Enthusiasm for initial public offerings seems to be cooling after a strong recent stretch that saw companies chalk up outsize gains despite the gloomy background of a global pandemic.
Following a year of “big price jumps and a lot of investor enthusiasm” for IPOs, investors appear to be getting a bit more pragmatic when it comes to offerings, said University of Florida finance professor Jay Ritter, but only so much. Even the more muted price movement in March is high by historical standards.
The end of March brought a series of less-than-stellar debuts, especially given the backdrop of the booming IPO market over the past year. Real-estate brokerage Compass Inc.
COMP,
+1.76%
downsized its offering, which then priced at the low end of the company’s already-lowered range. Shares of airline Frontier Group Holdings Inc.
ULCC,
-0.79%
ended their first trading day below their IPO price, which also came at the low end of the company’s expected range.
The average first-day stock gain for March IPOs was 21.3% among operating companies, Ritter said, below what it was in nearly all of the prior 12 months but still above historical levels. Half of March IPOs priced above their midpoints, a lower percentage than what was seen in much of the past 12 months as well, based on Ritter’s analysis of IPOs with original file price midpoints of at least $8 a share.
Compass CEO Robert Reffkin: COVID created a ‘permanent shift’ in real-estate demand
“Individual companies are being viewed based upon on those companies’ fundamentals rather than just ‘it’s an IPO,’” Ritter said.
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“It’s not as if investors are saying, ‘we’re pessimistic about these companies. It’s more of a pullback from wildly overoptimistic to optimistic.”
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— Jay Ritter, Professor of Finance, University of Florida
Still, valuation ratios remain high. Over the past 20 years, the price-to-sales (P/S) ratio for tech companies going public was typically about 6, according to Ritter. In 2018 and 2019, the median P/S ratio climbed above 10, before rising to 23.3 in 2020. So far this year, the median is 17.8.
“It’s not as if investors are saying, ‘we’re pessimistic about these companies,’” Ritter said. “It’s more of a pullback from wildly overoptimistic to optimistic.”
While the IPO market is likely to stay active, recent dynamics suggest companies may have to reset their expectations, said Chester Spatt, a finance professor at Carnegie Mellon University’s Tepper School of Business.
“Expectations throughout much of last year, once past the initial part of the pandemic, kept ratcheting higher,” he told MarketWatch. Now, “companies may need to have more of a track record to have an effective IPO or to obtain a very desirable valuation.”
Spatt still expects to see continued deal activity, “perhaps at more modest valuations, in part based upon the performance of other tech companies and the level of interest rates.” He argued that “fundamentally there’s a lot of savings out there that’s sitting on the sidelines,” which is “going to have the effect of keeping interest in IPOs.”
Entertainment company Endeavor Group Holdings
EDR,
+4.98%
recently brought back its IPO plans after shelving them in late 2019, but Intermedia Cloud Communications Inc. said in late March that it was postponing its own plans, citing “challenging current conditions in the market for initial public offerings, especially for technology companies.”
Crypto platform Coinbase plans to go public in an April 14 direct listing. This represents “a classic situation of a company doing a direct listing to avoid potentially leaving a lot of money on the table with an underpriced IPO,” Ritter said. Direct listings are an option for companies that don’t need to raise money through offerings.
While name-brand tech companies tend to generate a lot of IPO buzz, Ritter points out that 40% of IPOs over the past eight years have come from biotech or biopharmaceutical names, and there should continue to be a steady flow of those deals.
Helping fuel the roaring IPO market of 2020 was the boom in special-purpose acquisition companies, or SPACs, which raised billions of dollars while looking for companies to acquire. Now there are 433 SPACs that went public and are looking for targets, Ritter said, and with all of them out there, new SPAC offerings are dying down. SPACs, or blank-check companies, raise money in an IPO and then have two years to acquire a business, or businesses.
An average of 24 SPACs went public each week this year, according to Ritter, until the past 7-day span, when only 2 SPACs went public.
Officials from the SEC have issued a series of warnings about SPACs and SPAC mergers, with the latest urging “careful consideration of whether the target company has a clear, comprehensive plan to be prepared to be a public company.”
A slowdown for SPACs “may be a good thing in that we have so many SPACs coming to market,” said James Angel, finance professor at Georgetown University’s McDonough School of Business. “The fear is that SPACs could become a crowded trade with so many SPACs chasing too few opportunities,” all with roughly the same deadline to find a deal.
Ritter added that with so many SPACs in the market, it may be hard for them to negotiate deal prices that are attractive to their investors. “The bargaining power has shifted to the operating companies,” he said.
The Renaissance IPO ETF
IPO,
+2.06%
is down 1.6% in the year to date, underperforming the S&P 500
SPX,
+1.18%,
which is up 7%.
