With the volatility index continuing to trend lower investors are increasing their risk appetite, elevating supply and demand for IPOs
Despite geopolitical volatility, a pandemic that has shut down major portions of the global economy over the past several months, and growing civil unrest across the US, markets continue to climb. With the volatility index (VIX) continuing to trend lower, investors have increased their risk appetite across the credit and product spectrum. This has resulted in elevated supply and demand for initial public offerings (IPOs).
Not surprisingly, IPO activity is down considerably this year. Through May, the number of IPOs (ex-business development companies (BDCs) and special purpose acquisition companies (SPACs)) has been cut in half compared with last year, and gross IPO proceeds are down about 65%. These year-over-year comparisons would look even worse if 2019 IPO activity had not been negatively impacted by the government-mandated shutdown early in the year.
On a brighter note, a narrow portion of the IPO market has continued to function well throughout this period of market volatility. Of note, seven biotech companies have gone public since mid-March, many of which upsized their deals and priced at the top (or above) their marketed price range. This group is currently trading up nearly 90% from their IPO price, a positive indicator highly correlated with future interest in the IPO product.
Importantly, we are beginning to observe several positive indicators for the broader IPO market, as well as a few notable trends that we highlight below.
The broader IPO market is beginning to re-emerge
- Stock prices and valuations have recovered despite economic and fundamental business headwinds. The S&P 500 is now off only 5% YTD (as of June 4, 2020), with several sectors back to pre-crisis levels. While some degree of re-tracing is expected, the velocity of the rebound reflects improved investor sentiment and risk appetite.
- The Chicago Board Options Exchange Volatility Index (VIX) is currently trading in a range between 25 and 30, receding considerably from its high of 83 in March. The current level remains elevated on a historical basis, but it is significantly closer to normalized and constructive levels (the 10-year VIX average through February 15 (pre-crisis) was 17). For context, market environments with a VIX below 20 are generally the most conducive/receptive for IPO issuance.
- The IPO asset class has generally performed well for investors this year. Aftermarket performance, often a leading indicator for IPO investor appetite generally, is up over 65% YTD. *
- Several tech companies that navigated the market over the last month have priced and traded well, including:
- SelectQuote ($656m insurance-tech IPO, mid-May) — after an accelerated three-day roadshow, the deal was upsized and priced above the range. The stock increased 35% on its first day of trading.
- Inari Medical ($156m medical device IPO, mid-May) — priced well above the initially marketed price range and rose nearly 125% on its first day of trading, even though the market for its products is currently constrained by the ongoing crisis.
- Last week, Warner Music Group launched its mega-IPO, and ZoomInfo Technologies launched the first software IPO of the year. On June 3, Warner priced an upsized deal raising $1.9b, making it the largest US IPO in 2020. ZoomInfo Technologies has already increased its marketing range and is scheduled to price this week.
- Additionally, several large high-growth companies have recently elected to file publicly and enter the IPO pipeline, including Dada Nexus, Vroom and Shift4payments.
Emerging IPO trends: are we “seeing the future” of IPOs?
- Shorter, virtual roadshows. Since the onset of the crisis, most IPO roadshows have been reduced to three to four days from the traditional seven to eight-day marketing period. The shorter roadshows have been driven by the desire to limit market risk and have been enabled by the ability to cover more ground through video conferencing.
- Extensive pre-marketing and pre-funding. Shorter roadshows have been enabled by extensive pre-marketing activities, as well as additional funding rounds shortly before IPO launches. Companies are pursuing capital raises ahead of IPOs for a few reasons, including to mitigate some of the uncertainty and imbedded deal risk in the IPO market, and to have flexibility to reduce IPO deal sizes and increase cash, improving pricing leverage with investors.
- The rise of SPACs. Despite the market crisis, SPAC issuance is on pace to meet or exceed 2019’s record of 59 SPAC IPOs raising more than $12b. The deals are larger and the sponsors are more mainstream than ever before. The combination of record SPAC acquisition capacity, constrained IPO markets, strong ongoing SPAC merger activity, and higher-profile sponsors should continue to enhance the viability of the SPAC path to the public markets for a broader swath of issuers than in the past.
Looking ahead: potential inflection points on the horizon
- Impact of the presidential election. Although IPO activity in election years has historically tended to skew toward the first half of the year and away from the election, recent market volatility and the “postponement” of a portion of the IPO pipeline could lead to more deals around the election than in years past. Prospective issuers are preparing for potential IPOs over the next few quarters, perhaps with less focus on the election than there might have been in a more normalized environment.
- Prospective impact of the pandemic:
- Financials. In general, companies will need to educate Wall Street on the impact of the pandemic on their business and forward projections. For companies that experienced a dip in performance, it will be critical to demonstrate the one-time nature of the impact and the signs of a return to “normal.” For those that experienced a surge during the pandemic, the Street will seek comfort on the portion of the bump that will “stick” as conditions moderate.
- Business models. For business models that have been adjusted during the pandemic, investors will focus on how well the revised model has been “battle-tested” before giving valuation credit for the changes.
- Valuations. IPO investors look at projected results to determine valuation and pricing. For example, a late 2020 or early 2021 IPO will typically reference calendar year 2021 as the primary valuation driver. However, depending on the shape of the recovery, the question for companies might be whether investors are willing to look further out for more “normalized” results.
Overall, we are still in the early innings of an IPO market recovery despite the sharp recent rebound in stock prices and market sentiment. If investors continue to see outsized IPO returns, we expect the pipeline to reload quickly. However, there is limited precedent for the intensity of this recovery, so some retracing in the coming weeks or months could be possible, and a corresponding pullback in risk appetite for IPOs would then also be expected. Even so, companies that prepare to go public ahead of time and can move quickly when markets are conducive will have a clear advantage. Advanced IPO preparation could be the difference between gaining access to the public markets and getting shut out.