Online Brokers Offer IPO Access

Some investors now can buy stock in newly minted public companies before it starts trading -- but that doesn't mean they should.

Initial public offerings tend to be exclusive affairs. Underwriters usually give the first crack at new stock issues to large institutions, such as pension funds, banks and money-management firms. Individual investors generally have to wait until the shares begin trading before they can get in on the action.

But some discount brokers have lifted the velvet rope. Over the summer, Fidelity inked distribution deals with Kohlberg Kravis Roberts, one of the biggest private-equity companies, and investment bank Deutsche Bank. That means that Fidelity customers will have an opportunity to buy new issues at their IPO prices in deals underwritten by KKR and Deutsche Bank.

Fidelity, which we rated number one in our most recent survey of online brokers, isn't new to IPOs. It's made deals with several investment banks since it first teamed up with Salomon Brothers in the mid 1990s as dot-com stocks fueled IPO mania. Customers of Charles Schwab and TD Ameritrade have had access to some Goldman Sachs offerings over the past eight years.

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Fidelity's deal with KKR is novel. Generally, private-equity firms use borrowed money to buy troubled companies, turn them around and then take them public or sell them to another investor for a fat profit. KKR currently has 49 companies in its portfolio, including Dollar General, the discount retailer; Nielsen Co., the market-research company; and Sealy, the mattress company. Dollar General has filed to go public. If it actually does so, Fidelity clients will have the same access to the new issue as institutional investors. "We have never before done an arrangement like this with a private-equity firm, and we don't think any other broker has done one, either," says Mark Haggerty, president of Fidelity Capital Markets.

Not every discount-broker customer can get in on IPOs. Fidelity restricts access to KKR new issues to customers who trade at least 36 times a year or have $100,000 or more in assets. For Deutsche Bank-sponsored IPOs, the requirement is $500,000 in assets or 36 trades a year. Rules at other online brokers are squishier: TD Ameritrade says it randomly allocates any IPO shares, and Schwab says it has a different asset minimum for each offering.

IPO activity has been recovering along with the rest of the stock market. In the first quarter of 2009, only two companies launched IPOs, and not a single firm filed for a public offering. But from April 1 -- about three weeks after the U.S. stock market bottomed -- through September 14, 21 companies took their shares to market, and 40 more filed to go public.

Being able to get into a stock before it starts trading can be lucrative when the IPO market is hot. In 1999, at the height of dot-com mania, the typical IPO popped more than 70% on the first day of trading. So far this year, the average IPO has climbed 12% on its initial trading day.

The big winner so far this year has been OpenTable (symbol OPEN), an online restaurant-reservation service. Its shares gained 60% on the first day of trading. The biggest loser was CDC Software (CDCS), a Chinese maker of business software. It posted a first-day loss of 17%. IPOs underwritten by Deutsche Bank this year have had mixed first-day results: PennyMac Mortgage (PMT) lost 5%; Starwood Property Trust (STWD) was flat; and Avago Technologies (AVGO) gained 8%. KKR was also involved in underwriting Avago's public offering.

Buying an IPO in the hope of making a one-day killing is risky stuff. Better to invest for the long term in great companies with outstanding managements and attractive products or services-think Amgen, Google and Microsoft. You can learn more about IPOs at Renaissance Capital's IPOHome.com and Hoover's IPOCentral.com.

Contributing Editor, Kiplinger's Personal Finance