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Sunday, November 14, 2010

Should you buy the GM IPO?

This week the much anticipated and highly hyped IPO of the Government Bailed out GM is expected to hit the market.

Should you buy in to the hype, the IPO and the stock?

Lets look.





First of all, even though the government bailed out GM with your and my tax money, you and I are NOT investors or “interested / invested” parties. The big name bankers, financial institutions are. They are the ones bringing this IPO to market, setting the initial price offering, and stand to make the most initial profit. This is really pissing off disappointing a lot of common investors and taxpayers.

Money is power, and you already gave yours away to the government. So stop complaining. But that does not mean you and I cannot invest in GM. It just means that it is a bit riskier.

What usually happens with highly anticipated and high demand IPO’s is that the offering price is what the institutional backers get as a strike price and the demand and hype drives the pricing up for the individual investors.

So, what is the initial public offering price?
Currently it is somewhere between $26 and $29 per share.

In fact, if I were the government, I’d be more than a little annoyed at this IPO price. The government got 60% control of the company for a price of $44 a share. This means even at $29 a share, the government is losing 35 cents on the dollar. Yet the financial institutions are going to make, in all likely hood, a nice tidy profit. Recent reports have demand for the shares at 6 times the number being offered. This demand is certainly going to drive up the price.

Generally I do not invest in IPO’s because historically they are not profitable and actually tend to underperform the market over the short term. This is because most IPO’s are offered after the company has made money doing whatever they have done and are looking to pay off debt and or generate cash for other investments.

There have been numerous studies on IPO’s over the years and many have shown variations of the following:

1. Most were afflicted by declining sales and earnings trends and slip in profitability within 2 years of their IPO. Very few (about 10 -15%) showed improvement.
2. In fact, over half show quarterly earnings drop in the first four quarters after the IPO occurs.

In all fairness, the winners enjoy on average price increase of 134% from their IPO dates and 71% from the close of their first trading date. 76% outperformed the overall market from their IPO date and 72% outperformed from the first day's close. Admittedly, the last part shows significant promise - that is until you realize that most of the better IPO's are already pre sold to institutional investors.

So, how should the average investor play the IPO market or more to the point the GM IPO?

You could look for the quick hit or profit but this is highly risky. Only the best and most highly anticipated IPO’s of profitable and well run companies make the good money and investments. And even those do not always show the stock profit initially.

That is because the hype has already built the price up over the IPO pricing that the institutional investors get. In fact if one were to look only at the best and most profitable IPO’s you will see that at some point the price often falls off a bit and only after it goes though a consolidation phase does it actually show a gain for the average investor.

The big question: Is GM one of these hyped and well run companies?

They are certainly generating a lot of interest. So I think it is safe to say that the “hype” factor is in full play here.

But are they a well run company?

If you have followed their company reports recently, and watched their dog and pony show, you will see that they have in fact been able to not only repay many of their debt obligations but actually make a profit. The big question is will they be able to sustain this profitability and more importantly show a profit for the average investor?

There are pros and cons to the GM IPO.

First the some of the Cons:

GM is prohibited from paying dividends as a condition of many of its loans. Meanwhile, it must make payments on new preferred stock, given to the United Auto Workers, before paying a dividend. This isn't the GM of old. Don't expect dividends anytime soon.

Much of the proceeds of the IPO will go to service obligations to the UAW, including pension liabilities.

Gotta Love those Unions.... ;-)

Now for some of the Pros:

They are obviously re-engineering their brand to try and be more green and competitive. Which is a good thing.

Also, a huge element to the government's takeover of GM was a provision that allows the company to hold onto nearly $16 billion in operating loss credits. Over the coming years the GM will be allowed to use these prior losses to offset future tax bills.

Sounds like a pretty good deal right? Essentially the company lost money, then got bailed out and went through a restructuring, but keeps the 'benefits' of losing money in the past.

Gee, that is a sweet deal!

I think, at least for the first few years, GM will have enough support from government credits to keep it profitable and competitive.

Over the years I have only played in the IPO opening day game twice. This was with Visa and Chipotle. Another well hyped and sucessfull IPO was Google. I thought about Google but did not buy in at first.

All these were well hyped, well known companies, and well run.

So, how did they do?

Visa was priced at 44 and opened around 60.
Chipotle was priced at 22 and opened at 44.
Pretty nice profits for the institutions huh!.

How did the stock perform once it started trading?
Did the average investor (me for that matter) get that “quick” profit?

Well, depends on how you look at it.

VISA










CHIPOTLE










GOOGLE











All of them experience a bit of volatility and swings in price but if you look at the first few weeks of trading, the stocks tended to trade within a range before taking off again.

VISA showed some classic triangle and pendant patterns with a well defined resistance level which it finally broke out above 2 - 3 weeks after offering.

CHIPOTLE showed a well defined trading range.

And GOOGLE peaked quicklyfor a 10% gain, but over the next couple weeks drifted back down to its initial opening and support level before take off.

All these stocks showed good strength by NOT falling below their opening range support levels.

In pattern investing we call this consolidating. After a big run up, which is exactly what happens with IPO’s like these, the movement of the stock will look to settle within a new support and resistance range.

The key is this; will the opening days range(s) of the IPO set the new support level.

My advice would be to take the wait and see approach to make sure a new support level is established.

If, you really do want to try for the quick hit profit then I would look to set a buy limit price of about 33% above the offering price. Say somewhere between $34.5 and $38.5 and hope that is good enough to get in on the action and that the new GM support level is higher than that.

Me, I’m going to wait at least a week or two to see what it does.

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