With the S&P 500 having registered an 18% gain during the first nine months of 2013, it’s beginning to feel like a late-market cycle stock environment. Investors who believe the U S stock market’s bull run is “long in the tooth” might be wondering what to make of the recent decision by several high-profile companies to jump on the IPO bandwagon.
I once discussed the merits of a particular stock offering with a portfolio manager, who groused about the tendency of “low-quality companies” to issue equity in the latter stages of a bull market. In such periods, strong equity valuations and favorable market conditions tempt many company executives and financial sponsors to raise capital through initial public offerings.
In 2002, The Journal of Finance published an article about IPO activity that echoed a similar viewpoint: “It is conventional wisdom among both academics and practitioners that the quality of firms going public deteriorates as a period of high issuing volume progresses.”
If there is a connection between the buoyancy of stock prices and the tendency of “lower-quality” companies to go public, one wouldn’t know it from the roster of firms that recently announced IPO plans. Twitter, Hilton and Chrysler are among those expected to tap the public markets.
The very strength of the current IPO market – a beneficiary of this year’s powerful stock price gains – has also been a surprise to market watchers. In early 2013, CNBC had predicted that “a volatile year for IPOs” in 2012 would pave “the way for a potentially meager 2013.”
The CNBC story had cited an academic article, entitled, “Where Have All the IPOs Gone?” That article pinned the reduced volume of IPOs since 2000 to regulatory compliance costs, the demise of mid-market investment banks and incentives for companies to grow through acquisition, rather than internal expansion. Advisory firm BDO began 2013 by predicting only a 6% increase in US IPOs for the current year.
In hindsight, the 2013 IPO market has been anything but meager. According to Renaissance Capital, the first nine months of 2013 saw a 54% increase in the number of IPO pricings and a 66% increase in total IPO filings.
A solid year for IPOs has unfolded against the backdrop of a four-and-a-half-year-old bull market. In the wake of last year’s botched initial stock offering by Facebook (FB), the public market debut of Twitter and other “household name” companies has potential to alter investor perceptions of the risks associated with new equity issues – and hopefully for the better.