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Posted by Craig Basinger on Mar 25th, 2024

IPOs – Where Art Thou?

There is no denying the equity markets are in the throes of a strong advance. The S&P is up 21% over the past six months, Europe is up 19%,  and Japan is up 25%. And given the even stronger gains in pockets such as AI, there is no shortage of people talking bubbles, including ourselves (Ethos from a few weeks ago). But it isn’t a system-wide bubble; it looks more like isolated mini bubbles, in our opinion. That doesn’t mean it won’t hurt at some point, yet it is unlikely to be overly destabilizing. The fact is, a number of key ingredients are missing to label this as a major bubble. Equity flows is one as there isn’t really a rush of cash coming into the market as measured by fund & ETF flow data. And another crucial ingredient is the IPO market.

Yesterday, Reddit IPOed (Initial Public Offering) with an offer size of $748 million and closed on day one at $1.25 billion. That gives the company a total value of $7.5 billion, which is not bad given the $800 million in sales during the last 12 months. IPOs doubling on the first day of trading was a weekly occurrence in the tech bubble, yet this was anything but regular. The IPO market has remained very quiet. In North America, $5 billion of IPOs began trading so this year, on pace with the bleak annual pace for the past two years of $17B in 2023 and $22B in 2022. Even more anemic is Canada, with virtually no IPOs in 2024 so far.

Despite markets making new highs, IPO market remains rather quiet

Markets strong, lots of indices making new all-time highs, so why is the IPO market so dormant? 2021 was an investment banker’s dream, fuelled by strong equity markets and lots of mini bubbles in things like clean tech, profitless tech, digital assets… the list goes on even including the non-fundamentally driven rise of Gamestop, coincidentally fuelled by the Reddit crowd. To be clear, Reddit announced its IPO in 2021 and didn’t start trading until just now.

It is not just the IPO market that is eerily quiet; mergers and acquisitions (M&A) have also been subdued. The normal playbook is that later in a bull market, corporate leaders start getting more aggressive. And to fuel growth faster than normal organic initiatives, they turn to buying one another. Helping this process is high valuations for the buying company’s equity or easy access to credit. Perhaps we are not seeing as much M&A activity as the availability of low-cost credit appears to be over, making it more expensive to lever up and buy one of your competitors. Yet, there is no denying the valuations among many equities are at historically high levels.

Even mergers & acquisitions are really not what you would expect, given equity market advances

Of course the question is why. There are likely a number of contributing factors to the dearth of IPO and M&A activity. As we pointed out the higher cost of capital has made it more challenging, the greater the cost of doing a deal the higher the expected rate of return must be. Strapping on more debt to buy a competitor or other business now requires a lot more expected benefit than it did when capital was cheap and plentiful.

The rise of private equity has undoubtedly played a part. Companies are now staying private much longer in their growth stages and using private funding sources. If the equity market environment isn’t just right, many companies may continue to opt for private funding over tapping a less receptive public market.

One of the other missing ingredients may be confidence. Chief Executive magazine has a monthly survey of CEOs asking how they would rate the economic outlook for the next year on a scale of 1 to 10. Confidence obviously falls during a recession, and it also fell in 2022 during the battle against inflation. While inflation has calmed, markets have recovered, and even financial conditions have returned to normal levels, CEO confidence is still on the lower side. Perhaps the uncertainty of recession risks and lingering inflation are weighing on their minds. Nonetheless, lower confidence equals less M&A and fewer IPOs. On a positive note, this confidence survey has been gradually improving.

CEO confidence rising, as are financial conditions

Final Thoughts

If this were a broader bubble market environment we would be seeing a lot more corporate activities from mergers, acquisitions or tapping the public market for dollars. Yet, it also demonstrates the challenges companies are facing with the higher cost of capital due to higher yields. And given executives lack of confidence about the future, it likely encourages more of a cautious or wait-and-see attitude.

Maybe the Reddit IPO will become infectious and inject some optimism for those waiting to hit the market. Or maybe the new highs of markets will help. Or the stabilizing of bond yields. There is likely a lot of pent-up demand for raising capital or doing deals or going public. Another factor that may encourage an end to this IPO drought is performance of those that had the guts to IPO. The Renaissance IPO index tracks the performance of IPOs for two years. It is a bumpier road, yet IPOs have certainly been beating the broader market. Maybe the deal drought is coming to an end.

Those companies that did have the guts to IPO, have rewarded investors

— Craig Basinger is the Chief Market Strategist at Purpose Investments

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Sources: Charts are sourced to Bloomberg L. P.

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Craig Basinger, CFA

Craig Basinger is the Chief Market Strategist at Purpose Investments. With over 25 years of investment experience, Craig combines an educational foundation in economics & psychology with years of experience in both fundamental and quantitative research. A long-term student of the markets, Craig’s thoughts and insights can be seen in his Market Ethos publications and through his regular contributions on BNN.

Craig and his team bring a transparent and cost-efficient approach to investment management. The team provides asset allocation OCIO services and directly manages over $1 billion in assets. The team manages dividend mandates, quantitative risk reduction strategies and asset allocation services.