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2011 has been a strong year for Internet IPOs, and in order to track this latest bout of .com flavored hubris, UBS recently announced the creation of the E-TRACS Internet IPO index (and accompanying ETNs to play it). The index concept sounds great in a headline, but should you invest? Let's have a look.

First, it is worthwhile to note that the ETN expectedly provides no exposure to pre-IPO shares, so retail investors looking for a piece of the big first-day pops will not find it with this vehicle. Second, rebalancing occurs on a monthly basis, so by the time the fund grabs some of that latest-must-have Internet stock, (Facebook, anyone?), it may already have been trading for weeks and will have lost some initial momentum. However, this built-in "waiting period" provides a form of discipline for the excited IPO investor, such that huge one-day gains may be missed, but similar reversals may be avoided.

The index uses 20 stocks in the Internet sector that have traded publicly for three years or less. Here is a brief analysis of the top five holdings of the ETF that all together comprise nearly 50% of the total index weighting.

LinkedIn (NYSE:LNKD)

Growth expectations for social networking site LinkedIn are enormous, given its sky-high valuation, but there are many near-term catalysts that should keep investors interested in the stock. Headline-making "social" Internet firms such as Groupon and Zynga will be going public soon, and strong performances from those IPOs will keep LNKD in the spotlight. Down the road, an eventual Facebook IPO will also give credibility to LinkedIn's huge valuation, and will further increase demand for LNKD shares. This pent-up demand combined with a small float (only 10% of the outstanding shares) should continue to move LNKD upward over the next year. Look for upward movements based on growth in India and the popularity of their new "Apply with LinkedIn" feature (allowing users to apply to jobs using their LinkedIn profile as a resume).

HomeAway (NASDAQ:AWAY)

In the crowded market for online vacation sales, HomeAway differentiates itself by connecting property managers directly to travelers looking for an alternative to hotels while on the road. Investment interest in this specific segment of the travel market should continue, as one of HomeAway's competitors, Airbnb, recently received a large second round of funding totaling $112 million - relatively large, given that the first round of financing to Airbnb was $7.8 million. Look for signs of continued growth in HomeAway by way of more acquisition announcements and improved margins.

Yandex (NASDAQ:YNDX)

Operating the largest search engine in Russia, Yandex is one of a handful of companies that manages to top Google’s search market share in their home country. Based on Yandex’s established user base, it trades at a fair valuation compared to its peers. As the Russian economy continues to improve, Yandex is poised to take advantage and makes for a compelling investment. Furthermore, with Baidu’s earnings recently beating expectations (another non-Google search player), Yandex shares may also follow a similar trend in the near-term.

Rackspace Hosting (NYSE:RAX)

RAX is a player in the growing cloud-computing industry, providing web site and application hosting similar to Amazon Web Services [AWS]. As businesses continue migrating their services and data to cloud-based solutions, Rackspace should continue its rapid growth. In the near-term, watch for good news coming out of Rackspace’s expansion into Asia and continued consumer uptake of their Rackspace Cloud solution. Note that Rackspace’s three-year anniversary of public trading will be August 8th, 2011, meaning that if the IPO index adheres to its goal of only including companies trading for less than three years, RAX will have to be replaced at the end of August (or possibly July).

Pandora Media (NYSE:P)

Pandora's risk factors revolve around how strong and deep-pocketed its competitors are. Apple is expected to announce their own music streaming service (coupled with their iTunes Genius technology, this will rival Pandora's own music-prediction features), while Spotify recently launched in the USA to much delight. Apple and Spotify both offer around 15 million tracks of music each, while Pandora has an estimated slightly under one million. Furthermore, with more players entering the market, ad revenue growth will slow at a time when Pandora needs it most.

Currently, Pandora's strength lies in its music-streaming simplicity (e.g. no need for additional software, no need to set up accounts). However, without significant differentiation, Pandora will be outmatched by its competitors' offerings, and the wild growth investors are counting on may not stay on track. While I agree that Pandora is a good candidate for this index, I'd be concerned about its relatively heavy weighting – close to 10%.

Overall, EIPO looks like a reasonable tool for near-term buyers looking to capture some upside during the next few earnings seasons. Short-term traders looking for daily price swings in these high-beta stocks would likely be more interested in the accompanying Monthly 2x Leveraged ETN (NYSEARCA:EIPL), which aims to track twice the movement of the same index. For a longer-term investor, however, it may be wiser to hand-select the "best of" stocks in the index in order to control the weighting manually, or track a more conservative Internet stock index such as Merrill Lynch's Internet HOLDRs (NYSE:HHH).

Source: UBS E-TRACS IPO ETNs: Will Internet IPOs Party Like It's 1999?