IPO market grinds to a halt

Companies are shelving IPO plans rather than face the wrath of market volatility.

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Similar to the S&P 500 Index, recent IPOs have been hammered by the economic slowdown that is pushing global economies potentially toward recession. The S&P 500 Index is down 23% and the Renaissance IPO Index* has lost 17% year to date on a price return basis, as of late March (see IPOs plunge along with the broad market chart).

Here's what's happening with the IPO market, and what you might look for in the coming weeks and months.

Unprecedented times

Based on virtually every metric, the IPO market has entirely collapsed. Just 24 companies have completed their US IPO this year (nearly all of which took place before coronavirus fears took hold in late February), according to Renaissance Capital. That would put 2020 on pace for the worst year for IPO issuance since 2008. That compares with well over 150 IPOs completed on average over the past 10 years (see IPO activity could hit multiyear low chart).

Many widely known companies that were at various stages of going public this year have announced postponements. These include home rental company Airbnb, music conglomerate Warner Music, J Crew spinoff and apparel brand Madewell, footwear maker Cole Haan, and specialty chemicals and equipment company Atotech.

There was momentum heading into the year. While IPO activity has been lower over the past 5 years relative to the high-water mark in 2014, both in terms of number of deals and proceeds of those deals, last year was relatively strong, and IPO indexes outperformed the S&P 500 by a wide margin in 2019. But IPO activity has all but evaporated thus far this year, with most companies shelving plans to go public until the waters calm.

Here's another data point highlighting how difficult the IPO market is right now. According to Renaissance Capital, even blank check IPOs are currently in the red more than might be typical for a down year for IPOs. The only asset for blank check IPOs is the initial cash investment by investors. These companies allow investors to redeem shares for $10 plus interest prior to an acquisition or if the special purpose acquisition company (SPAC) doesn't complete an acquisition—usually within 2 years. "That structure makes it unusual for SPACs to trade more than a few percentage points above or below their $10 offer price,” Renaissance noted in a recent report. "However, all 13 of the year's SPACs are in the red, ranging from $9.25 (-7.5%) to $9.85 (-1.5%)."

On the other hand, Renaissance has spotlighted several so-called "virus proof" newly public companies that debuted last year, including remote-work enabler Slack (WORK), video conferencing company Zoom Video (ZM), telemedicine provider Teladoc (TDOC), and genetic medicines company Passage Bio (PASG), all of whom have significantly outperformed the broad market and IPO Index. Of course, this doesn't mean these stocks will continue to be immune to market volatility. 

What to look for

Given how sensitive the IPO market is to existing market and economic conditions, many of the same factors that are needed for stocks to stabilize would also be necessary to see a rebound in IPO activity. Investors are broadly looking to central banks for support, in addition to massive fiscal stimulus packages from governments worldwide to offset much of the lost GDP that will result from efforts to stem the spread of the pandemic. Volatility would need to subside, and much of the longer-term uncertainty surrounding COVID-19 would need to resolve before both the broader stock market as well as the IPO market returns to some semblance of normalcy.

Additionally, from a logistical perspective, travel restrictions would likely need to loosen to boost IPO activity. A typical component of the IPO process is what is known as a roadshow. Investment bankers who are attempting to raise funds for IPOs will typically travel to pitch potential investors. Bans on public gatherings, social distancing, and travel restrictions make this aspect of the IPO process more difficult.

Caution is warranted

If and when IPO activity picks back up, you should be mindful of the increased risks that a black swan event like COVID-19 has introduced. Renaissance Capital believes it is possible that companies will shelve IPO plans until much further into the year, and possibly into 2021. Even those companies that are currently proceeding with plans this year could postpone if market conditions are not attractive at the scheduled IPO date. If you have an interest in IPOs, you should proceed with extreme caution, and strongly consider avoiding IPOs (the few that there may be) until there is much more clarity into the depth and scope of the current crisis.

Of course, IPOs can generate buzz among investors, particularly for so-called "hot issues" that garner a lot of interest. Companies that might be considered hot issues in the current environment might be those that would like to fall into the "virus proof" bucket.

But beware of getting caught up in the hype. IPO investing can be complex, and may be suitable only for experienced investors. Be sure to consider any opportunities within the constraints of your unique investment goals and risk tolerance. And perhaps more importantly, there are exogenous factors right now that might overwhelm any outlook for an individual stock or IPO.

Even in normal conditions, there are unique considerations to keep in mind when it comes to investing in IPOs. For instance, the stock of an IPO can be particularly unpredictable on its first day—and also the first few months—of trading. For every AT&T (T), Alphabet (GOOG), and Visa (V) that had successful IPOs and are now entrenched leaders in their respective industries, there is a long history of initial public offerings that have not performed well.

Moreover, extracting long-term value out of IPOs, even successful ones, can be tricky for a retail investor. For example, suppose you identify an IPO that you find attractive as a long-term investment, and the price at which it begins trading on the IPO date is $20 (which is by no means a given). If you were to buy the shares at around this price, and by the end of the IPO day the stock price had risen to $30, you might think this is a winning trade.

But take a step back. This means that the company and its underwriters (a financial group, typically a bank that is responsible for determining the market price of an IPO) underestimated demand for the company's stock. Therefore, the company lost out on the opportunity to raise more money to grow its business, because the IPO was mispriced (i.e., instead of receiving let's say $30 a share from the public, it will have received only $20 a share).

In this scenario, if you were looking for short-term profits, great. If you are a long-term investor, however, a mispriced IPO may not be in your best interest.

Do your homework

IPOs and you

Individual Fidelity investors can sign up to participate in an upcoming IPO (there are eligibility requirements).

Like any other investment, before making a decision regarding an IPO, you should review your investment goals and conduct a thorough analysis of the company, along with its growth prospects. Beyond the general risks associated with an individual investment opportunity, there are distinctive risks associated with IPO investing—each IPO is unique, and it needs to be evaluated independently to determine its investment potential.

For example, one of the primary difficulties that some investors face when it comes to researching companies that have not yet become public is the extent to which there is access to information. Publicly traded companies in the US, for example, are required by the Securities and Exchange Commission to disseminate financial information quarterly. Private companies are not required to do the same. Consequently, for those investors who do not have access or the skill to analyze all of the financial information necessary to build an informed view of a potential IPO opportunity, it can be hard to fully assess the company's merits as a sound investment. A key source of information for an IPO is the prospectus.

One way that you might be able to navigate the intricate IPO waters is to consider an actively managed fund. Most investment management companies have the research capabilities and resources needed to conduct this analysis, which many individual investors are not able to do. And, as always, it is important to build a diversified portfolio, given that one of the risks of IPOs is the stock-specific risk that is present in any concentrated, individual investment.

It’s likely that IPO deal activity could be stuck in neutral for the foreseeable future, and recent IPOs—along with the rest of the market—will trade at the whim of COVID-19 developments.

Next steps to consider



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