Decoding the Secrets of a Strong IPO
WSJ MarketBeat, April 16, 2009, 12:56 PM ET
By David Gaffen
It’s easy in this market to have a successful initial public offering. Just make sure you’re a company that has 87% gross margins, and the equity market is your oyster.

The market for initial public offerings has been generally quiet for the last few months, and those companies that have sold shares for the first time have, for the last 11 months, been forced to offer a concession. Not so for Rosetta Stone, the language software company that sold 6.25 million shares at $18, the first time an IPO was priced above its range since valve company Colfax Corp. sold shares in May 2008.

"People say, ‘What does it take to do an IPO?’ and this is a great example," says Francis Gaskins, president of IPOdesktop.com. According to regulatory filings, the company sported gross margins of 87% in the first six months of 2008, which is pretty ridiculous, and of course, as Mr. Gaskins says, "is inviting competition."

Still, the company’s brand recognition will help it as it continues to try to expand overseas. The market for IPOs is slowly starting to improve after collapsing in the fourth quarter of 2008. In that quarter, just six deals were priced world-wide, and in the first quarter, there were just two, according to Renaissance Capital. In April, there have been three pricings. Along with Rosetta Stone, education company Bridgepoint Education sold shares Tuesday, and Changyou.com, a Chinese on-line game developer, priced on the first day of the month.

Overall, newer stock issues are performing well, particularly when compared with major averages. Wednesday, Renaissance Capital introduced its FTSE Renaissance IPO Composite Index, which includes a two-year rolling population of IPOs, and the constituents are then removed on their second anniversary. In a period of speculation, high-flying share offerings would propel this index to a performance that major averages could not keep up with – but they could also show more depressed returns when investors reduce risk.

So far this year, that index is up 8.8%, compared with a 5.7% decline for the Standard & Poor’s 500-stock index. The relatively strong performance of the newest publicly traded issues shows that investor confidence is returning, says Nick Einhorn, analyst at Renaissance Capital in Greenwich, Conn. Renaissance Capital found that between 1976 and 1980, new issues posted an average annual gain of 27% in their first three years, a sign of improving sentiment in stocks.

"It shows that even though there are not going to be a lot of deals, investor sentiment is improving, and people are more willing to bet on newer issues, as long as they’re good companies," says Mr. Einhorn.