NovaCardia, which hopes to market two drugs for cardiovascular disease, filed to go public last March. But in July it abandoned the public offering and sold itself to the big pharmaceutical firm Merck for $366 million in stock. Nova-Cardia had never had any revenue, had a cumulative deficit of $51.5 million, and didn't think it would be profitable for several years. "It wasn't that the [IPO] market was tough. We had a good offer and chose the offer," explains Brian Farmer, formerly corporate development director. NovaCardia is unusual. It had only 11 employees. It had paid for licenses to the rights to two drugs that were developed by other companies. Its manufacturing and research were done by outside companies. The employees will not continue with Merck; they have joined a company that had once been part of NovaCardia. Former insiders had paid an average $1.01 for their shares and got out at roughly four times that.
CardioNet, Inc., another local company that specializes in the heart, appears to be plunging ahead with its plans. In August, the company filed to raise $150 million in a public offering and then filed an amended prospectus the next month. It made another amended filing November 9, even as tech stocks were being hammered. It will not respond to queries. The company provides ambulatory heart-monitoring equipment. It, too, has been a steady money loser, and it "may never become profitable," it admits in a filing. The losses have been diminishing, but its cumulative deficit is $82.5 million. In March of this year, it acquired a company in the same business for more than $50 million.
Entropic Communications filed on July 27 to raise $100 million in an offering; later, that was revised upward to a maximum of $126.5 million. The company's most recent amendments to its filings were this month, so it intends to go ahead. Entropic develops and markets systems permitting high-definition television and other multimedia entertainment to be delivered throughout a home. This company, too, has never been profitable, and it has a cumulative deficit of a whopping $91.8 million. Its net asset value is minus $10.60 a share. If it goes public at $10 to $11 a share, as tentatively planned, the stock buyer will start out in a deep hole. The insiders paid an average $3.79 a share. Entropic says it can't talk because it is in a so-called quiet period, the time leading up to a public offering when, generally, a company is not supposed to comment beyond what is in the public record.
So today's big questions: Was the strong tech IPO market a bubble, and is it bursting? And if so, will it carry along the overall market and the economy? Watch carefully.