Why the choppy IPO market is good for investors

Traders work the floor of the New York Stock Exchange.

The hysteria has already started: The IPO market is in trouble! First Data prices well below the range! Albertson’s is in trouble!

It’s not in trouble. The IPO market is repricing, and that is good news for investors.

There’s an obvious reason for the hysteria. Only 13 initial public offerings have gotten done since Labor Day, about half of the planned number. There have been several high-profile postponements due to “market conditions” since Labor Day, notably Neiman Marcus, and now — perhaps — Albertson’s, which failed to price last night and will try again tonight.

Of those that have gone public since Labor Day, the average price has been 18.1 percent below the midpoint of the suggested price range, according to Renaissance Capital, the firm that runs the Renaissance Capital IPO ETF (IPO), a basket of roughly 60 recent IPOs.

Read MoreAlbertsons aims for IPO re-do at lower price, considers downsize

Obviously, if you are one of the companies going public, you are disappointed you didn’t get a higher price.

But for everyone else — including the public that is buying the IPO at the open, as well as those who hope to trade it a short while later — this is great news.

Why? Because lower prices make it much more likely that the IPO will: 1) trade up at the open, and 2) not fade away in the days following the open.

Indeed, the price cuts we have seen on IPOs since Labor Day bear this out. The aftermarket returns for the IPO market have been improving.

Those IPOs that have got done since then have seen an average first-day pop of 10.5 percent. After the first day, the average return has been 6.5 percent.

That is a lot better than the S&P 500’s 4 percent return for this month!

Read MoreNeiman Marcus delays IPO amid volatility: Sources

Earlier in the year, when IPOs were hot and pricing at and even above their price range, it was very typical to have a first-day pop, but then fade over the next few days. That’s not good for investors!

Which brings us to today’s news. First Data (FDC) priced at $16, 16 percent below the midpoint of the $18-to-$20 price talk.

There are a lot of pros for First Data:

  1. A leader in its industry, three times bigger than its next competitor
  2. Long-term contracts, with fairly stable and recurring revenue
  3. Strong cash flow: $3 billion in EBITDA

But there are some cons as well:

  1. High debt: $21.3 billion, with a high debt/EBITDA ratio
  2. Much of the debt is variable rate, so there is interest rate risk
  3. Forecasts depend on the ability to refinance that debt
  4. Pricing pressure and competition (Square, which announced its IPO last night, is a competitor)

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Here’s how to judge this: If First Data opens with a “$16” handle and holds through the day, that’s good. If it closes the week out above $16, that’s very good. Mind you, that is a modest goal, but modest is all anyone is shooting for. We don’t need First Data to close in the $20s, though investors would be delighted if it did.

If it closes below $16, the talk will immediately be that prices need to be cut even more. So far the average price cut has been in the 15 percent to 18 percent range. If First Data sinks, talk will be even deeper price cuts for those that are coming.

Bottom line: First Data — the biggest IPO of the year — is an important signpost for the IPO market for the rest of 2015.

[“source -cncb”]

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