No Tech, No Takers

Eight myths about going public that this year's market shatters

Thinking about taking your company public? This may not be the year to depend on conventional wisdom about the initial-public-offering market. We present eight myths to ponder.

1. In this market, high tech is the name of the game.
In recent years IPO dockets have been crammed with companies in sexy growth areas -- medical technology, software, anything for the Internet. With the stunning valuations racked up by the likes of Netscape, Pixar, and other hot technology outfits, one might wonder, Can a company in a more mundane business also hit a bonanza?

In a word, yes -- particularly if it looks as if it can be a dominant player in its industry. There have been more than 2,300 IPOs in the past four years, and portfolio managers at the biggest investors -- mutual funds -- look for industry winners, no matter the industry.

A few examples:

( Baby Superstore Inc., based in Duncan, S.C. Founded in 1971, this retailer went public in September 1994, pricing its stock at $18. By the time the offering closed, however, the price had jumped to $34.75, raising some $40 million. "It was one of the most successful retailing IPOs over the last couple of years," says Marcia Aaron, a retail analyst with Alex. Brown & Sons in San Francisco, who covers the company. Now it boasts a market value of around $700 million. We're talking diapers here, along with clothing, furniture, toys, shoes, and other baby needs -- a category killer for tykes. Baby Superstore is the first superstore in its sector and expects to add 20-odd stores this year, bringing its total to 80. "They are exploiting a very large market, $23 billion and growing," says Aaron, "and they'll hopefully do in this sector what Home Depot did in home improvement."

( Sunglass Hut International, based in Coral Gables, Fla. Public since 1993, Sunglass Hut developed sunglasses as a separate retail category and then claimed it. Its IPO brought in $64 million. As the company has tightened its grip on the category, investors have opened their wallets wider. Its stock price has shot from $5 at the IPO to about $31 recently, adjusted for stock splits. Multiplied by the 55 million shares outstanding, that works out to a market capitalization of more than $1.7 billion -- for a company with earnings last year of $28 million on sales of $418 million. "Sunglass Hut's valuation is basically the size of the premium sunglass market, so the valuation is as large as the sector it's in, and it owns only one-third of it," says David Buchsbaum, who tracks the company for Southeast Research Partners, in Boca Raton, Fla.

Borders Group, based in Ann Arbor, Mich. In 1994 Kmart spun off its Borders Books and Waldenbooks divisions. The two joined forces as an independent entity and went public in May 1995, raising $500 million. Waldenbooks has been stable at about 1,000 stores and $1 billion in sales. But Borders Books superstores have grown explosively in the 1990s. Chris Vroom, senior retail analyst at Alex. Brown in Baltimore, says, "From a growth standpoint, Borders is one of the best-?positioned companies in all of retail." There were 75 Borders Group superstores in 1994, doing $12 million; by the end of last year, with the company at 116 stores, sales hit $700 million. Another 40 are opening this year.

The stock is up nearly a third since the IPO, from $14.50 to $26.75, bringing the market value to more than $1 billion. On revenues last year of about $1.7 billion (for Waldenbooks and Borders), earnings hit 85¢ a share, which makes the price-earnings multiple an above-average 31.

-- Jay Finegan

2. If you're doing OK, don't worry about the aftermarket.
The first 9 or 12 months after an IPO are especially critical, according to Boston securities lawyer John Piccione, a former investment banker. "Believe me," he says, "the analysts will kill you if you're wrong about those early quarters."

Even a tiny disappointment can savage a stock, as Diamond Multimedia learned the hard way. A computer-products outfit based in San Jose, Calif., Diamond went public in April 1995 on the heels of its best year: revenues had jumped from $130 million in 1993 to $203 million in 1994 (and then to $467 million in 1995). The company had been consistently profitable for four years.

In January analysts were looking for fourth-quarter earnings of 42¢ to 45¢ per share for Diamond. "We would have hit the high end of that range," says chief executive officer Bill Schroeder, "but we had an unexpected inventory variance, so we reported 40¢. They didn't like that."

Indeed not. When Diamond announced its results, on January 18, its stock plunged from $26 to $16 in two hours. Schroeder isn't na×ve about Wall Street -- Diamond is the third company he's taken public -- but he was startled by the "panic reaction." He addressed his workforce that very afternoon. "I wanted the employees to know what was going on, so they wouldn't be distracted," he says. "I told them that Wall Street is driven by people who have a phone in each ear and a cup of coffee in one hand and a cigarette in the other, and they trade stocks like commodities." -- J.F.

3. The analysts will follow you through thick and thin.
The burgeoning IPO market makes it tough for analysts to follow every deal. And when analysts abandon coverage, a company can fade into stock-market oblivion, becoming, in Wall Street lingo, an orphan.

"There's a limit to the number of good analysts," says Kevin Landry, CEO and managing director at TA Associates, an investment firm in Boston. "With so many deals coming through, at some point analysts have to pick and choose, and they're going to choose the companies with great long-term prospects -- that's how their firms make money."