IPOs or IPNOs
If you follow the latest news coming from the Silicon Valley startup scene, you will likely have become accustomed to the oft-repeated phrase “This is another record year for tech IPOs.” Each new quarter seems to bring with it a new graduating class of venture capitalized companies seeking to go public. 2019 was set to take the cake, with Uber, Lyft, and Saudi Aramco announcing their IPOs at the start of the fiscal year. Yet, reality has turned out quite differently from expectations. Both Uber and Lyft’s share prices dropped on their first day and Saudi Aramco delayed their IPO to “2021”. Wework saw its market capitalization drop by 66% even before it officially went public, leading to the resignation of its CEO, Adam Neumann. The performance of the IPO market raises a couple of questions that private companies should ask themselves:
- How are newly public companies actually doing in the markets compared to their historical counterparts?
- How does IPO performance compare amongst different industries?
- How does an initial public offering compare to the other exit strategies?
As of this writing, 2019 has seen 136 IPOs raising a total of $42.7 billion in proceeds. Although this number declined from 2018, the proceeds are at one of their highest amounts of the last decade. This aligns with the narrative of the multiple billion-dollar IPOs highlighting 2019. By these number alone, this year has been one of the strongest. However, for this trend of mega-deals (multi-billion dollar proceed deals) to continue, there needs to be more large private companies seeking to go public in 2020. Saudi Aramco, Saudi Arabia’s state-owned oil company and one of the largest companies in the world by revenue, for one, has raised expectations for its estimated 1.5 to 2 trillion-dollar proceeds. This year, however, was expected to be the largest on record with Uber, Lyft, and Zoom starting it off. As we now know, that wasn’t necessarily the case.
As this graph shows, IPO proceeds for many industries are at multi-year lows. Communication services, energy, consumer discretionary, financials, materials, and utilities are perfect examples of this with half-decade lows. There is still an opportunity for 2019 to catch up, but the rest of the US public offering line-up doesn’t look sufficient to prop the numbers up. There is a good chance that this trend will continue, suggesting that such declines are more reflective of changing industry interest than a lack of interest in investing. If a C-suite in a shrinking industries wants to conduct an IPO, they may have greater difficulty attracting attention form financial firms and institutional investors.
For the IPOs of 2019, I have compiled a spreadsheet with the help of IPOScoop.com, a website that compiles the movement of newly public companies over the last few years. This list shows both overall returns up to the beginning of November and the returns of the initial offering day. The overall returns so far have actually been strong, with an average of 5.37%. However, they greatly differ from first-day returns, which average at 19.36%, revealing a 15% difference from the end of the first day. This means that most company prices have fallen since their first day of trading to the present. So, how well does this compare to other years holistically? Surprisingly well, actually. Average first-day returns of 19.36% are actually the highest in the last five years. 2018 had first-day returns of 15.7%, and that was already higher than the preceding four years by a decent margin. After-market returns, or returns up to the financial year-end, for IPOs historically have actually been mixed. The 2019 returns of 5.37% are quite low when compared to 2014, 2016, and 2017; that 5.37% is way higher than the -16.7% of 2018. By all means, 2019 has been weaker in many industries, but the amount of money startups have made from proceeds has not wavered, and the stock market overall has been, on average, very receptive to IPOs this year. However, the amount that first year returns differ from full year returns is alarming. It doesn’t seem like an important factor, but the overall returns of the S&P this year have been 22.34%. IPOs have underperformed the S&P by a factor of nearly 80%. Unlike 2019, the IPOs of previous years mainly moved similarly to the overall market instead of jumping off a cliff. The 15% difference between the market and the performance of the newly public companies is highly concerning and shows that many investors are losing faith in the high-growth, no cash flow companies that debuted this year.
The statistics cited in this article reveal a trend. There were multiple super-hyped IPOs that fell flat or completely tanked; IPO proceeds, on average, are less than last year but high nonetheless, there were fewer IPOs this year than in the last few years, some industries are doing better than others, first-day returns for companies have been pretty impressive, but their yearly returns have lagged. This year’s small number of IPOs had enough proceeds to nearly surpass last year. In other words: there were fewer IPOs, but they were larger. This trend is unlikely to continue for 2020 due to the lack of highly anticipated IPOs so far, so it is safe to assume that there will be a decrease in overall money raised. This means almost nothing for founders since the amount raised overall has no effect on what they can raise alone. However, lower proceeds may decrease the interest of financial institutions and deter possible funds for the IPO in the first place, which might decrease the price companies can expect to sell their equity.
Some industries are seriously lagging in the IPO department, and there are multiple explanations for why this is happening. Changing investor sentiment is definitely possible in this era of sustainability funds, and tech companies have looked more appealing than other companies for a while now. However, I am of the belief that the private equity industry and larger players consolidating their dying markets are acquiring companies from their respective industries instead of letting them go public. In other words, if you own an oil company, getting acquired beats a public equity offering as an exit strategy.
First day returns indicate how well the public (normal investors, not your BlackRocks) perceive an IPO while the year-end returns are closer to the sentiment of everyone — it’s usually by the end of the holdout period where financial institutions can finally sell their shares. First day returns were solid with an average percent increase of around 19%, but the full-year returns were only a mere 5% in comparison with the market’s 22%. High first day returns show that public sentiment is still on the side of new companies, and the power of hype is still real. However, year-end returns that are far from the market’s return mean that investors of both large and small scale have lost hope and interest in these new companies. In other words, if you are a company getting ready to IPO, then you might see the price of your company drop within the span of a year. You can still expect positive returns, but it is a little scary to think about what will happen if a recession occurs. Overall, a public offering can lower the valuation of your company, but you will still make money. Since there are still people paying for negative cash flow companies and since most founders do not want to get acquired, founders are probably satisfied with public offerings. IPOs just won’t reach the levels of returns they did previously. The public markets are stronger than ever though, so acquisitions may be more effective if founders are comfortable with leaving their companies.
Afternote: At the time of writing this article, Saudi Aramco has decided to IPO on December 11. A few months ago, it was planned for 2021. Nobody predicted this, and they plan on raising more than $13 Billion, a game-changing amount. They will not offer their shares through the US Market, but it is still interesting to see just how volatile the IPO timeline can be.
