Everyone, or most everyone, loves initial public offerings and the allure of great gains on the great growth engines of the next decade.  Sometimes things just don’t work out as well as the hype and the hope.  That is the market for you.  But then there is a different scenario where the underwriters misprice an IPO by a mile.  These either dupe the companies which are coming public or they hose investors who buy in the public market at the IPO or in the post-IPO public markets.  It actually happens a lot in good markets and in bad markets.

2011 has seen its fair share of poorly priced IPOs.  24/7 Wall St. took a look at the entire IPO class of 2011 and looked through to see which IPOs were greatly mispriced.  The most obvious were in the following: Arcos Dorados Holdings Inc. (NYSE: ARCO); Boingo Wireless, Inc. (NASDAQ: WIFI); Demand Media, Inc. (NYSE: DMD); Epocrates, Inc. (NASDAQ: EPOC); Freescale Semiconductor Inc. (NYSE: FSL); FriendFinder Networks Inc. (NASDAQ: FFN); HCA Inc. (NYSE: HCA); Kips Bay Medical, Inc. (NASDAQ: KIPS); LinkedIn Corporation (NYSE: LNKD); NetQin Mobile Inc. (NYSE: NQ); Pandora Media Inc. (NYSE: P); Renren Inc. (NYSE: RENN); and Skullcandy, Inc. (NASDAQ: SKUL).

Some of the mispricing will appear to be the weak stock market. These mispriced issues go above and beyond the stock market performance. We took a look at the underwriters, the pricing around the pre-IPO ranges, the float, the valuation then and now, and more.  In many cases, we even noted what the analyst group thinks of these outfits today with consensus price targets from Thomson Reuters.

Arcos Dorados Holdings Inc. (NYSE: ARCO) is the Latin American operator of McDonald’s.  The offering was 73.5 million shares, 11 million higher than expected at $17.00 per share, above the $13 to $15 price range.  This one was rather simple to observe: the raised shares and the raised price just didn’t get raised enough. Unlike the bulk of the mispriced IPOs, “The Latin Golden Arches” had money left on the table.  The Chairman and CEO controls the company with a super-majority stake, but he even bought shares in the IPO. It came public in April and it did not get killed May and did not get killed in the July-August market panic.

Bank of America Merrill Lynch, J.P. Morgan, Morgan Stanley and the others left money on the table here for the company.  It seemed as though a $20.00 offering could have been easily supported even at the higher share count. To prove the point, the post-IPO range is $19.70 to $29.43 and that sub-$20 price was only on one day in July. This IPO had very little hype going into it when you consider what you get: McDonald’s growth versus Latin American population growth.  This last week has been the only real drop with major emerging market selling or the gains would even be more.  Investors may be getting a chance to get back in on the cheap.

Boingo Wireless, Inc. (NASDAQ: WIFI) was in the pre-selling waves before the summer, but its hotspot model is not as hot when you consider how so many smartphones and subscriber services are doing the company’s job.  We actually have no issues with the company’s business model, but the issue is on how it is valued.  After selling 5.77 million shares at $13.50 per share on May 4, the opening price was about 7% lower and it closed down almost 10% on the first day.  It never saw that price again and by May 16 this was under $10.00.

Earnings were a disappointment in June, something we think the company or the underwriters should have known at the IPO when the price range was $12 to $14 per share.  Credit Suisse and Deutsche Bank were the joint book-runners on the deal and this stock is now down close to $8.00 after trading under $7.00.  Should a questionable IPO price even be valued now at close to 60-times 2011 expected earnings?  Nothing wrong with the company, but a lot wrong with how it was priced.

Demand Media, Inc. (NYSE: DMD) is one that was just wrong all the way around.  The company was an easy story: online media with user-generated content.  It was able to sell even more shares with the overallotment option because it was still late-January.  The $17.00 pricing for 8.9 million shares actually saw a big pop on the first day with a close of $22.65.  This was broker-driven hype because the revenue model and its ad-model were being questioned literally from the start.  This one even went north of $27.00 but it was the hype of the online media craze at the time.  How the business model was valued at the IPO was the real problem, not just the stock market.

We think the Demand Media model is fine as long as the online ad world will support it and as long as it can keep interest.  Our take was that the blow-up from Google’s ranking system that was going to count it as a content farm should have been known the entire time.  Shares now sit close to $8.00.  Goldman Sachs and Morgan Stanley lead that offering and they just got the story wrong.  The company even announced a $25 million buyback recently, which is not very becoming of a recent IPO to have to do. Analysts still have a value just under $18.00 on this one, which feels like alchemy today.

Epocrates, Inc. (NASDAQ: EPOC) was one which we had a hard time grasping a premium on, but it priced 5.36 million shares at $16.00 in early February, above the $13 to $15 range we had indicated, and the stock was above $20.00 on its debut trading day.  J.P. Morgan and Piper Jaffray were the joint book-running managers.  The company makes handheld applications for doctors and medical staff.  Think apps and programs for smartphones and tablets at the doctor’s office or the hospital.

What is amazing is that the stock actually went as high as $30.00 before the market selling and before everyone figured it out.  Shares now sit around $9.00 and that translates to 32-times 2011 expected earnings and about 19-times expected 2012 earnings.  There is nothing wrong with this company, other than the valuation.  It was expensive at the pricing and even after being cut in more than half it is not exactly a cheap stock.

Freescale Semiconductor Inc. (NYSE: FSL) was the old Motorola semiconductor company that came public and was bought by private equity.  It then came public again in an IPO that was force-fed into the public markets again.  One employee told me the name internally years ago was “FREEFALL” to its employees.  We noted that at the time of the IPO that “Freescale is going to be a disappointing private equity technology IPO if the pricing matters… the company’s initial public offering is only about 75% of the original amount we expected.”  Private equity backers leveraged this up and the IPO proceeds (at the end of May) were going almost entirely to pay back debt (guess to whom!).  It was losing money and the $18.00 price was at the lower end of the $18 to $20 range that was already cut from $22 to $24 initially.

Again, Freescale was force-fed to investors and the underwriters should have delayed it.  Freefall is more fairly value now around $12.00 after it briefly traded under $10.00.  Our take is not just that this was mispriced.  It should have been delayed entirely.  The world does not revolve around new public investors returning money to private equity buyers solely acquiring companies to flip them back to the market later (and usually leveraged up on debt).  The consensus analyst target is $22.30 today, but we’d call that more than questionable.

FriendFinder Networks Inc. (NASDAQ: FFN) was one we were critical of from the start.  This was social networking meets porn and it had to withdraw its IPO at least once before.  This IPO went off for 5 million shares at $10.00 and that price was at the low-end of its price range.  The $50 million sale compared to a whopping “up to $460 million” it sought to raise in its first attempt to come public.  The joint book-runners of the offering were Imperial Capital and Ladenburg Thalmann and they probably did not win any favors asking IPO buyers to buy “Facebook Meets Porn.”  The IPO came in May and while it had one print at $10.01 it closed down at $7.85 on its first trading day and was down at $5.75 after just 5 trading days.  Now the stock is close to $2.00.  We asked this before and ask again, “With friends like this, who needs enemies?”  This deal was so mispriced that there should be a paddling for punishment.

HCA Inc. (NYSE: HCA) was strange because it was a re-IPO and a giant one at that from private equity and management.  The 124 million shares came public at $30.00 and there was actually a $31.00 price right after the IPO and ultimately this hit $35.00.  The IPO price range was $27 to $30 and we were only expecting a mid-point pricing at the time.  Our take is that the underwriters could have known even in March that surgeries were soft, even if they did not know about pending reimbursement changes coming down the pipe.

When HCA warned on earnings, we asked “Who Knew What When?” and the shares remain pressured even after taking out part of the overhang from the Merrill Lynch private equity stake repurchase.  The stock is actually cheap on an earnings metric now, but the market is just not willing to endorse the current estimates as gospel is how it feels. Where it should have priced would be a guess and the market would have punished it regardless, but a drop of this magnitude measures up to a big mispriced IPO for a private equity deal and for a company which was coming public for the third time.

Kips Bay Medical, Inc. (NASDAQ: KIPS) was mostly unheard of until recently when its news flow worked against it.  It is developing MESH for use in coronary artery bypass grafting surgery.  The company came public in February with a 2.06 million share offering at $8.00 per share, but it barely traded above $8.00 and closed down at $7.93.  Rodman & Renshaw was the sole book-running manager. Its stock chart looked like a staircase heading to the basement shortly after the IPO and the stock was challenging the $2.00 mark this summer.

Shares had recovered to get back above $3.00 but now the company has been crushed on news that the FDA continues to require additional information from the company before allowing it to pursue a clinical study of its eSVS MESH in the U.S.  The stock is now under $2.00 after falling more than 30% freshly on the FDA news.  Should the underwriters have known that these delays were coming?  Maybe, but the deal was so small that you have to question it just out of good measure.  A drop of 75%.  Crystal ball or not, some might be confused into thinking this was a reverse merger stock from China because it has done so poorly.

LinkedIn Corporation (NYSE: LNKD) may be an IPO shell game with such a low float, but that is a different argument.  The demand was massive here for the professional social networking company’s May IPO.  This was one of our Top 17 IPOs to Watch for 2011 and we did a poll on the IPO pricing that about 56% of respondents said the $45.00 price was too high another 19% said that was the top, and only 13% said it should go for over $60.00 per share.  We noted the first price terms called for a $32 to $35 price range.  The opening price was $83.00 and shares then went to $90 and then over $100 before reaching $122 at the peak… Now shares are back down to $77.50 and the analyst group sees a consensus price target of $93.80.

It turns out that the pricing was not high enough, but what the underwriters could have done more fairly was demand that more than 8% of its float come public.  This remains a conundrum for investors today.  A higher price or just a lot more shares… Either way the company was not done the greatest justice by the underwriters.

NetQin Mobile Inc. (NYSE: NQ) is supposed to be the mobile security leader in China with millions and millions of users.  It sold 7.75 million ADRs at $11.50 per share, higher than the 7.1 million shares projected and at the top of its $9.50 to $11.50 per share range.  The May 5 IPO fell from the start and closed down at $9.30 on its debut day. By May 23, NetQin was under $6.00 and the ADR is now under $5.00.  Piper Jaffray & Co. was the sole book-runner and co-managers were Oppenheimer & Co. and Canaccord Genuity. They didn’t do investors any favors here even if the stock has recovered from its post-IPO low of $3.95.

Pandora Media Inc. (NYSE: P) was another lesson where the underwriters should have told the online music outfit “No!” on its low float.  It came public in the middle of June when the underwriters could have been more forceful.  The 14.7 million shares was only 9% of the float and the $16.00 price compared to the first print at $20.00 and a high print for some unlucky soul at $26.00. It closed down at $17.42 on its debut day, and the shares recovered after going to about $13.00 within the first few days to close back at $20.04 on July 1.  That was the peak and shares are now down around the $10.00 mark.

A firm called BTIG, which was not in the underwriting group, said that Pandora was a “Sell” and worth only $5.50 per share almost simultaneously with the June IPO.  The underwriters were more positive than that and Pandora has been trying to rectify the issue of having a lack of scale on its music costs.  The analysts currently have a $16.81 consensus target, but we’ll see if that holds up when the float is increased in the months ahead.

Renren Inc. (NYSE: RENN) was an early May IPO that came public before the summer doldrums set in and it was being sold as “The Facebook of China.”  We were shocked that Morgan Stanley, Deutsche Bank, and Credit Suisse still allowed the pricing on Renren when the company lowered its prior growth forecasts a week or so before the offering and considering that the head of the audit panel resigned a day or two before the IPO.  The company sold 53.1 million shares at $14.00 and the stock surged some 40% initially.

The price gap up was shocking, and you can tally that to the brokers being able to appeal to investor greed at the time.  “The Facebook of China” was all it took.  Now shares are down under $6.00.  That is crazy.  The next time a company lowers prior growth and has the head of the audit committee leave before an IPO, will you burn your cash as rapidly?  We said it before and will say it again, Renren was more like the “Face%$#& of China.”

Skullcandy, Inc. (NASDAQ: SKUL) also came public before the July sell-off turned into the July-August market panic.  The company plays on premium headsets for MP3 players and premium music headsets for the young hipster crowd.  Technically, this is a pure premium product company for those who want flashier earphones and headsets. Skullcandy sold 9.44 million shares at $20.00 per share for a premium pricing.

The company’s first earnings report was also a disappointment (despite 46% revenue growth) and you have to assume that the company and the underwriters could have guessed that the numbers would be weak at the time of the IPO.  The same firms’ analysts actually gave this one a positive ratings bias after the earnings drop but the damage was done and the stock now resides under $15.00.  Had this one priced at the low-end of the range it would have been more fair, but the $20.00 and higher prices (up to $23.40) were just too high for a company that almost every customer can technically live without.

And, what lies ahead…

The First Trust US IPO Index (NYSE: FPX) is not having a good 2011.  At $21.95, its 52-week trading range is $20.65 to $26.67.  Even the Global IPO Plus Aftermarket (IPOSX) around $10.50 is hovering around its year lows and down from $13.50 in July.  You can thank many mispriced IPOs for at least part of that.

Don’t think that these companies are alone.  Far from it.  There are only so many that can be considered.  Facebook is facing a serious conundrum ahead as it is reportedly delaying an IPO to keep employees focused.  Mark Zuckerberg may be jeopardizing billions here or he could be winning on the upside.  We also recently noted what the Teavana Holdings, Inc. (NYSE: TEA) implied: full valuation.  Private equity-backed IPOs are often accused of being mispriced, and now Carlyle is looking to come public itself… When private equity wants to go public.  We have also noted that Carbonite, Inc. (NASDAQ: CARB) was simply a victim of the stock market pressure.  Otherwise it would have fetched more as underwriters had to cut the price to a giveaway to make investors buy the stock at the IPO price.

These were far from the first of the mispriced IPOs, and there will be many more in the years ahead. Lessons for Group and Zynga are many and the lessons for the underwriters and the IPO after-market investors await.

JON C. OGG

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