The proliferation of online trading provides retail investors with an unprecedented level of access to initial public offerings.
The bad news, market analysts say, is that the same access has contributed to the recent volatility of Internet companies going public on Nasdaq.
Reacting to complaints of disorderly IPO trading in general, and volatility in particular, the National Association of Securities Dealers has prescribed measures to help ease the chaos.
Will the measures, and others possibly in the pipeline, work?
Some discount brokers, who have seen retail IPO orders grow dramatically on their online trading services, are not waiting to find out. Instead, they have taken their own steps, restricting access by online investors to some Internet IPOs.
"The landscape has changed and our responsibility is to help our customers understand the nature of trading in fast-moving market conditions," said Dan Hubbard, a spokesman for San Francisco-based Charles Schwab & Co., which imposed a first-day moratorium for online trading of some IPOs.
Since the beginning of December, Charles Schwab has placed restrictions on the trading of more than a dozen IPOs, requiring customers to call in their orders rather than execute trades online.
The nation's largest discount brokerage implemented the policy in an effort to educate customers about the potential for extreme volatility in new IPOs.
In addition, it has advised customers how to use limit orders to reduce their exposure to volatile markets. "It's fine to drive these stocks, just wear a seat belt," Hubbard quipped.
Other discount brokerages, such as Ameritrade Holdings, DLJ Direct and National Discount Brokers, reportedly have similar restrictions in place.
Nowhere has the reemergence of the retail investor as a powerful constituency on Wall Street been more evident than in the large volume of retail orders being executed for Internet stocks. And these same orders, experts say, are pushing up prices to stratospheric levels in early IPO trading. The buzz is that investors are in love with Internet IPOs and lust for more of "anything.com."
Some Examples
What started with a Donaldson, Lufkin & Jenrette price target of $100 for a newly-minted eBay (Nasdaq:EBAY) in October, and a December CIBC Oppenheimer $400 bogey for a now venerable Amazon.com (Nasdaq:AMZN), has spread like wildfire.
Paced by new offerings from EarthWeb (Nasdaq:EWBX), theglobe.com (Nasdaq: TGLO), Computer Literacy (Nasdaq: CMPL), Ticketmaster Online-CitySearch (Nasdaq:TMCS) and uBID (Nasdaq:UBID), some ten Internet-related offerings hit the market since the beginning of November.
Among the most recent: Market Watch.com, a San Francisco-based provider of financial news, which had a mid-January offering of $17 a share, and rose in early trading to $130, finally settling on its debut at $97 1/2 at the market close.
As a result of the tremendous initial demand for Internet stocks, many issues like MarketWatch.com have skyrocketed to tremendous first-day openings only to erode in value later.
For example, on November 12, theglobe.com priced 3.1 million shares at $14 each. The stock opened trading in the aftermarket at $87, and quickly climbed to as high as $97 before retreating to close its inaugural session at $48 11/16 on a volume of 15.66 million shares.
At a recent price of $32 11/16, theglobe.com now trades at about one-third of its first-day high.
"I have never seen the individual investor as interested in IPOs as we're seeing them now," said Ben Holmes, founder of ipoPros.com, an Internet-based research firm. A testament to that interest is the robust first-day demand for anything Internet. First-day trading volumes for these stocks is averaging triple the number of shares offered.
The Market Makers
Some Nasdaq market makers, meanwhile, are worried. Why, asked the head of Nasdaq trading at one major regional desk, does Nasdaq not take a more aggressive approach to the Internet IPO chaos?
Moreover, why does it allow trading in an IPO to continue when, as has happened in the past, the market is locked and crossed?
Raising his voice from the floor, Dennis Green, a veteran Nasdaq trader with Legg Mason Wood Walker in Baltimore, put this to a panel of experts gathered at the mid-winter conference of the Security Traders Association in Chicago: "It sounds ridiculous that you would allow trading to open. You don't need a committee to solve the [volatility] problem."
But a committee is exactly what was formed by the NASD to find a solution. Taking the podium at the conference at the Chicago Hilton & Towers, then-STA President John Tognino explained that a group of STA members met in December with NASD Chairman Frank Zarb. The purpose of the meeting was to discuss dealers' "tremendous concern" about locked and crossed markets during IPOs. Zarb subsequently commissioned Patrick Campbell, chief operating office of the Nasdaq-Amex Market Group, to form a subcommittee to examine the problem. The STA in turn conducted its own probe.
"We all agree that when the market is at $51 [bid] and $49 [offer], it is locked and impossible to open the market. But you've got to have committees to look at the underlying evidence [of volatility]," said Tognino, who has since joined the NASD as executive vice president of global sales and member affairs.
At press time, the STA had documented some 20 trading issues of concern to market makers, including IPO volatility. Tognino said the STA and the NASD would work together to try to resolve them "We will go around the country to work out the most appropriate action," he said.
Not Unprecedented
The robust demand for IPOs in the aftermarket is not unprecedented. Investors gobbled up biotechnology stocks in the 1980s and those of restaurant concepts earlier in this decade. But the current bouts of volatility do make regulators anxious.
Aside from the subcommittee it formed, the NASD filed a preliminary ruling with the Securities and Exchange Commission in late December to create a more orderly market prior to the opening of IPOs.
NASD Rule 9898, approved by the SEC on January 25, took effect the next day, extending the current pre-opening window during which all dealers must reveal their prices from five to 15 minutes. Another 15 minutes is available during locked and crossed markets.
"The excessive volatility has inhibited the smooth functioning of the Nasdaq market during the initial trading of these IPOs to the detriment of all market participants," a Nasdaq official said. With the NASD considering other alternatives, the measure may just be a temporary stop-gap.
Chasing Internet Tulips
Notwithstanding the new measure, market observers wonder whether retail investors have unwittingly become the conduits through which institutions make outsized gains in price run-ups. Institutions typically receive the lion's share of the stock allocated in IPOs.
"This volatility is just nuts," said Irv DeGraw, an independent IPO analyst based in Sarasota, Fla. "I think many retail investors are jumping in with more enthusiasm than prudence."
Instead of focusing on underlying fundamentals, investors are potentially playing a dangerous game of Russian roulette by buying into Internet companies at extreme valuations.
"I can't come up with a reasonable explanation for some of the [Internet] valuations that we're seeing," said Mark Basham, who follows the new issues market for Standard & Poor's. "That's the whole reason for bubbles. It's not a zero-sum game in the short run."
"It's almost a game of musical chairs," added Ivo Welch, a professor of finance at the University of California at Los Angeles. "It's not so much the first-day openings that have gone crazy, but the overall valuations."
Based on Amazon.com's recent closing price of $321 1/4, the book and music retailer has a market capitalization of about $16.9 billion, or more than three times the combined capitalization of rivals Barnes & Noble (NYSE:BKS) and Borders Group (NYSE:BGI).
The Music Dies?
Need more proof that the music is still alive? Look no further than theglobe.com (Nasdaq:TGLL), Computer Literacy (Nasdaq:CMPL), Internet America (Nasdaq: GEEK) and audiohighway.com (Nasdaq: AHWY), which flourished in the aftermarket after their underwriting syndicates were unable to complete earlier efforts to place their offerings because of negative market conditions.
"We set the price based on fundamentals. The lunatics are the ones that are taking these stocks to such extremes," said the head of one equity syndicate desk shortly after pricing one of the sector's high-flyers. John A. Byrne contributed to this story.
