Exceptional year for IPOs unlikely to be repeated

On the face of it, the prospects for the IPO market looks rosy after a stellar 12 months.

Proceeds from IPOs for the year to 1 December are up 96 per cent on last year, with companies raising a total of $383.8bn (£290bn) globally, according to Refinitiv.

About 29 per cent of the total was raised in the US, where IPO proceeds doubled to $111.7bn. Growth rates were even stronger in Europe, where companies floating raised a total of $82.7bn, and in the UK there was a fivefold increase in issuance proceeds to $22.6bn.

“This year has been an exceptional year,” says Grant Humphrey, director of strategy and transactions at EY.

This is partly due to “pent-up demand”, he said, as companies delayed decisions to float last year in the midst of market turbulence caused by early waves of Covid-19 infections and uncertainty around Brexit negotiations.

“But I think that also clouds the picture slightly in that actually the underlying fundamentals are really strong and the market is quite hot,” he said.

“There’s money out there, which means that even if (there was no pent-up demand) this would have been a strong year. It’s just been an exceptionally strong year because it’s got another six to nine months of delays coming into it.”

In the UK, at least, some of this lag is expected to feed into next year, meaning the market for new listings should continue to be stronger than in pre-pandemic times, Humphrey said, barring potential disruptions caused by Omicron or other coronavirus variants.

Across the world, the appetite for participating in IPOs has been “strongly supported by central bank liquidity” this year, says Gareth McCartney, global co-head of equity markets at UBS.

“Interest rate normalisation into 2022 will be critical in dictating the path of issuance,” he added.

How long that will take and how quickly rates will rise remains a matter of debate, though.

Risk of rate rises

With US inflation hitting 6.8 per cent in the US last month – rising at its fastest pace since 1982 – the US Federal Reserve is likely to face further pressure “to quicken the withdrawal of quantitative easing and raise interest rates sooner than expected”, Dan Boardman-Weston, chief investment officer of BRI Wealth Management, says.

Although UK inflation remained some way above the Bank of England’s target at 4.2 per cent in October, gross domestic product growth slowed to just 0.1 per cent. Given the reintroduction of ‘work from home’ measures and other restrictions, “there’s a very real risk of the economy contracting in December”, Capital Economics’ senior UK economist Ruth Gregory said in a note, meaning the bank remains unlikely to alter its accommodative monetary policy.

Real interest rates and monetary policy “are likely to still be very loose next year”, supporting a level of IPOs above historic trends, says Sean Darby, a global equity strategist at Jefferies.

Low interest rates are a boon for private equity firms who have played a big part in contributing to the plethora of new listings on both sides of the Atlantic this year. Not only do low rates provide an influx of capital into private equity funds from investors seeking a better return on their capital, they also support higher public market valuations, offering a useful option when selling portfolio companies.

By 1 December, 46 private equity-backed companies had listed in London in 2021, compared with just 14 in the whole of last year. The amount of money raised rose by 93 per cent to £16.6bn, according to Pitchbook.

In the same period, the number of US-based private companies floating jumped by 90 per cent to 272, while the amount raised was more than 50 per cent higher at $249bn.

Humphrey says many more firms that were being prepared for listings ended up being sold to other private equity firms as part of dual-track processes that sellers usually run.

Private equity firms are flush with cash. In August, ratings agency S&P Global and data firm Preqin estimated that they were sitting on $2.29 trillion of ‘dry powder’, or undeployed funds.

Momentum in private equity-backed exits has tailed off since September, though, and Pitchbook’s Europe, Middle East and Africa private capital analyst Dominick Mondesir said he expects that accelerating inflation and a potential for a more hawkish monetary policy environment next year will mean the number of private equity-backed companies listing will slow.

Winners and losers

There may also be some investor reticence towards taking stakes in private equity-backed IPOs, given the patchy record of some of this year’s biggest deals.

Although some private equity-backed business have offered stellar returns, such as the 139 per cent gain made by investors in US buy now, pay later company Affirm (US:AFRM) since its listing, there have been several high-profile flops, including Bridgepoint-backed food delivery app Deliveroo (ROO), whose shares remain more than 40 per cent below its £3.90 list price.

Of the $1bn-plus IPOs undertaken in New York, London, Hong Kong and India this year, 64 per cent of the companies’ shares are currently trading below their listing price, according to data provided by Dealogic. Globally, 43 per cent of the $1bn-plus companies listed are trading below their debut price.

Pricing an IPO is not easy, especially when there are a plethora of banks involved, says Bruce Garrow, co-head of corporate banking at Investec.

“If it’s just a one-bank IPO your ability to have influence and intimacy with that company is obviously greater than if there’s lots of banks,” he said. “If you get a syndicate of 20 banks on a big, big deal, whose fault is it if it goes wrong?”

Pricing can be hardest when equity markets are as buoyant as they have been over the past year. When an order book for new issues is several times oversubscribed, it encourages founders or other selling shareholders to price offers at the top end of proposed ranges.

“Having a really frothy market is not helpful for anyone,” Garrow says. "It’s not helpful for investors, because they’ve got this fear of missing out when things go up even if they’re priced wrong.”

The exuberance in valuations of companies coming to market is showing signs of coming to an end, though and Garrow believes “people will be much more...challenging on forecasts” next year.

Already, listed high-growth technology stocks that have traded at an enterprise value as high as 10 to 15 times sales have de-rated by 30-40 per cent over the past three months, he said.

“A lot of that is to do with inflation and the yield curve,” he says, noting that higher government bond yields increase the rate at which future cash flows are discounted, meaning lower company valuations – especially for businesses that aren’t currently generating much cash.

Decent businesses will still be able to achieve IPOs, but “not probably to the multiples...that we saw at the first half of this year”, he adds.

Hill’s easier path

In the UK, the reforms proposed by Lord Hill’s review should encourage more listings, especially among technology companies, according to EY’s Humphrey.

The review was undertaken in a bid to reverse a decline in the number of listed companies, which have fallen by about 40 per cent since 2008. Between 2015 and 2020, the UK accounted for only 5 per cent of global IPOs, it found.

Reforms introduced earlier this month allow for dual-class share structures within the premium listing segment of the London Stock Exchange, which is aimed at encouraging founders to list their companies sooner without fear of losing control through unwanted takeover approaches. The minimum amount of shares a company is required to float has also been cut to 10 per cent, from 25 per cent.

“For certain companies, I can see why a 10 per cent free float or a dual class is justified and you will get investor demand because it’s a really good business,” Garrow says.

For others, though, the limited liquidity as result of the smaller free float will make them less attractive to investors, he adds.

Retail investors typically have limited exposure to IPOs, as about 90 per cent of shares on offer are usually allocated to institutional buyers, although some companies such as Robinhood (US:HOOD)  in the US and Pension Bee (PBEE) in the UK reserved slices of their offerings for their own customers.

There are also dedicated IPO funds and apps such as Primary Bid that cater to those looking to invest directly in IPOs.

Private investors won’t enjoy the same sort of access to management or information that institutional investors enjoy, though, and the volatility of opening day trades means those that do should be mindful of the risks.

London far behind US as a home for large tech debuts

The good, the bad and the ugly

The best (and worst) performing IPOs of 2021, globally – based on initial offerings of at least $1bn.

The Good

The Bad

The Ugly