Over the worst?
EY’s latest analysis of the IPO market underlines a troubled start to 2016. UK and global IPO activity fell to its lowest level since 2009 in the first quarter, as uncertainty and volatility in global equity markets forced issuers to wait out the storm or encouraged them to move into the relatively calmer M&A waters. The recent markets rally should provide a safer harbour to launch new issues in the second quarter, although we need to question the rally’s long-term endurance in the face of some tough challenges. I suspect there may be more choppy waters to come and expect companies to remain opportunist, follow the capital and keep their options open.
Volatile equity markets stymie IPOs
It’s been a bumpy ride in global equity markets to say the least in the first quarter of 2016, with a significant knock-on effect in IPO activity. The EY Global IPO Trends report for Q1 shows just 167 deals raising a total of US$12.1b, down 39% in volume terms and 70% in value compared with the same period in 2015. This is the worst start since 2009, with the fall in activity coming across the board in the Americas, Asia-Pacific and EMIEA. The UK market did outperform Europe as a whole, with London seeing 47% of the regions’ IPOs in Q1 16 and two of the top five deals globally, but value still dropped from £1.6b from £4b in the last quarter of 2015.
The universality of the decline isn’t a surprise. Global growth concerns were to blame for much of the equity markets’ fall, which limited the number of safe harbours. The Euro Stoxx 600 fell by almost 15% in the first half of the quarter, the Shanghai 22% and the S&P 500 and FTSE 100 almost 9%. Each index also showed considerable volatility, the scourge of new issues. According to Dealogic, 17 IPOs were withdrawn after launch this year – a new year-to-date record – representing $2.5b, or 17.6% of the total volume. This compares to just 3% of withdrawn deals in the same period of 2015.
Just to underline the impact of volatility on IPOs, it is worth taking a look at figures from Barclays, which show that since 2010, 80% of US IPOs have occurred when the CBOE’s VIX index was under 20. The VIX index is a measure of expected S&P 500 volatility over a 30 day period. In the first half of Q1, it was under 20 for just two days. The index has only consistently fallen below 20 since the start of March.
In response to these difficult conditions, we’ve seen issuers predominantly take a wait and see or a multi-track approach – depending on their situation. M&A markets, whilst more subdued in 2016, have been relatively unscathed by the choppy start to the year. Technology IPOs have been particularly noticeable by their relative absence for a while, with many looking to buoyant private markets for fundraising. This might not be their ‘forever home’ in terms of raising capital, but for relatively new start-ups “pre-profit”, it is tougher to make the case for IPO in a more troubled world. As ever, companies will follow the capital.
So what of Q2?
So what comes next – for markets and IPOs? The first quarter can often be the slowest for new issues and the number of cancelled and delayed IPOs means that there is a considerable pipeline of deals waiting in the wings in Q2. With markets rallying and more stable – VIX now under 14 – we expect more companies to take the plunge. Much like ducklings, we probably need the biggest and the bravest to make the first move and the rest will follow.
The one big question mark and caveat that invariably hangs over this outlook is the endurance of this recent equity market rally. The improvement we’ve seen since around the middle of February has very closely followed the bounce in oil prices and a fall in dollar, inspired by a seemingly more dovish Fed. Indeed, the assets that have seen the greatest improvement are those strongly connected with a weaker greenback – S&P 500, emerging markets, commodities etc.
This reliance creates an inherent fragility. In particular, we’d question if anything fundamental has changed in oil and query the strength of this commodity rally. Barclays recently noted that the shift into commodities isn’t from long-term investors:
The kind of commodity investment that is taking place currently is not the long-term buy-and-hold strategy for portfolio diversification and inflation protection that underpinned the huge inflows of the previous decade. It is much more short term and opportunistic…many have been liquidating on the recent move up in prices, having held their positions for only 5-6 weeks.
The Fed also seems divided in tone. That’s probably because there are obvious reasons to raise rates from a US economic perspective and reasons to pause globally. A conflicted Fed could put markets back into volatile mode again. UK markets – and arguably EU and beyond – also have the June 23 EU Referendum to navigate around. So it won’t be plain-sailing, even if markets avoid the repeat of the global recession panic that plagued Q1. Volatility could still be an issue in Q2 .
On the growth point, if we look at the nitty-gritty of economic data, the overall picture seems mildly positive for most major economies. It certainly confirms that recession fears of early 2016 were overdone, but we can’t get away from the fact that growth will remain slow. Which is why we’ll be watching the upcoming earnings season very closely, to look for signals on how this slower economic grow is translating into profits.
In terms of market reaction, it’s safe to say that expectations have been well and truly dampened. According to S&P Capital IQ, analysts forecast the S&P 500 will see Q1 earnings per share fall 7.4% from Q1 2015 – compared with an expected fall of 1.2% at the start of 2016. There are similar low expectations in across Europe, so markets might stay serene for now – especially if companies jump this low bar. But in the end, it’s the actual performance – not the performance against expectations – that will matter and significant falls in earnings will hit fragile IPO investor confidence.
M&A markets are of course marching to a different tune, buying to defend against low growth. It should be a better quarter for IPOs, but with so uncertainty and volatility waiting in the wings, it will still pay for companies to keep their options open.