Indeed, billion-dollar valuations for companies like Pandora and online coupon site Groupon Inc. have lured tech-hungry investors into buying what they think is the next big Internet stock. But the reality is that these companies are driving demand through low-float IPOs and undeliverable growth promises.
Investors need to understand that despite the excitement surrounding Internet and social media companies, the chance that these businesses will deliver on profitability promises is slim to none.
The fact that these companies were able to garner as much investor interest as they did raises a red flag that suggests a new tech bubble has formed - and is ready to burst.
"It's 1999; I wouldn't touch any of them," said Money Morning Contributing Editor Martin Hutchinson. "Every possible warning bell is telling me this is a bubble and we're close to its maximum inflation."
Beware the Low-Float IPO
Pandora's IPO was initially expected to go for $7 to $9, but doubled to a $16 per share offer price. When trading started Wednesday, its shares soared more than 40% in the first hour, but closed only 8.9% higher. Then they promptly fell about 23% on day two.
Now shares are down about 35% from the IPO price - and many investors wonder why they were so quick to buy in.
Analysts partly blame Pandora's low-float IPO strategy. A low-float IPO drives demand because investors think they will be shut out of a chance to get the stock at a good price and they act more impulsively, ignoring fundamentals. The strategy has been especially effective this year, as buzz around tech stocks has stoked pent-up investor demand.
"If you're dying of thirst, you'll accept iced tea even if you really want lemonade," Max Wolff, senior analyst at GreenCrest Capital, told CNNMoney. "It's a perfect storm of fury, frustration, excitement and delay."
Pandora floated only 9.2% of shares, far below the 24% average float for U.S. tech IPOs in the past year.
Caught up in the thrill of the chase - lots of investment dollars are chasing a small amount of available shares - investors ignored that Pandora's profitability is threatened by increasing competition and costs. The company has provided nothing substantial to show it can overcome these threats and give investors solid returns.
"I wouldn't touch it with a 10-foot pole," Money Morning Chief Investment Strategist Keith Fitz-Gerald said on FoxBusiness' "Bulls & Bears." "Pandora has lost money for a decade and faces the same problem used car salesmen face worldwide...how to convert tire kickers to buyers."
Fitz-Gerald's fellow "Bulls & Bears" panel member Gary B. Smith agrees that Pandora's profitability is too questionable to be a good investment - at almost any price.
"At any price, unless it was maybe $1 or something, I wouldn't touch it," said Smith. "This is a company with 39 million active subscribers. They're losing money - in fact, every time they add a subscriber they lose money. I use Pandora, I like it - it's free, I would never pay for it."
The next Internet stock that could go public is gaming company Zynga Game Network Inc., which is also expected to use the low-float IPO maneuver. Rumors are swirling that it could file this month and make less than 10% of its shares available to the public.
"Companies in this space realize there's a feeding frenzy afoot," David Menlow, president of research firm IPOfinancial.com, told Bloomberg News. "The risk is that as a CEO you believe you are better than you actually are. The reality may be something very different." For the latest updates PRESS CTR + D or visit Stock Market news Today
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