A Boom-to-Bust Year for IPOs
by George E. Nichols | 12-18-00 | Morningstar

In a famous scene from the movie Titanic, Leonardo DiCaprio's character exclaims "I'm the king of the world!" while hanging off the bow of the ship. By the end of the flick, however, his corpse sinks unceremoniously to the bottom of the ocean. Similarly, IPOs were seen by many as the king of the investing world in early 2000, but the Nasdaq crash cooled investors' ardor and caused the IPO market to sink like a stone.

A circuslike atmosphere predominated in the early part of the year--several new issues quadrupled in price during their first few minutes of frenzied trading. Investors emboldened by a soaring tech market clamored for a piece of young startups. In doing so, investors increasingly shouldered the risks normally associated with venture capitalism.

Then the bubble burst. The ensuing hangover has been painful for investors: The Bloomberg IPO Index is down 57% from its March peak. For the last two months of the year, the number of withdrawals and postponements handily outpaced the number of debuts.

One hallmark of the IPO market--a moon-shot opening--is increasingly rare. That is actually positive news. As we've pointed out numerous times, ordinary investors often lose their shirts chasing these gains.

There were more than 350 offerings during the year, and we've tried to highlight the gems while steering investors away from the losers. Now it's time to review our best and worst calls (from myself and fellow Morningstar.com analysts).

Let me start off with a mea culpa: My take on Krispy Kreme (KREM) was off by a country mile. In March, I told investors not to expect much from the offering. Then, in July, I argued it was overpriced at more than 100 times earnings. But this gravity-defying purveyor of doughnuts now trades 250% above its IPO price. Call me stubborn, but I still think investors should buy KK's tasty treats rather than its inflated stock. As Morningstar.com analyst Corey McElveen points out, the stock doesn't merit such a huge premium to the restaurant industry average P/E of 22.

And back in April, I screened for the best buys among recently completed offerings. I gave kudos to three tech-related stocks, Breakaway Solutions (BWAY) among them. Since then, Breakaway is breaking shareholders' backs, down 93%. Oops--I didn't anticipate the incineration of the e-consulting market. Unfortunately for Breakaway, an industry recovery isn't on the immediate horizon.

Lest you think we're just contrary indicators, we've also made plenty of good calls. Along with Breakaway, I made a case for Avanex (AVNX) and Homestore.com (HOMS). Since then, the Nasdaq has nose-dived 25%, but these two firms are swimming against the tide. Avanex and Homestore.com have risen 42% and 25%, respectively.

Among unattractive IPOs, I skewered America Online-Latin America (AOLA) in a July preview. It met with a cold reception and the stock continues to make a beeline for the floor. Problems include management turnover, pricing pressures, and the company's late entry into its markets. AOL-LA is much cheaper than when I previewed it, but not nearly cheap enough.

I also have to tip my hat to a couple of colleagues. Morningstar.com stock director Pat Dorsey panned Fairmarket (FAIM) and warned about Buy.com's (BUYX) "laughable business model". These hot IPOs now languish in penny-stock territory. The lesson to be learned (which should've been obvious from the get-go) is that it doesn't pay to ignore a "going concern" warning from a company's auditors. And always be skeptical of any business with razor-thin (or negative) gross margins (for example, PeoplePC (PEOP) and eMachines (EEEE).

A review of the year in IPOs wouldn't be complete without tackling the biggest of the bunch: AT&T Wireless (AWE). Todd Bernier, Morningstar.com's wireless analyst, outlined reasons to avoid the tracking stock. Sure enough, the company had a lackluster debut and shed a third of its value in its first six months of trading. Recently, AT&T indicated its wireless tracking stock will be spun out as an independent entity. On the basis of this good news, and AT&T Wireless' strong business fundamentals, Bernier now believes the stock is undervalued. Indeed, we consider this stock to be among few recent IPOs worth a look right now.

[Note: This story originally contained now-inactive links, which have been edited out for readability.]