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March 1, 1999

Near the Market Top?

By Stephen Lacey

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Is the stock market near the peak? Is the resurgence of secondary offerings by public companies one of the tell-tale signs of the market top?

Some experts think so.

The giveaway, they add, is the increasing number of venture capitalists using secondary offerings as exit mechanisms. That is, as a route to liquidate their equity stakes.

"There should be a red flag [raised] each time an equity offering is done," said Ivo Welch, professor of finance at the University of California at Los Angeles. Indeed, he advises investors to closely monitor the distance between an initial public offering and a follow-up secondary offering.

Welch and other experts say historical evidence portends a market correction. In the past, the pace of secondary offerings accelerated as the stock market neared a peak. Today, the pace of secondary offerings is once again picking up steam.

"If venture capitalists sell the younger stocks first, six months after the company goes public, that should be a source of concern," warned Welch, referring to the mandatory 180-day waiting period between an IPO and a secondary offering.

Profitable Exit

Venture capitalists typically invest in small start-up companies, taking management roles at the same time. Once the start-ups have matured, the venture capitalists will seek a final return on their investments.

Many venture capitalists presumably judge the current market as perfect for the most profitable exit. Some start-ups have seen huge leaps in share prices while long-term growth potential is questionable. Internet outfits are good examples.

After the volume of secondary offerings peaked in July with 71 companies raising $10.55 billion, investor appetite for these seasoned equities evaporated with the subsequent market collapse. At summer's end, only 18 issuers stepped back into the market, placing under $2.5 billion in new equities, according to Securities Data Co.

Since that time, however, rebounding market conditions have enticed both issuers and buyers back into the market. In January, 22 companies returned to the market, raising an additional $5.5 billion, including five companies that priced 1998 IPOs. Another 27 issuers returned to the market February 1 through February 22, raising $7.9 billion.

Unsuccessful Offering

The pending launch of a secondary offering is followed closely by investors. For experts, like UCLA's Welch, it sometimes suggests a coming market peak. For others, it sends a negative message about the company embarking on the offering.

Consider financial-services outfits INVESTCORP and SIPCO. In a secondary offering on December 8, these two unloaded about seven million shares at $26 3/8, two-thirds of their respective holdings in CSK Auto (NYSE:CAO). That came on the heels of a post-IPO run-up of roughly 40 percent in the company's share price. The company went public a mere ten months earlier. (CSK Auto, incidentally, did not sell stock. Therefore, it generated no cash in the offering.)

The investing public apparently saw the exodus of INVESTCORP and SIPCO, the firm's largest shareholders, as a sign of weakness. The stock price consequently dipped to as low as $21 1/8 on news of the pending secondary offering. It took an analyst's positive report to restore the stock's luster.