Back To Basics
Back in 1983, when the market for initial public offerings roared, the roster of best-selling new issues read like a venture capitalist's fantasy. Scores of young companies named Bio-this and Micro-that were raising money at prices that harkened back to the go-go years of the late 1960s. No matter that many of the businesses were embryonic and expecting to lose money for several years. Investors seemed convinced that, with the right amount of cash, these fledgling enterprises were going to transform the way we work and live.
How swiftly things change. The 1983 market is a distant memory these days, and so are the visions that fueled it. Many of its most active investors are on the sidelines, licking their wounds. As for the 1985 new issues market, it looked nothing like its legendary predecessor. The exotic was out, and the mundane was in. In place of companies whose names ended in "-onics," the year's hot IPOs included an "-ooter," as in Roto-Rooter, the sewer cleaning company; an "-osh," as in OshKosh B'Gosh, the clothing maker; and an "-eese," as in Pasta & Cheese, the food packager and retailer.
To be sure, Wall Street's newfound enthusiasm for down-to-earth companies had much to do with its earlier voyage into the IPO stratosphere. During the record-shattering year of 1983, 673 companies collectively raised nearly $12.5 billion in IPOs -- almost four times the amount companies had garnered in the previous record year of 1981. (These figures do not include "best efforts" issues or offerings priced below $1 a share.) In the heady aftermarket, moreover, many new issues soared, only to come crashing back to earth as the investing public lost faith in their ability to perform. Naturally, the stocks that had risen to the highest multiples had the furthest to fall. These were mainly the stocks of young technology companies, one of the more infamous examples being Diasonics Inc., an extraordinarily well-financed maker of medical diagnostic equipment. After going public at $22 a share, more than 70 times its prior year's earnings, it quickly climbed to 27 1/4. Within a year, however, the company was reporting losses, and its stock price had plunged to 5 1/4; last year, it dropped to 2 1/2, before creeping up to around 4. A similar fate befell many other stars of the 1983 new issues market -- TeleVideo Systems, Kaypro, and Seeq Technology, to name but three.
Having been bloodied to the tune of several billion dollars, many investors, institutional and otherwise, were less than eager to chase after high-tech IPOs again. During the first nine months of 1985, for instance, makers of electronic equipment and instrumentation accounted for just 2.1% of the IPO dollars raised, compared with 11.2% of the IPO dollars during 1983. Manufacturers of other kinds of machinery and computers didn't fare much better, accounting for only 2.4% of the dollars raised through mid-November 1985, versus 11.6% in 1983.
Moreover, underwriters of hightech deals really had to sell their offerings in 1985. That was hardly the case in 1983, when "you filed the prospectus, and the crowds appeared," recalls William R. Hambrecht, president of San Francisco-based Hambrecht & Quist Group, which managed 26 offerings that year. Now he finds that investors do their homework and want to be convinced beyond a reasonable doubt that a company will make it -- that is, if they are willing to listen at all.
Which is not to say that investors have been turning a deaf ear to new issues in general, or that 1985 was a bad year for IPOs. On the contrary, it was a very good one. Granted, the market started off slowly, but by mid-December, companies had sold $8.1 billion of equity, more than twice what was raised in all of 1984, making 1985 the second most active year ever.
As a rule, investors tended to look most favorably on new issues of companies in changing industries -- notably, financial services, including banks; and health care, including health maintenance organizations. Another industry segment that picked up a big following in 1985 was retailing and wholesaling. As a group, nonfood retailers and wholesalers raised 11.4% of the IPO dollars in 1985, up from 6.6% in 1984 and 8.8% in 1983. Especially popular were retail chains specializing in consumer electronics, and membership discount stores that sell everything from food to lawn furniture, but only to customers who have paid a membership fee. In recent months, there were five deals in the first category and four in the second.
Industries aside, the 1985 market required a more circumspect approach on the part of issuing companies. Greed was out. Unlike 1983, when company founders were almost expected to use their IPOs for their own enrichment, those looking for personal liquidity in 1985 were wise to be discreet. One who found that out was Austin O. Furst Jr., the 42-year-old founder and chief executive officer of Vestron Inc., a Stamford, Conn., publisher of prerecorded videocassettes. The company's preliminary prospectus, filed last September, indicated that 5.4 million shares were to be sold by the founder and an equal number by the company, raising a total of up to $205 million. After the offering, Furst would not only be richer, by about $100 million, but he would also still own 70% of Vestron's stock. This did not sit well with institutional investors. When Vestron came to market a few weeks later, the offering had been scaled down to $70.2 million; was pegged at $13 a share, instead of the original $16 to $19; and did not include any founder's shares.
By the same token, investors were leery of inflated price/earnings ratios. No longer could companies benefit from offerings priced at multiples of 50 or 60 times the previous year's earnings, as many had in 1983. In 1985, multiples generally ranged from 15 to 30. Many investment bankers, in fact, advised clients to underprice their IPOs so as to "leave something on the table" for shareholders, who would presumably show their appreciation by supporting future offerings. (All of this, of course, makes you wonder what investment bankers were telling their clients back in 1983 -- maybe, to take the suckers for every penny they're worth -- but that's another matter.)
But what most distinguished the 1985 new issues market from its predecessors was the intensity with which investors scrutinized the companies making their initial offerings. Indeed, there were probably fewer opportunities for unproven companies to raise money in 1985 than at any other time in recent years. Investors wanted nothing to do with stunning new concepts -- in marked contrast to 1983, when they "were perfectly willing to look over a four- or five-year valley," notes Barry B. Conrad, head of corporate finance at Dallas-based Rauscher Pierce Refsnes Inc. For that reason, investment bankers tended to discourage very young companies from even doing IPOs, with the result that the average age of issuing companies rose to about seven years in 1985, up from three years in 1983, and five years in 1984.
As for the companies that did well in the 1985 market, most of them offered evidence of an ability to weather difficult market conditions, and to perform over time. In this regard, investors seemed to be paying particularly close attention to certain key aspects of a company's operation, including:
MANAGEMENT. One thing investors wanted was reassurance that a company's management knew where the business was going, and had the horsepower to get there. That certainly helped The Peanut Shack of America Inc., a 10-year-old retailer based in Winston-Salem, N.C. A $13-million company, with earnings of $600,000 in fiscal 1985, Peanut Shack had placed 241 of its shops, many of them franchised units, in shopping malls located in 30 states. While most of the company's existing shops sold nuts, candy, confections, and other specialty foods, president and CEO Alan R. Kleinmaier wanted to develop two parallel chains, one selling coffee and tea, the other selling cookies.
To help in this undertaking, Kleinmaier, 39, had brought aboard several proven managers. His general manager, for instance, had experience running his own industrial-equipment sales company for more than 10 years; his marketing vice-president was a 12-year veteran of R.J. Reynolds Industries Inc.; and his chief financial officer had spent five years as an accountant with Deloitte Haskins & Sells. "The management is young and smart," says Ed Crawford, an investment banker in the Winston-Salem office of Wheat, First Securities Inc., which co-managed the deal. "They showed they had energy and hustle, and the only thing they really lacked was money." Evidently, investors agreed: Peanut Shack had little trouble raising $4.8 million in its August IPO.
PROFITABILITY. Whether a company had deep management or not, investors generally insisted on evidence that it knew how to make money. A case in point is Lancer Corp., a San Antonio-based company that manufactures and sells beverage-dispensing equipment for use in restaurants and soda fountains. Since the late 1960s, Lancer had been supporting its growth with bank debt, retained earnings, and private equity placements. It had enjoyed great success in the market as well, selling its dispensing systems to big-name beverage companies and their bottlers, including The Coca-Cola Co., which had even collaborated with Lancer on designing some of its products.
But, most important, the company could show a record of steady earnings growth over the past few years. By the end of 1984, its operating income had risen to 12.3%, with aftertax profits of 6.6% on sales of $19 million. It was a known quantity. "We didn't have some mysterious black box," says George F. Schroeder, 46, who co-founded the business with his older brother. "We're conservative, and our prospectus was clean. There were no inside transactions, and nobody in the company was making more than $85,000." Investors liked what they saw. In its June IPO, Lancer raised a total of $6.9 million, at a solid multiple of nearly 13 times earnings.
Steel Technologies Inc., a processor of flat-rolled steel, projected a similar image of soundness. The Louisville-based company sells mainly to the Detroit auto companies, their suppliers, and large appliance manufacturers, all of which have become increasingly demanding with regard to quality and on-time delivery. Steel Technologies had risen to the challenge, investing heavily in computerized production equipment. "We process steel to extremely stringent tolerances, to as close as one-half a thousandth of an inch," says Daryl A. Elser, president and chief operating officer. "So no one can really confuse us with U.S. Steel."
Nor could anyone confuse its performance with that of Big Steel. While sales were more than doubling, from $19.6 million in 1980 to $49.4 million in 1984, net earnings increased more than ninefold, from $223,000 to $2.1 million. That pleased investors, who bought out Steel Technology's $11.8-million offering at $11.75 per share -- about 11 times the previous 12 months' earnings.
MARKET POSITION. It also helped for an issuer to be recognized as a leader in its market, or as a company with the potential to become one. Central Sprinkler Corp., for instance, is a $30-million manufacturer and distributor of automatic fire sprinklers, with a reputation among contractors for designing some of the industry's most innovative sprinkler heads and valves. The industry, moreover, is growing, thanks to the national trend toward installation of sprinkler systems in both new and old buildings. "There's hardly a highrise building under construction in this country that doesn't have a sprinkler system in it," says chairman William J. Meyer, one of a group that acquired the company via a leveraged buyout in May 1984. "And the more militant fire marshals become, the more it helps us."
The owners estimated that Central Sprinkler had a 25% to 35% share of a highly competitive domestic market. From a financial standpoint, moreover, the Lansdale, Pa., company looked strong, having earned an aftertax profit of $1.3 million (3.8% of sales) in fiscal 1984, even though its interest expenses had soared as a result of the buyout. On the strength of that record, Central Sprinkler raised $8.3 million in its May IPO, with investors paying $12.75 per share, or about 16 times earnings of the previous year.
That was not the end of it, however, for Central had left quite a lot "on the table." By early September, its stock was trading at nearly $17, allowing Central to return to the market and raise another $17.3 million in subordiated debt at a bargain rate of 8%. The company is using the money to pay off its bank debt and to fund expansion. As for the new investors, they have the right to convert their 25-year bonds to shares of common stock as soon as the price of Central's stock reaches 20 1/8.
Market strength was an equally important factor for other companies entering the public equity market -- notably Roto-Rooter Inc., the $28-million business that has been cleaning America's stopped-up drains for a half century. Formerly a private company, Roto-Rooter had been acquired in 1980 by Chemed Corp., a public company in Cincinnati, which continues to own more than 60% of the business after the offering. Sewer and drain cleaning may not be the most glamorous business in the world, but neither is the need for it apt to disappear, and Roto-Rooter certainly has the name recognition needed to attract customers. In any case, investors were willing to pay a healthy 25 times earnings, as Roto-Rooter's IPO raised $13.5 million last June.
Name recognition also helped OshKosh B'Gosh Inc., a leading maker of work wear and children's clothing. Overalls may be overalls, but the Wisconsin company had managed to turn theirs into a fashion item. "It's a brand name people know," says David Coolidge, who heads the corporate finance department at William Blair & Co., headquartered in Chicago. He notes as well that the primarily family-owned company, which earned $12.8 million on 1984 sales of $137 million, "was a lot more solid than many public companies." That perception was certainly a factor as OshKosh raised $21 million in its IPO last May.
You might wonder whether last year's investors were ever willing to support a company that didn't have all the pieces in place. They were, but not very often. Carolyn Bean Publishing Ltd., for example, was able to do a $3.7-million IPO last July, despite the fact that it had lost $333,406 on 1984 sales of $2.3 million. In fact, it had never earned a dime during the five years of its existence.
But the San Francisco company does occupy a strong position in the fastest-growing segment of the $3-billion greeting-card industry, the production and distribution of "alternative" greeting cards, and that fact weighed heavily with investors, according to investment banker Robert Fagenson, a director of Starr Securities Inc., in New York City.He points to Carolyn Bean's Sierra Club cards, its comic series by "Mrs. Bagelman," and a new line called "True Wit" -- diverse products that founder Lawrence Barnett, 37, proudly maintains are "about as far away from Hallmark Cards as you can get." Investors were apparently confident that Carolyn Bean would become highly profitable once the company had money for additional personnel and better internal systems. In the greeting-card business, says Fagenson, "gross margins average 60% to 70%. And these guys understand the business as well as anyone."
So what does all this mean to a company contemplating an initial public offering in 1986? In all likelihood, not very much. Wall Street works in capricious and curious ways. What appeals to investors during one period of time is often not what attracts them during another.
This is not to suggest that the financing "window" for, say, growing retailing companies will slam shut anytime soon.But it might -- and quite possibly for reasons that have nothing to do with a company's own performance and everything to do with such factors as Wall Street's attitude toward retailing stocks in general. The only real certainty, it seems, is that investors' tastes and appetites are always changing. And when investors get bored with, or spooked by, an industry sector, they run the other way, as they ran from technology stocks in 1985.
If you wait long enough, however, the pendulum usually swings back. Some investment bankers and analysts are already beginning to wager that a new crop of technology companies will come to market with their IPOs in 1986. Once the dead wood has been cleared away, and the survivors start to perform, the market will be looking for more new technology issues, they say. "It won't be a long list, but more than we saw in 1985," predicts Richard Franyo, managing director of corporate finance at Baltimore-based Alex. Brown & Sons, which managed 21 high-tech deals in 1983 and 2 in 1985. Franyo also believes that the next batch of technology issues will have to be stronger and less speculative than their predecessors to meet the tougher standards of today's investors.
Hambrecht agrees. "We think there will be markets for good companies in 1986, but not at 1983 prices. . . . And some companies are going to have to wait." Indeed, he and many others contend that the painful memories of 1983 will continue to influence the IPO market for a long time to come. "There was so much blood spilled," he says, that it may be 10 years before all is forgotten. Why 10 years? "That's just how long it usually takes to produce a new generation of investors."
Note: This table may be divided, and additional information on a particular entry may appear on more than one screen.
THE BEST-PERFORMING NEW ISSUES OF 1985
Rank & Company City & State Size ($ M) price
1. ENTERTAINMENT MARKETING Houston, TX $3.0 2
2. IDENTIX Palo Alto, CA 5.0 4
3. CONTROL RESOURCE INDUS. Michigan City, IN 3.3 5
4. PDA ENGINEERING Santa Ana, CA 7.3 7 1/4
5. SONEX RESEARCH Annapolis, MD 2.5 5
6. PRAXIS PHARMACEUTICALS Beverly Hills, CA 4.0 1 1/2
7. LSI LIGHTING SYSTEMS Cincinnati, OH 10.0 8 1/3
8. METALBANC Miami, FL 1.1 1
9. CONSOLIDATED STORES Columbus, OH 33.4 14 1/2
10. VIDEO IMAGE Oklahoma City, OK 1.6 1 3/4
11. AUTODESK Sausalito, CA 15.4 11
12. INTL. AMERICAN HOMES Union, NJ 5.4 3
13. ANITEC IMAGE TECHNOLOGY Binghamton, NY 26.4 11
14. AMER. CITY BUS. JOURNALS Kansas City, MO 9.2 10 1/2
15. AJ ROSS LOGISTICS Keasbey, NJ 2.8 1
16. PASTA & CHEESE Long Island City, NY 5.0 6
17. BRANTREE SAVINGS BANK Braintree, MA 2.2 10 1/2
18. LANCER San Antonio, TX 6.9 9 1/2
19. SBARRO Melville, NY 11.9 10 3/8
20. UNION FEDERAL S&L Los Angeles, CA 19.2 8 3/4
21. CENTRAL SPRINKLER Lansdale, PA 8.3 12 3/4
22. CAROLYN BEAN PUBLISHING San Francisco, CA 3.8 6
23. NUVISION Flint, MI 6.8 13 1/4
24. SALICK HEALTH CARE Beverly Hills, CA 16.8 9 1/3
25. FIRST FEDERAL S&L Kalamazoo, MI 10.2 9 1/2
26. H&E VENTURES Minneapolis, MN 1.6 2
27. TELECALC Bellevue, WA 2.6 6
28. VIDEO DISPLAY Stone Mountain, GA 2.4 4 3/4
29. GRIDCOMM Danbury, CT 3.0 6
30. AMER. VIDEO TELECON. Oceanside, NY 1.0 1
31. WSTRN. FED. SAVINGS BANK Mayaguez, PR 8.2 8
32. CFS FINANCIAL Fairfax, VA 8.6 9
33. IVERSON TECHNOLOGY McLean, VA 5.6 8
34. ISCO Lincoln, NB 7.7 10 1/4
35. BINGHAMTON SAVINGS BANK Binghamton, NY 15.8 8 3/4
36. GATEWAY BANK South Norwalk, CT 43.2 17
37. MILTOPE GROUP New York, NY 9.1 13
38. CIRCADIAN San Jose, CA 7.8 6
39. ROTO-ROOTER Cincinnati, OH 13.5 13 1/2
40. BARRISTER INFO. SYSTS. Buffalo, NY 6.3 9
41. OSHKOSH B'GOSH Oshkosh, WI 19.7 25
42. AMER. TECHNICAL CERAMICS Huntington Sta., NY 7.3 6 3/4
43. BIOCRAFT LABORATORIES Elmwood Park, NJ 25.2 14
44. INTL CONTAINER SYSTS. Tampa, FL 3.0 5
45. BRIDGE COMMUNICATIONS Mountain View, CA 24.0 12
46. APPLE BANK FOR SAVINGS New York, NY 44.7 12 3/4
47. SYLVAN LEARNING Bellevue, WA 7.7 9
48. SANFORD Bellwood, IL 15.3 17
49. XL/DATA COMP Hinsdale, IL 20.0 15
50. ENGINEERED SUPPORT SYSTS. St. Louis, MO 9.8 9 3/4
THE BEST-PERFORMING NEW ISSUES OF 1985
Rank & Company 11/21/85 % change Business Description
1. ENTERTAINMENT MARKETING 6 1/8 206.3% Distr. consumer
2. IDENTIX 10 1/2 162.8 Mfr. fingerprint
3. CONTROL RESOURCE INDUS. 12 1/4 145.0 Devel. air filtration systs.
4. PDA ENGINEERING 14 1/2 100.0 Devel. software for
5. SONEX RESEARCH 10 100.0 R&D on efficient
6. PRAXIS PHARMACEUTICALS 2 13/16 87.5 Devel. pharmaceutical
7. LSI LIGHTING SYSTEMS 15 5/8 87.5 Mfr. outdoor lighting
8. METALBANC 1 7/8 87.5 Purchase & sale of
9. CONSOLIDATED STORES 27 1/8 87.1 Retail close-out
10. VIDEO IMAGE 3 1/8 78.6 Mfr. instructional video
11. AUTODESK 18 1/2 68.2 Devel. CAD software
12. INTL. AMERICAN HOMES 5 66.7 Acquires regional home
13. ANITEC IMAGE TECHNOLOGY 18 1/8 64.8 Mfr. photographic
14. AMER. CITY BUS. JOURNALS 17 1/4 64.3 Pub. metropolitan
weekly business newspapers
15. AJ ROSS LOGISTICS 1 5/8 62.5 Refurbishes, transports
16. PASTA & CHEESE 9 3/4 62.5 Mfr. pasta products
17. BRAINTREE SAVINGS BANK 17 61.9 Savings bank
18. LANCER 15 1/4 60.5 Mfr. beverage dispensing
19. SBARRO 16 1/2 59.0 Operates chain of Italian
20. UNION FEDERAL S&L 13 7/8 58.6 S&L association
21. CENTRAL SPRINKLER 19 3/4 54.9 Mfr. sprinkler syst.
22. CAROLYN BEAN PUBLISHING 9 1/4 54.2 Pub. note & greeting
23. NUVISION 20 1/4 52.8 Mkts. eyewear & optical
24. SALICK HEALTH CARE 14 1/8 51.3 Prov. facilities & svcs.
for kidney dialysis
25. FIRST FEDERAL S&L 14 3/8 51.3 S&L association
26. H&E VENTURES 3 50.0 Devel. & mkt. computer
27. TELECALC 9 50.0 Prod. computer-based
phone info. systs.
28. VIDEO DISPLAY 7 1/8 50.0 Mfr. cathode ray tubes
29. GRIDCOMM 9 50.0 Devel. LAN data
30. AMER. VIDEO TELECON. 1 1/2 50.0 Mfr. software & hardware
for video telec.
31. WSTRN. FED. SAVINGS BANK 11 7/8 50.0 Operates a savings bank
32. CFS FINANCIAL 13 1/4 48.4 Operates a savings bank
33. IVERSON TECHNOLOGY 11 1/4 47.2 Modifies comp. prods. to
34. ISCO 14 1/4 40.6 Mfr. scientific instruments
35. BINGHAMTON SAVINGS BANK 12 39.0 Savings bank
36. GATEWAY BANK 23 1/8 37.1 Operates a savings bank
37. MILTOPE GROUP 17 1/2 36.0 Mfr. computer peripherals
38. CIRCADIAN 8 34.6 Mfr. ambulatory ECG systs.
39. ROTO-ROOTER 17 3/4 33.3 Prov. sewer, drain, pipe
40. BARRISTER INFO. SYSTS. 11 3/4 31.5 Assembles computerized
legal info. systs.
41. OSHKOSH B'GOSH 32 1/2 30.6 Mfr. clothing
42. AMER. TECHNICAL CERAMICS 8 3/4 29.6 Mfr. ceramic &
43. BIOCRAFT LABORATORIES 18 1/8 29.5 Mfr. generic drug prods.
44. INTL. CONTAINER SYSTS. 6 3/8 27.5 Devel. plastic cases
for soft drink bottle
45. BRIDGE COMMUNICATIONS 15 1/4 27.1 Supplies LAN systs.
46. APPLE BANK FOR SAVINGS 16 25.5 Savings bank
47. SYLVAN LEARNING 11 1/4 25.0 Franchises child
48. SANFORD 21 23.5 Mfr. disposable markers
49. XL/DATA COMP 18 1/2 23.3 Sells IBM computer systs.
50. ENGINEERED SUPPORT SYSTS. 12 23.1 Mfr. defense systems
CompuServe Inc., Columbus, Ohio
Does not include "best-efforts" issues or offerings for less than $1 per share.
The chart above lists the top 50 new issues during the first three quarters of 1985, ranked according to the percentage increase in share price from the stock's issue date through November 21, 1985 (the most recent date available prior to publication).
CORRECTION-DATE: April, 1986
In "Back to Basics" (February), the chart titled "The Changing Industry Mix: 1983 and 1985" should have been credited to Securities Data Co., New York City; the chart "The Best-Performing New Issues of 1985" should have been credited to CompuServe Inc., Columbus, Ohio; and the price for #23, Nuvision, should have read 13 1/4.