New issues fight bruised image

The dramatic scaling back of expectations for the issue price of shares in Albright & Wilson this week underlined the high jitters afflicting the new-issues market.

A price of 150p a share compares with original hopes of nearer 200p and reduces the amount Albright's 100 per cent owner, Tenneco, will raise from the flotation by more than £100m.

Albright was not alone in struggling to persuade investors of its merits. Indeed, following the late withdrawal of two flotations last week, the pub operator Century Inns and the holiday group Sunsail, getting the issue away at all reflects the quality of the company.

The market's current gloom is in marked contrast to the euphoria with which record numbers of companies gained listings in the first half of 1994. So what has gone wrong?

The market appears to have been overwhelmed by flotations, financially and psychologically. Because many of the floats have been of smaller companies, smaller-company fund managers have come up against severe cash constraints.

Perhaps more importantly, they have lost the inclination to invest in companies that many investors perceive to have been of poor quality. They have been especially put off by the number that have come to market only to shock the City soon afterwards with a profits warning.

It is not altogether clear, however, that nervousness is justified by statistical evidence. James Capel has researched the new-issues market over the past two years and concluded that, contrary to popular belief, newcomers have outperformed the rest of the market.

Excluding the first six months of 1994, new issues have outperformed the market in three of the last four half-year periods. And they have outperformed the rest of their sectors by more than 10 per cent in each of those periods. If technology and software issues, which constituted most of the worst performers, are excluded from the comparison, the outperformance is even more marked.

But it would be wrong to dismiss as insignificant the dreadful share price performance of the worst floats. Four companies - McDonnell Information Systems, Coda, DRS and Drew Scientific - have all lost more than 50 per cent of their value since coming to the market.

Interestingly, slumping share prices have often had little to do with underlying trading performance, as Maid, another of last year's computer flotations, illustrates. Despite announcing results ahead of budget and good news on product introductions, and despite a reduction in the issue price from 150p to 110p just before flotation, the shares have fallen to 69p.

It would also be wrong to tar all technology stocks with the same brush. Although the sector includes the worst failures, it also includes a selection of dazzling performances. Telspec is trading 131 per cent above its flotation price. Virtuality, Trafficmaster and Calluna have all risen by more than 30 per cent.

How can investors spot the right companies? According to James Capel, many accepted criteria do not stand up to scrutiny. It tested the level of directors' holdings, size of company, of issue, yield and price/earnings relatives and the amount raised by management, without finding any significant correlations with share price performance.

Management buyouts have tended to do better than other types of company. Capel thinks there are a number of reasons to explain this. MBO flotation candidates tend to have had detailed due diligence performed at the time of the original buyout, and therefore tend to be relatively clean companies.

They are also usually focused on one area of business and outperform as a result. Because managements have had to perform under the weight of heavy debts taken out to buy their companies, they also tend to have a keen understanding of the importance of cash management.

In the final analysis, it seems the only way of being sure about a company is to scrutinise its record thoroughly. Avoiding companies that have never made a profit may mean investors miss out on the occasional star performance, but it should ensure the real dogs are missed. And, if the market is demanding better and better terms from better and better companies before giving a float the nod, the chance of outperformance must be better in 1995 than for several years.