3 minute read.
After years of sporadic initial public offerings (IPOs), 2019 is set to be a banner year for well-known billion-dollar companies hitting the US share markets. The first half of 2019 saw record share issuances, and Q2 saw the highest funds raised in the IPO market in any second quarter ever. More than 200 private companies each worth over $1 billion are in the IPO backlog – record highs that the market has never seen before. With the impending Airbnb IPO, 2019 could be a record year for funds raised for IPOs, well beyond the dotcom bubble.
What’s going on here? Compared to the past, tech companies have stayed private longer and are worth more than ever. Now they’re seeking deeper pools of money to fund their big appetites for growth.
The benefit for everyday investors is that by investing in companies going public, they’re able to share in the success of big names that they use and know so well like Uber (UBER), Pinterest (PIN), and Slack (WORK). Investors can also get in on leading innovators like Beyond Meat (BYND), Zoom Video Communications (ZM), CrowdStrike (CRWD), and Cloudflare (NET). With a high volume of post IPO market trading, investors are showing their excitement about investing in these companies for the first time – particularly companies that can show a path to profitability and have a clear addressable market for growth.
How have these companies been doing since making their public debuts? Well, it’s been a mixed bag. Luckily, many have been helped by a strong share market, so the average first-day share price increase of a newly listed company has been 22% which is well above the historical average of roughly 15%. The most recent exception was SmileDirectClub's frosty welcome to the markets on September 12th. Their share price closed down 27.5% from its initial offering price of $23, the worst first-day showing in about two decades among IPOs that raised more than $500 million. It has since bounced back. Probably the year’s biggest IPO story (aside from WeWork, more on that below), is Beyond Meat which is still up over 130%* since its public debut, even though analysts ruthlessly debate its staying power.
A good indicator of the general IPO market this year is the Renaissance IPO ETF (IPO). Consisting of a basket of 60 of the most recent large IPOs, it has climbed more than 33% since the beginning of the year. Comparatively, the S&P 500 has risen about 13%*. Some of the ETF’s biggest holdings include Spotify (SPOT), Uber (UBER), Roku (ROKU) and DocuSign (DOCU). But buyer beware! Goldman Sachs reported earlier this year that the median IPO share performance since 2010 has lagged behind the Russell 3000 (which tracks the US share markets) by 28% over their first three years of trading.
*As as September 18, 2019
IPO vs Direct Investing
A company looking to raise funds from the public by listing its shares has two options – an IPO or a direct listing.
In an IPO, new shares are created and are sold to raise money for the company. The company uses the services of an investment bank – known as underwriters – who organise the IPO process and charge a fee for their work. Underwriters promote the IPO in an “IPO roadshow” as well as developing the prospectus, a report that shares details of the IPO, the business, and how the money raised will be spent. They also act as an insurance company and buy shares if they need to, to keep the share price from dropping too much on debut.
In a direct listing, instead of raising new funds like an IPO, a company’s employees and investors convert their ownership into shares to be listed on the share market. Companies will choose a direct listing process if they can't afford the underwriters, don't want to raise money, or want to avoid lock-up periods. Without an underwriter, however, there is no safety net ensuring shares will sell. This means that companies considering a direct listing need strong brand awareness for investors to want to snap up shares.
IPOs include a “lock-up period” where insiders with a large shareholding in the company can’t sell shares, typically in the first six months. A lock-up period prevents insiders from dumping shares after the company's IPO, which would drop the share price with a sudden flood of selling. In an IPO, share price discovery happens the night before on a secondary market between large institutional investors. Unfortunately, this means that everyday investors can’t access initial share price gains before they hit the share markets.
Once the company is listed, employees and existing investors can cash their shares out at any time without the lock-up period of a traditional IPO. Spotify and Slack are recent examples of a direct listing and Airbnb are rumoured to be investigating a direct listing.
Direct listings are seen as a cheaper, more transparent (no secondary market trading) way to get to market for a company that doesn’t need to raise money right now.
What defines an IPO’s success?
Goldman Sachs analysed over 4000 IPOs over 25 years and concluded that certain traits can make or break a newly public company.
The sector: during the tech-IPO boom/bust in 2000, close to half of all new listings were either tech or media companies. According to Goldman Sachs, the sector breakdown for IPOs has changed a lot, with tech and media companies only accounting for 19% of new listings since 2010.
Age of company: according to research from Jay Ritter, an IPO expert at the University of Florida, during the tech-IPO boom/bust the median age for tech companies going public was under five years old, compared with 12 years in 2018.
The valuation: a growing concern in 2019 is that newly listed companies are too expensive relative to their fundamentals. Analysts have pointed to Uber’s lacklustre IPO and recent WeWork IPO backlash as a valuation problem.
Path to profitability: according to Goldman Sachs, IPO investors are intently-focussed on when a company will achieve profitability. Once publicly listed, a “grow at all costs” mentality may no longer be as palatable to retail investors.
Sales growth: according to Goldman Sachs, sales growth has been the strongest determinant of IPO outperformance. IPOs with annual sales growth greater than 20% year on year have been more likely to outperform the Russell 3000 over three years than a comparable, slower-growing IPO.
Thinking about investing in an IPO?
Read the prospectus
The IPO prospectus lays out what the company is, how it makes money, what risks and opportunities there are, and how the company will use the funds raised. Remember that while most companies try to disclose as much as possible in their prospectus, it's still written by the company itself and not by an unbiased third party.
Research, research, research
Getting information on companies about to go public can be a challenge. Unlike most publicly traded companies, private companies do not usually have analysts covering their every move. You can still search for information on the company and its competitors, how they’ve raised money so far, as well as overall industry information. Even though available info may be limited, learning as much as you can about the company is a good idea. If you really want to dip your toe in right away, the Renaissance IPO ETF (IPO) could be a good option.
Find out when the lock-up period expires
The lock-up period usually takes three months to two years. During this period, underwriters and insiders of the company are not allowed to sell shares. Share prices have historically experienced volatility on and around their lock-up dates; however, once the lock-up period is over, the focus returns to fundamentals (and interested investors tend to keep calm and invest on).
Approach with a cool head
Scepticism can be a positive strategy when you’re considering investing in a newly listed company. There can be quite a bit of uncertainty surrounding IPOs, and as a result, share price volatility. Approach investing armed with information, and remember that a good company should still be a good company and a worthy investment, even after the lock-up period expires.
IPOs on their way to a Hatch platform near you
Peloton: Exercise equipment and live-streaming media company.
Airbnb: Online hospitality marketplace.
SoFi: Online personal finance company (lending).
Stripe: Online payment systems.
Postmates: Courier logistics company.
Casper: mattress retailer.
And potentially WeWork (shared office spaces). At this point, they’ve placed their IPO on hold, so watch this space!
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