After a fairly good showing in 2007, the U.S. market for initial public offerings went into hiding during the first quarter of 2008. Only 10 companies went public on U.S. stock exchanges. But the drought was not limited to the United States. The first quarter saw fewer IPOs list in each of the world’s major markets than during the same period in 2007.
Even if you never participate in an initial public offering – few investors do – much can be learned from the IPO market about the financial climate at home and abroad. Keeping an eye on this important corner of securities trading can reveal a wealth of clues.
Timing Is All
Although the IPO market can be complex, new issuers tend to approach it based on one simple concept: Time the offering to coincide with investor appetites. Going public when investors are wary or feeling poor, as many were during the first quarter, can result in disappointing results. Because companies go public in order to raise cash, they are more apt to wait for the right time than risk a smaller debut price.
There is one important IPO characteristic that can trump a weak market: a high-quality, fair-priced opportunity – something that the type of investors who participate in public offerings are always looking for. For example, one of the companies that came to market during the disappointing first quarter turned out to be the largest IPO in U.S. history and the second largest in world history.3
Companies that aim to go public and the investment banks that help take their offerings public have a tremendous incentive to monitor investor sentiment, so it’s a smart move to keep an eye on IPO timing. For example, as of mid-May, there were more than 100 companies waiting to go public in the U.S. market. Waiting for volatility to subside. Waiting for the major market indexes to enter a solidly upward trend. Waiting for investors to enter a bidding mood.
How long they will have to wait depends on a range of factors, not the least of which is the upcoming election. Even if the major indexes post significant gains in the second and third quarters, it’s possible that companies-in-waiting will look for the fog of uncertainty surrounding the U.S. political and economic situations to lift before they decide to pull the trigger.
Regulatory Retaliation
It’s impossible to evaluate the IPO market without considering the sweeping changes brought about by the Sarbanes-Oxley Act of 2002, a federal law that imposed rigorous new accounting standards on companies that are publicly traded in the United States. Although the purpose of the legislation was to create greater transparency, critics will tell you that the costs to comply have dulled the appeal of going public on a U.S. exchange. There are plenty of clues to support these claims.
- A survey of founders and executives of emerging companies found that only 6% had an exit strategy that included plans to go public; they were more likely to seek acquisition by larger companies.
- In the first three quarters of 2007, 15 U.S. companies took the highly unusual step of going public outside the United States by listing only on a foreign exchange, compared with just three that went public only on a foreign exchange between 1996 and 2001, a remarkable period in U.S. stock market history that preceded the Sarbanes-Oxley Act.6
- Between 2002 and 2007, four out of five foreign firms that came to the United States to raise capital with an IPO used Rule 144a offerings, which are generally off-limits to the average investor. These restricted offerings are not subject to many of the laws that are designed to protect investors, including Sarbox.
- Although IPOs declined around the world during the first quarter of 2008, three regions saw more deals than the United States: North Asia had 35; Europe had 16; and India had 15. Trailing the United States were Japan (6 deals), Latin America (1 deal), and Russia (no deals).
Although the United States continues to be an appealing place to raise capital with an IPO, it would be naive to think that the IPO landscape will not continue to evolve as other capital markets around the world mature. Keeping an eye on the IPO market may reveal clues about what could be in store for your own portfolio.
