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Miniature Action Figure: Manoj Thawani of Sunnyvale searches for IPOs daily from his Sunnyvale home. Since he is a small player, his purchases are limited to 100 shares. His major claim to fame: Last year he was able to invest $3,000 in VA Linux stock and make $20,000.

Trading Places

In the frenzy to grab hold of initial-public-offering stocks, the rich are still getting richer and the poor are still getting, well, not nearly as rich.

By Jim Rendon

THE OFFICE IN MANOJ THAWANI'S Sunnyvale home feels sparse; only the necessities fill the room: a computer workstation, a bookshelf. But the two chairs parked in front of his PC are surprisingly well-stuffed and comfortable. As his modem makes a noisy connection to the Internet, Thawani explains that nearly every day he or someone in his family sits here, trying to get into two or more investment deals. On a good week, he hits one of more than a dozen he tries for.

Though he doesn't get into many of the initial public offerings he aims for, the money he makes from those few he lands is very good. Last year, he says, he made 200 percent on his investments. But now the offerings are hard to come by. Because the money can be so good, more and more people are lining up to get in on the investments, and every week they get tougher to land.

"1999 was spectacular for IPOs," says Jay Ritter, a finance professor at the University of Florida who specializes in IPOs. While over the last decade IPOs have on average risen 14 percent on the first day of trading, in 1999 the average first-day increase soared to 70 percent. And over the course of the year, the average return was 160 percent for those who hung onto that stock, Ritter says.

With a smile, Thawani explains that he was one of the lucky few to get in on last year's hottest deal, a deal that makes the averages look like spare change.

On Dec. 9 of last year, VA Linux Systems, a Sunnyvale company that makes hardware for the Linux operating system, put its stock on the market in an initial public offering. Until recently, access to those investments was completely off limits to average investors. Thawani and the growing thousands now hooked on IPOs could have only watched as huge institutional investors that run mutual funds, and the favorite wealthy clients of top-end brokers, made money on the deal.

"Institutional investors get to make all that money," Thawani says. "But there is really no reason why they should and I shouldn't."

With the advent of online investing, that has started to change. Last December, Thawani logged into one of his three E-Trade accounts and put in a request for the VA Linux stock, which was offered at $30 a share. The broker then used a lottery to determine who would be able to buy into the stock. Thawani was one of the few chosen.

But Thawani and the handful of others like him who got into the deal were limited to 100 shares each, the standard IPO allotment at E-Trade. Other online brokerages offered even fewer shares to those few who made it through the lotteries and screenings that online investment houses use to determine who can buy into an IPO. Thawani plunked down his $3,000 and waited for the market to open.

Demand for the stock was so intense, and there was so much anticipation, that VA Linux's price increased tenfold before trading even began. The stock opened at $299 a share. Though it was the largest first-day gain in stock market history, the stock actually lost money for those who bought it on the open market. It climbed to $320 a share, but then turned. By then end of the day, it closed at $239, $60 below its opening price.

For those lucky, or, more likely, privileged, few who bought in at the offering price of $30 a share, the profits were unbelievable. Investors made $920 million off VA Linux that day. Most of that remained with institutional investors and insiders. While E-Trade will not reveal what percentage of the overall stock they get in any deal, it was certainly a small fraction of the 4.4 million shares offered by VA Linux.

Thawani sold his shares at $240 and made an easy $20,000 off his $3,000 investment. It was money he never would have been able to make just three years ago. But he, like thousands of other individual investors, wanted to buy far more shares than were made available to him. And the vast majority of people who wanted in on the deal were still barred from any access at all.

Though the Internet has opened up access to this elite corner of the market, that opening has been largely symbolic. The bulk of the profits remain within a tight circle of wealth and privilege.

"Hot IPOs are basically just a marketing tool for brokerage firms," Ritter says. "If the IPO market goes back to a more normal amount of first-day return, the importance of this as marketing tool will decrease a lot."

THE MOTLEY FOOL'S IPO message board has the feel of a city under siege. On the personal finance web zine site (www.fool.com), investors from across the country hungry for the kind of sky-high returns that Thawani lucked into talk amongst themselves about how to increase their odds of getting into an offering, and spread rumors about which online brokerages offer the best shot at IPOs.

E-Trade goes by the nickname E-Tease. Complaints about the lottery process and the time-sensitive confirmation notices that E-Trade and others require are rampant. Conspiracy theories about the selection process spring up with surprising regularity. Those keeping the message-board vigil speculate that E-Trade's high-end investors get preference.

Helen Lin-Murphy, an investment banking manager at E-Trade, says that nearly anyone who has an E-Trade account can have a shot at getting into an IPO, and that all requests are treated equally. But early on, she says, the company did switch from a first-come, first-served system to a random-number lottery due to investor complaints.

Competition to get into IPOs is so intense that small businesses have sprung up to help investors keep track of all the notices that brokerages post on their websites.

Richard Mehta, a Sunnyvale computer consultant, says his IPO addiction led him to start his own company. In order to get into the IPO lottery, investors must spend a lot of time checking up on their brokerage's web pages. Many companies do not send out notification of IPOs, and investors are given only a few hours in which to register or confirm their interest. In work-obsessed Silicon Valley, not everyone has the time to check up on a broker's web page three or four times a day.

Mehta and a few friends started a small company called eWebWatch as much for themselves as for paying clients. Their software monitors the web pages of online investment houses and sends messages to investors about IPOs as they come up. Thawani says the service has been invaluable and has definitely helped him get into a few offerings that he otherwise might have missed.

But even with the best notice, it is still hard for investors to get past the lottery system, especially for those offerings with a lot of hype.

Mehta says that he gets into about one in every five or six offerings that he tries for. And that is many times better than most. Some investors have given up on E-Trade completely after trying as many as 10 times with no success. One message-board poster who goes by Moose figured out his success rate for getting into an IPO in 1999 was 4 percent. Others reported roughly the same success rate. Thawani says that he gets into about 1 of every 20 he applies for.

And even when he does get in, he can only buy 100 shares, tops.

But the tiny amount of shares available can actually be a blessing, Mehta says.

"The small investor can definitely afford to buy into the IPO of an Internet company offering stock from $10 to $20 a share," Mehta says. "That is certainly what I can afford to take a risk on. I lose less money on the stock I pay less for," he says.

But that also means that Mehta is making less on those investments that do well, generally bringing in under $2,000 per investment. The traditional players still have access to the bulk of the shares and continue to make the most money.

Even some of the more traditional investors have gotten grumpy about the dearth of IPO stocks. W. R. Hambrecht underwrites IPOs and has innovated a system called the Dutch auction. Stocks are offered to individual investors over the Internet through a blind auction. The price of the stock is determined through the level of interest and the amount investors are bidding. Anyone who offers less than the determined price is eliminated. Those who offer at or above the price are entered into a lottery which determines who can buy the stock. The catch is that investors must buy at the price they bid. If they bid too high, they stand to lose money.

In early January, Norton Capital Management, an investment company based in Denver, sued Hambrecht, alleging that Hambrecht excluded the company from an offering that it should have been able to buy into.

MATTHEW BOWIN of Santa Cruz was the first to offer initial shares in a company over the Internet. He did it in November of 1996. One hundred and fifty different people invested $160,000 in his Santa Cruz company, Interactive Products and Services.

Bowin told his investors that he would put the funds in an escrow account, and if he did not receive $500,000 the money would be returned. Instead he spent the cash on a beach house rental, stereo equipment, even groceries, according to investigators. All the while, he promised to send investors stock certificates.

Bowin will be eligible for parole in 2004.

Since then, IPOs, at least those done through major brokers, have shaken their shady initiation.

"It was primarily a question of making sure that purchasers of securities have access to adequate information to make informed decisions," says John Hiney, a spokesperson with the Securities and Exchange Commission, which regulates the stock market. In the case of an initial public offering, that information is the prospectus.

Traditionally, when a company wants to go public, it works with an underwriter to help position the company to be well-received by stock market analysts and investors. Companies file a prospectus with the SEC that details information about the company. Then, the company's top officials go on what has become known as the road show, where they pitch the strengths of the company to potential institutional investors, hoping to draw interest and land some big stock purchases.

Hiney says that the SEC is more concerned about regulating the companies issuing the stock, not with determining who has access.

In 1997, E-Trade offered its customers the first legitimate online IPO ever distributed to regular investors. Since then other companies like Wit Capital, DLJ Direct and FBR now offer their customers some access to IPOs, though DLJ Direct requires an account balance of over $100,000 to participate. E-Trade has continued to expand access to IPOs, even becoming a partner in an underwriting company, E-Offering. That partnership allows E-Trade to give its customers more initial offering shares.

Even though these companies are starting to shake up a long-standing Wall Street tradition, they also need the cooperation of underwriters to obtain shares for their own investors. They need the aid of the very nexus of the Wall Street network.

Many old-line investment firms walk the line of quiet criticism and timid participation in expanding access to IPO shares. Goldman Sachs, which underwrites offerings, has invested in Wit Capital and has partnered with the company to offer IPO shares on line. But when contacted for this story, a spokesperson at Goldman Sachs said that no one there would comment on the recent shift in how initial-offering shares are allocated.

EVEN THOUGH LAST YEAR'S spectacular market may make IPO investing look simple, it has traditionally been a very risky endeavor. New companies do not have a track record of stock performance and public disclosures that investors can evaluate. Meir Statman, a professor in the finance department at Santa Clara University, says that the hype about the IPO market will inevitably draw in inexperienced investors hoping to make a fortune overnight. Most likely, he says, they will be disappointed.

"It has some of the characteristics of a game in an amusement park," Statman says. "The game seems really easy: you pay a dollar to throw a ball through a hoop. You might think it is easy and you are likely to win, but in fact the fellow behind the counter is a shill."

Thawani says that this past year, the market has made investing in IPOs so lucrative that he buys shares with almost no information at all. While Lin-Murphy at E-Trade insists that every investor must read a company's prospectus, Thawani laughs at this idea. "I get into one IPO for every 15 I apply for. Do you think I have time to read all those prospectuses?" he asks.

His research is simple. He turns to his computer and goes to bookmarked website. The Red Herring, a technology business publication's web site, loads onto his computer. A grid appears with color-coded ratings for upcoming IPOs. Red for "Red Hot" offerings, Yellow for "Mild" and a spectrum of oranges in between. "I just go for the warm and hot ones," Thawani explains.

Statman compares this kind of investing to a lottery, and the kind of lottery where people can get burned. "People do this kind of mental accounting all the time," he says. "They say, 'Yes I'll buy a lottery ticket, it's just a dollar, how much can I lose?' People buy lottery tickets to win, to be rich, to compete with Larry Ellison. Who am I to get in the way? The odds are against him, but if it brings him joy and hope, who am I to get in between him and his aspiration?"

Gimmick or not, Thawani says he can't let the easy money slide by. "It's a no-brainer," he says with a smile.

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From the February 3-9, 2000 issue of Metro, Silicon Valley's Weekly Newspaper.

Copyright © 1999 Metro Publishing Inc. Metroactive is affiliated with the Boulevards Network.

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