2002's IPO Market: Down, But Not Out
Despite Drop in Underwriting; Performance of IPOs Bests General Market
By Jeffrey R. Hirschkorn, Senior IPO Analyst

There's no question that 2002's initial public offering market experienced a sizeable decline in total volume and deals underwritten. For the year there were 82 IPOs totaling $27 billion in domestic proceeds. Data courtesy of Thomson Financial excludes closed-end funds, units, self-underwritten deals and IPOs priced under $5. It continues a trend of declining conditions for new issues that started following the meltdown of the tech-laden Nasdaq Composite in April 2000.

Nevertheless, the major attraction for IPOs is that the average performance over offering is substantially better than the returns of the major market indexes. The average return for this year's freshman class stood at a decline of 4% while the S&P500 and Nasdaq Composite were off 22% and 30%. More importantly, investment bankers continued to practice quality over quantity. Consider that the market for initial public offerings peaked in 1996 when 864 deals were priced and in 1999 a record year for proceeds was set when $73 billion was raised from 437 offerings.

No matter the lineup of new issues for 2003, Wall Street will likely be dealing with new rules governing initial public offerings. On Dec. 20, the ten largest securities firms agreed to pay $1.4 billion to settle charges of misleading investors by issuing biased research and penalized some clients by doling out big chunks of IPOs to others. Amongst other admissions, the brokerage firms agreed to close out research analysts from attending investment road shows. Such firms also will eliminate the practice of directing shares of lucrative offerings from favored clients.

Market observers have given credit to a newfound professionalism amongst investors for not proceeding to invest in entities with burgeoning losses and highly questionable business models. Investors are now unwilling to back money-losing operations, with the result leading to profitability at more than half of this year's issuance of IPOs. That compares with fewer than 21% in 2000. With not much selection out there for investors to peruse, Doug Baird, a managing director at Deutsche Bank Securities tells Barron's, "There's simply not much product out there. And what there is tends to be in more mature industries."

More than ever, Barron's reports, that "megadeals dictated the shape and tenor of this year's IPO market. Five billion-dollar-plus issues raised 52% of the year's gross domestic proceeds." Analysts interviewed by IPO Monitor feel that the hardest deal of 2002 was the $4.9 billion float from CIT Group (CIT). Commenced on July 1, CIT faced additional scrutiny because of the scandals plaguing its parent Tyco International. The deal, according to well placed sources, was crucial to Tyco's financial health and also put CIT employees on firmer footing.

Sentiment Tips in Favor of Regional Underwriters

Tenuous conditions on Wall Street, including economic weakness and consequences resulting from a potential invasion of Iraq played an integral part of the decrease in underwriting business. Alan Greenspan chimed in with a couple of interest-rate reductions and it has apparently helped stimulate the market. 2003 should provide a solid landscape for President George Bush to press ahead with an agenda highlighted by a new series of tax cuts; eliminate the double taxation on dividend issuance and developing a prescription drug plan for seniors.

More specifically, the investment banking community was forced to undergo substantial changes due to government investigations into questionable allocation procedures and overstepping by star analysts and investment bankers during the underwriting frenzy of the late 90's. As a result of new securities regulations, investment banks have been forced to pay substantial retribution to clients. One major culprit: Citigroup announced widespread organizational changes at Salomon Smith Barney aimed at changing its image from the days of disgraced market analyst Jack Grubman. As a result of unethical investment research and unlawful involvement in banking initiatives, Mr. Grubman has been barred from working in any official Wall Street capacity and fined for his actions. A plus: he avoided jail time for his criminal activities.

With those concerns in toe, there was an extremely large push for issuers to utilize second tier or regional investment banking firms. Nearly one quarter of the year's stock issuance was done under the tutelage of entities that included Keefe Bruyette & Woods, Legg Mason Wood Walker, Morgan Keegan, Raymond James & Associates and William Blair. As the year for new issues concluded, there were a couple of late-year additions to the corners of Broad and Wall Street by the regional bankers.

There's no secret that the pace of underwriting has slowed and that has played an integral role in the gamesmanship of investment banks. The competition to underwrite IPOs, in particular blockbuster transactions, escalated in 2002. Key: Ensure a diverse and layered distribution for large deals. For the sixth consecutive year, the number of IPOs utilizing joint book runners exceeded 20%.