The Initial Public Offerings (IPO) market is supposed to boom in a bull market and bust when the bears strike. Not this one. In a flat sharemarket, the IPOs kept coming. Many spiked on debut in 2015 and an unusually large number soared within months of listing.
That’s the good news, at least for investors who secured scarce stock in the most popular floats or bought them upon listing. The bad news: the 2015 IPO market was too hot; if not by capital raised, then by the magnitude of share-price gains. It had traits of a bubble.
The collapsing share prices of private-equity-vended floats, Dick Smith Holdings (DSH), Vocation (VET) and Spotless Group Holdings (SPO), in recent months reinforce the dangers of buying overvalued IPOs in a hot market.
Switzer Super Report analysis shows the average gain for 80 IPOs in calendar-year 2015 (to December 3), relative to the issue price, was 19%. With the S&P/ASX 200 Accumulation surprisingly strong.
Index barely in positive territory, IPO gains were surprisingly strong
Averages can be skewed by a few big IPO winners or losers. But the ratio of IPO winners to losers this year – about 2 to 1 – is the best since 2006. The ratio has been at these levels only three times in the past 15 years.
Soaring share-price gains from prominent floats reinforced the strength of this year’s IPO market. Skincare group BWX leapt 83% from its issue price within weeks of listing. Engine products groups PWR Holdings was up 82% on its issue price after listing in mid-November. IDP Education also rallied upon listing in late November.
The year’s largest float by capital raised, Link Administration Holdings (LNK), was up 15% after listing in mid-October. Agricultural producer Costa Group Holdings (CGC) added 19% after joining ASX in July. Baby Bunting Group (BBN) raced 78% higher on its offer price.
Comparisons between 2015 and 2014 IPO markets were stark. This year’s IPO market raised $7.7 billion compared with last year’s record-breaking $18.6 billion. There were no blockbuster floats this year (Link Administration Holdings and MYOB Group came closest). The multi-billion-dollar privatisation of Medibank Private was last year’s IPO highlight.
But the 2015 IPO market has been more rewarding for investors: the 19% average price gain in IPOs compared with an 8% gain last year in what was a stronger sharemarket. In a market going nowhere, IPO gains this year seem too good to be true.
First-day or “stag” gains have returned. The opening price for IPOs this year, on average, was 12% higher than issue price, ASX data shows. Just buying each IPO at the opening price would have delivered an 8% gain.
I could go on with statistics that highlight the rewards for IPO investors this year, excluding the 20 or so IPOs, mostly smaller, that fell below their issue price. But the strange dynamics of this year’s IPO market are a warning bell for investors.
Usual forces drive big gains
This year’s IPO market is further proof that record-low interest rates are distorting asset prices and creating bubbles. They are forcing investors to take higher risks to deliver decent returns in a stagnant Australian equities market.
One veteran micro-cap fund manager told me recently he had never seen so many large-cap fund managers attending IPO presentations for mid- and small-cap offers. With resource stocks tanking and the big banks retreating, gains in ASX 200 stocks have been harder to find. So fund managers are looking further down the market to add “alpha” (a return above the market return). IPOs have been one of the easier sources of alpha this year as investors piled into better-quality floats.
There’s also talk that broking firms offered larger allocations in mid- and small-cap floats to large-cap funds than normal this year because a) it keeps their biggest clients happy, and b) these funds are less inclined to hold such stocks for long periods, meaning more brokerage for advisers when these funds inevitably sell their IPO stock and reinvest in core holdings.
Trading IPOs has become a bigger performance driver for some funds. It may not be their core business, but avoiding the IPO market has meant missing out on quick gains in better-quality stocks and watching competitors add alpha to their portfolios.
Algorithmic trading, too, may be affecting IPO action. Having followed the IPO market closely for the past decade, I am surprised at how volatile floats are on listing these days. Some that edge below the issue price seem to be crushed by a wave of selling, while those that spike on debut seem to be swept higher. It reeks of computer-based momentum trading.
The emergence of tech IPOs is another factor. The traditional path for earlier-stage tech companies was several rounds of venture capital (VC) before embarking on an IPO to provide a full or partial exit for professional investors. More tech companies are bypassing this and raising capital through an IPO or “backdoor listing”, where a listed shell buys a private company or its assets and changes focus and control.
With less venture capital on the share register, founders are retaining a larger stake of tech companies that IPO. A lower free float and reduced stock liquidity can accentuate price gains and falls in tech floats. Witness the rollercoaster ride of Freelancer, a promising late-2013 IPO that had tightly held stock.
That tech companies are going straight to an IPO is another warning sign. A recurring complaint is that Australia’s VC market is too small, but the truth is that tech companies are achieving higher valuations in equity markets, such is IPO demand, than they can secure from professional investors who recognise these companies are overvalued.
Another factor behind strong IPO gains in a weak sharemarket is pent-up supply and demand. The IPO window was virtually shut from 2008 to 2012. Apart from a brief flurry of floats in 2010, notably Aurizon (then QR National) and Westfield Retail Trust (WRT), and Myer Holdings (MYR) in late 2009, there were hardly any IPOs of size. With the float pipeline now unblocked, IPOs are pouring out.
On the demand side, a wall of money on the sharemarket sidelines has looked for a new home. Fund managers have been eager for new exposures to industries such as healthcare, aged care, or technology, and more have been willing to pay higher valuation multiples for companies that can demonstrate faster growth than Australia’s lacklustre economy.
To be fair, the quality of this IPO’s market has been generally good. There have been fewer cyclical or resource-based companies and many IPOs have been for well-established, profitable companies with good prospects in growth industries. Accounting software group MYOB and share registry Link are examples. The question is whether investors are paying well over the odds for better-quality floats due to market distortions. Investors need great care with IPOs in the next 12 months. Float valuations are starting to resemble those in the late stages of a bull market. When investors pay Price Earnings (PE) multiples of 20-30 times for small companies with no history as listed entities, it is time to be selling rather than buying IPOs. Heavy falls this year in Spotless, Dick Smith and, earlier Vocation, has renewed concerns about buying floats vended by private equity firms. Expect more floats from 2014 and 2015 to slump in the next 18 months as reality sets.
As always, investors must focus on companies and valuation – not be swayed by top-down analysis or headline trends.
Here are some trends that caught my eye in the 2015 IPO market.
1. Agribusiness grows
Fresh fruit business Costa Group Holdings flew the agribusiness flag with a $551 million IPO in July 2015. It comfortably rose above the $2.25 issue price as the market paid more attention to its performance. Costa is one of the better IPOs: its intellectual property in berry and other fruit strains is more valuable than the market realises.
MG Unit Trust (MGC), linked to the performance of dairy co-operative Murray Goulburn, has good long-term prospects as demand for dairy in China rises. China-based Dongfang Modern Agriculture Holding Group (DFM), up 31 % on its issue price, and Beston Global Food Company were other agribusiness IPOs. Watch more food producers come to market as the “dining boom” in China gathers momentum, and after a strong 2015 for larger agribusiness stocks on ASX.
2. Rise of the LIC IPO
A new listed investment company seemingly joined ASX every month or two in 2015 as more managers recognised the benefits of listed managed funds and raised capital through IPOs.
Some big names joined the party: Platinum Asia Investments raised $293 million, Ellerston Asian Investments raised $120 million, and the Argo Global Infrastructure Fund raised $286 million. The LICs provide useful exposure to Asia and offshore infrastructure companies.
As the booming Self-Managed Superannuation Funds (SMSF) shows greater interest in LICs, watch for more such floats in 2016.
Some niche players braved an exceptionally tough market for retailers with IPOs in 2015. Infant goods provider Baby Bunting Group starred. Homewares group Adairs (ADH) had a solid start, up 14 % on its issue price, and has reasonable prospects.
Rising consumer confidence, improving retail sales growth and easing unemployment could create more interest in retail IPOs in 2016. The float of online furniture and homeware retailer Temple and Webster Group (TPW) was oversubscribed in November and jewellery retailer Plukka plans to join ASX this year through a backdoor listing.
But sharp falls in Myer Holdings and Kathmandu Holdings (KMD) are a reminder of the risks for retail floats.
3. Copycat IPOs attract attention
A booming IPO is often a catalyst for similar companies to list. National Veterinary Care’s (NVL) IPO attracted plenty attention after Greencross’ (GXL) success in the past five years. After raising $30 million and listing in August at $1 a share, National Veterinary Care has raced to $1.33. It has a less aggressive acquisition strategy than Greencross and solid long-term prospects.
Intellectual property firm Xenith IP, which listed in November after a $51 million IPO, benefited from soaring gains in another intellectual property holding company, IPH Limited, the market’s best-performed IPO in the past decade.
2016 Outlook
The IPO market shows few signs of slowing next year. Forty-one companies had applied for admission to ASX in early December. The fourth quarter is typically busiest for IPOs as companies try to close offers and list before the summer break. But IPO volumes this quarter are higher than in previous years.
IPOs of note include Apiam Animal Health, real estate firm McGrath Limited, PSC Insurance Group, Templer and Webster Group, printing and marketing provider IVE Group, US home- relocation service Updater Inc, and livestock exporter Wellard Group.
Among larger potential IPOs, Stateplus, the financial planning business owned by NSW’s SAS Trustee Corporation, is reportedly considering a float. It could be next year’s first $1 billion IPO.
Plumbing fittings and water-flow controls manufacturer Reliance Worldwide Corporation is another rumoured IPO for 2016. It, too, is expected to raise around $1 billion. Reliance has a growing presence in the US market.
The 2016 IPO market looks similar to this year’s: no multi-billion- dollar blockbusters and mostly smaller, entrepreneurial business companies coming to market.
My forecast is for broadly similar levels of capital raised and IPO volumes in 2016 to that in 2015, provided sharemarket conditions remain stable. But expect smaller price gains as investors become increasingly wary of inflated IPO valuations. It should be another busy, active year for IPOs and investors chase smaller, entrepreneurial firms that can grow faster than the economy.
Investors will need be even warier than usual in 2016. In a red- hot IPO market, the potential to be burned has rarely been higher. Remember that most floats are best bought well after listing, when the company has more history as a listed entity and has published several sets of financial accounts under ASX Listing Rules.
For the vast majority of floats, the safest place to watch the action will be on the sidelines. It won’t take much for more investment accidents to occur in 2016 as the IPO market hits top gear while the sharemarket grinds sideways.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.