Most folks have long since left the IPO market for dead… and it’s no wonder.

Scan the financial markets and very little – if anything – is consistently moving in a positive direction. And the latest economic data – unemployment, home foreclosures, bankruptcy filings, consumer spending – only underscores how far and wide this recession is cutting.

One thing, however, keeps chugging along, undeterred – innovation…

Innovation Will Lead The Economy’s Recovery

“Innovation goes up while the economy goes down,” says W. Chan Kim, Fellow of the World Economic Forum. And history suggests he’s not wrong. In 1969, while the economy slumped 1.9%, the number of patents granted jumped 14%.

During the energy-induced recession of the early 70s, unemployment hit 9%. GDP dropped 4.7%. And yet innovation handed us major breakthroughs in recombinant DNA and the Internet.

Recessions have served as the catalyst for the launches of more than a few innovative and now iconic brands like, Trader Joe’s (1958), MTV (1981) and the iPod (2001).

That’s why I’m going “all-in” and proclaiming this go-round will be no different – innovation will again lead the recovery. And the best way to play it is via IPOs.

IPO Activity Mirrors The Markets

We all know IPO activity mirrors the broad market. During rallies, companies flock to market like an autograph-hungry teenybopper at a Jonas Brothers concert. And during slowdowns, the IPO space is as lonely as a geek on prom night.

No doubt, we’re witnessing the latter.

• In the first quarter, just two IPOs made it out the door. And only five companies filed plans to go public. Seventeen companies bagged plans altogether, filing withdrawal documents with the SEC.
• But historical precedent tells us that IPOs are the place to invest coming out of a slump. They represent the rubber hitting the road for the innovative products birthed during the throes of recession.
• What’s more, the profit potential is most pronounced coming out of periods of prolonged sluggishness, like we’re experiencing now.

For proof, all we need to do is go back to the last “severe” recession on record, from 1973 to 1975.

Back then, we were contending with oil embargos, inflation, Vietnam, Watergate, soaring unemployment, among all else. Granted, conditions weren’t as severe worldwide as today, but they were close.

In fact, President Gerald Ford began the 1975 installment of The Economic Report of the President with lines befitting the current environment, “The economy is in a severe recession. Unemployment is too high and will rise higher.”

The IPO Market Explodes With Opportunity

Yet, beginning the very same year, at the peak of the doom and gloom, the IPO market exploded with opportunity. From 1975 to 1979, IPOs returned almost 140%, or 34% annually, enough to almost quadruple the gains of the Dow over the same period.

Of course, the standout innovators faired even better.

• Companies like Cray Research, inventor of the first supercomputer, popped 29% in its very first day of trading. And the move persisted – the stock rose another 63% in its second year as a public company.
• In similar fashion, overnight shipping innovator, Federal Express, also jumped 29% on its trading debut. And it, too, continued on a northward course in its second year of trading (shareholders bagged 318%).
• Likewise, St. Jude Medical stormed the markets with a 79% gain out of the gate. Shareholders netted a 514% profit in the second year.

You’ll notice, I’m not likening these gains to the fleeting returns that defined the dot-com boom, when IPOs jumped 300% or more in a single day, only to crash in a similarly spectacular fashion. (Think eToys. It popped 280% on its first day of trading, only to file bankruptcy two years later.)

Instead, I’m talking about sustained, meaningful, multi-year, triple-digit gainers that – in light of the recent market turmoil – are welcomed prospects for any investor.

Finding IPO Opportunities Around The Next Economic Bend

Even better, such IPO opportunities could be just around the next bend. In recent weeks, we’ve seen a few IPO greenshoots pierce the barren earth in IPOland.

• On April 2, a China-based online game provider – Changyou.com – made its stock market debut, rallying 25.1%.
• The same week, two innovative companies – Rosetta Stone and Bridgepoint Education – announced pricing terms, the last step before a public debut.

As long as underwriters take their cues from the Changyou deal – it was priced at a 40% discount compared to publicly traded peers – I expect the IPO rebound to really take root. And there are certainly enough companies to fuel it.

Despite 97 withdrawals in the last year, the IPO pipeline remains stacked with over 100 companies, including a three in particular that I’m tracking closely:

• Emdeon,
• Liquidnet Holdings,
• And A123 Systems.

Any investor savvy enough to pay attention to this lucrative, yet almost forgotten space will likely be rewarded handsomely.

Bottom line, if history is any guide, 2009 will likely be a very profitable year for IPOs. So for now, just keep an eye on the activity at the SEC’s website.

Louis Basenese
Investment U