After two poor years for global new listings, there is some hope that 2024 will see an improvement in the Initial Public Offering (IPO) market.
A number of large companies are expected to list this year, most notably the payments processor Stripe, and investment bankers are hoping this will lead to a recovery in new listings in 2024.
One of the most important functions of listed equity markets is the provision of new capital to businesses, so a healthy IPO market is critical to the relevance of listed equity markets as well as the performance of exchanges and investment banks.
Source: J. Ritter – University of Florida
What is behind the dearth of new listings over the past two years? As interest rates and bond yields have risen, private company valuations have fallen, making listing much more difficult. Private equity and venture capital firms that invested or marked their positions at higher valuations over the past few years are loath to exit through a listing at a lower price.
Similarly, staff who were granted options and share-based payments at these private equity valuations want to see an IPO price higher than their entry price.
High-growth companies that have little or no current earnings but offer the prospects of fast growth and large profits in the future are most sensitive to interest rates, as their value is made up mainly of future cash flows discounted to today at a discount rate that is related to the bond yield.
The percentage of new listings that have been loss-making at IPOs has steadily increased over the past 40 years. Charting this series against real bond yields suggests that as real yields fell over the past four decades, it became easier to list early-stage businesses that were still losing money, and the normalisation of bond yields over the past two years has been a headwind for new listings of this nature.
Source: J. Ritter – University of Florida, Mergence Calculations
Another driver of IPO appetite is the performance of recent new listings. If recent IPOs have done well with share prices rising post-listing, then management teams and their advisers are more likely to come to market, and investors are more likely to take an interest.
We test this idea by considering the annual performance of the Renaissance IPO index vs. the S&P 500. Investing in IPOs has underperformed the broader market over the past decade, although with periods of strong outperformance along the way.
Last year was one such year, with the Renaissance IPO ETF outperforming the S&P 500 by 26% over 2023.
Source: Bloomberg
Below, we chart the outperformance of the IPO ETF vs. the S&P 500 over the previous year and compare it to the number of new listings that occurred during that year.
While we caution that this is only based on 10 data points, the relationship is strikingly strong, suggesting that the relative performance of recently listed stocks is a strong driver of the IPO market.
Last year’s strong performance by newly listed companies, as well as the low number of listings over the past two years, should bode well for the IPO market in 2024. Higher interest rates and bond yields will remain a headwind, and some companies may wait for the beginning of rate cuts from the Fed before listing.
But as long as real yields remain positive, we would expect investors to have a greater preference for near-term profitability and more mature listings than during the zero-interest rate years.
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