The Secret Way to Play IPOs

A surging stock market has brought a smile to the face of investment bankers. They’ve suddenly found a much more receptive environment for new initial public offerings (IPOs), with 16 deals of at least $100 million being pulled off in October — the best month for IPOs this year. And the pipeline of fresh offerings is starting to fill, which means that the whole fourth quarter could prove to be a very active period for IPOs.

Notably, nearly half of October’s IPOs were based in China, though that proportion should diminish in coming months. Yet a word of caution about China-based IPOs: These companies tend to disappoint investors after a quarter or two, either by missing expectations that were too high, or meeting those expectations and then quickly doing a secondary offering to raise yet more money.

In a moment, we’ll look at October’s crop to find the best ideas, but we should first recall the “quiet period” play, and how you can profit from it. After a company is taken public, its underwriters are forbidden from writing about it for a period 25 business days. But when their mouths are unzipped, they often gush, giving the stock a fresh bounce. So many investors like to find attractive-looking new companies and buy shares soon before the quiet period ends.

Generally speaking, analysts will only speak cautiously of a fresh stock if it has already had a strong run since the IPO. So looking at the table below, China Cache (Nasdaq: CCIH), TAL Education (NYSE: XRS), and Vera Bradley (NYSE: VRA) are unlikely to see much of a push from analysts. (The analyst bounce can only come from IPOs that were brought public by large, reputable underwriters, which applies to all the names on this list).

China Ming Yang Wind Power (Nasdaq: MY) is the classic slow-to-build IPO. The company’s efforts to sell the deal were apparently underwhelming (as can be the case with many China-based IPOs, where management’s English-language proficiency is not up to snuff yet). Yet this is precisely the kind of business for which analysts gush as soon as they can. First, the company is seen as a technology innovator. Second, it has a large and growing backlog. And third, the Chinese government’s support of clean energy firms — especially those that have a solid shot of cracking export markets — means that demand should stay robust.

But be ready to move quickly if the stock gets a solid bounce from analysts. That’s because many rivals are lining up to go public as well, and this industry may soon suffer from too many newly-capitalized firms that all rush to add capacity at the same time with their IPO proceeds. And higher industry capacity often spells price wars — not a good thing for Ming Yang, which has yet to even show a full-year profit and may never generate anything more than tiny profit margins once competition really builds. So this may be more of a good trade rather than a good investment. The quiet period for this stock ends this coming Friday, so you’ve got a relatively small window to try and play the “quiet period” bounce.

#-ad_banner-#In a similar vein, Global Education & Technology (Nasdaq: GEDU) may get an analyst-led pop in mid-November. But this education firm, along with its other China/education peers, looks awfully expensive based on traditional metrics and would need to be a good bit cheaper to be found fundamentally attractive for long-term investors.

The Thanksgiving IPO bouncers
Later this month, we’ll see analyst coverage possibly boost more recent IPOs. For example, NetSpend (Nasdaq: NTSP), which StreetAuthority contributor Tom Taulli wrote about, has quickly become a force in the prepaid debit card market. [Read Tom’s article here] As long as analysts are willing to overlook the taint associated with troubled financial firm Meta Financial (Nasdaq: CASH), you can expect to see quite bullish reports.

Soon after Thanksgiving, analysts will weigh-in on Pacific Biosciences (Nasdaq: PACB) and Examworks (Nasdaq: EXAM). The former is a speculative but intriguing play on the ability to rapidly sequence DNA — the company has a strong technology base, but also strong rivals. The latter is a solid, experienced firm in anti-fraud efforts. Both of these stocks should receive glowing analyst coverage.

The month’s last IPO, SeaCube Container (NYSE: BOX), is arguably the best value play of the whole group. The company’s fully-rented fleet of specialized shipping containers means that cash flow is robust and more than ample to cover the company’s still-high debt load.

SeaCube’s bankers thought they could get $16 a share in the IPO, but had to cut that price to $10. Investors are shunning most shipping-related stocks, but this one may have been unfairly tarnished, as it has a more solid business model than firms like DryShips (Nasdaq: DRYS). At this lower price, analysts are likely to note that shares sport a single-digit price-to-earnings (P/E) multiple, and that SeaCube could eventually offer a dividend equating to a 7% or 8% yield, once debt levels start to come down.

Action to Take –> The coming weeks will be an interesting test for the IPO market. If these stocks get the “analyst bounce” that I expect, then yet-to-be-priced deals will start to be seen as post-quiet plays. This was a wining approach in the 1990s and again in the middle of the last decade, and could become so once again in coming weeks.