Number of IPO’s Denote Market Optimism (not the state of Economy)

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The high profile listing of social media company Twitter in the last quarter of 2013 and the much anticipated Initial Public Offering (IPO) of Chinese e-commerce giant Alibaba Group Holding in the subsequent quarter – are just one of the several signs of a rejuvenating global IPO market.

These IPOs are generating a lot of investor excitement and garnering media attention, but that is all there is to it. A large number of fresh listings in the equity markets do not necessarily indicate a genuine economic revival. It does, however, indicate a high degree of investor exuberance.

The year of IPOs

The year 2014 is being hailed as the year of IPOs. According to a Goldman Sachs investment banking division report, the first quarter of 2014 has seen greater IPO activity than the same time last year with about 85 global listings ready in the month of January alone.

An EY report says that the year 2014 will maintain the IPO momentum of 2013. “IPO activity in 2013 has proved to be the most active since 2004 when the number of listings was last highest and surpassed 2007 when capital raised was highest. The total number of IPOs on the US exchanges in 2013 is 222 with USD 59.6bn in proceeds raised. This is compared to 238 IPOS which raised USD 49.6bn in 2004 and 214 IPOs which raised USD 50.4bn in 2007,” adds the report.

Asian markets including China and Japan are looking at a higher number of IPOs in the current year. The major equity exchanges in Japan had 60 new listings in 2013, which is expected to go up to 80 in 2014. At the same time, as the government in mainland China prepares to release the freeze on IPOs, about 760 companies are said to be waiting for listing approval from this quarter of 2014.

While the number of possible public listings indicates a great economic mood with investor confidence running high, it also indicates the imminent peak of speculative activity. The volume of IPOs seems to have a significantly positive co-relation with investor optimism; higher the number, more upbeat the market.

This might denote a positive sentiment towards equities as an asset class and yet not be a precursor to a bull-run. In fact, the reverse could be true.

Consider the example of the US: of the 864 IPOs worldwide in 2013, the US had about 222 new listings: the most in the world. As can be seen in the table below (TABLE 1), the S&P index annual return for these over the next 12 months (2004 and 2007) is at 9% and 3.5%, respectively which is not very high. In fact for the year 2000, which had the highest number of IPOs in the history of US markets, the S&P index gave (-) 10% returns. (TABLE 1)

Year Number of  US IPO One Year Forward S & P 500 Return 2 Year Forward 3 Year Forward
2000 429 -10.10 -21.79 -40.09
2001 104 -13.00 -33.36 -15.76
2002 98 -23.40 -3.18 5.54
2003 88 26.40 37.78 41.91
2004 260 9.00 12.27 27.54
2005 221 3.00 17.00 21.1
2006 236 13.60 17.58 -27.69
2007 296 3.50 -36.35 -21.39
2008 57 -38.50 -24.0 -14.33
2009 69 23.50 39.31 39.31
2010 168 12.80 12.80 27.92

(S&P returns one year return data source: http://www.forecast-chart.com/historical-sp-500.html)

The India Story

Consider the Indian example. While majority of public issues happened around 2006-07 when the equity markets were peaking, IPO numbers dried up to a trickle during the bear market phase (2002-03 and 2013-14).

Year No of
Issues
One Year ForwardSensex Returns 2 Year
Forward
3 Year
Forward
2000 41 -24% -32% -24%
2001 67 -5% 4% 39%
2002 18 -11% 48% 122%
2003 12 91% 99% 234%
2004 25 9% 151% 206%
2005 23 138% 104% 87%
2006 97 38% 12% 20%
2007 88 -34% -1% 21%
2008 85 -28% 31% 40%
2009 25 82% 30% 20%
2010 39 6% -2% 10%
2011 57 -8% 3% 13%
2012 35 11% 23%
2013 10 7%
2014 5

If we look at the two year forward return, the Sensex seems to have rewarded the lean IPO periods much better. An investor who bought equity during a low sentiment year i.e. 2003 (which saw just about a dozen IPOs) has made an average return of 99% and 234% on the Sensex in years two and three years, respectively.

In comparison, those who bought into the equity markets during the high optimism period (2007 and 2008 with IPO numbers above 85 for each year) have generated comparatively low returns on the Sensex two years on (-1% and 31%).

Why Are IPOs Flagging (in India)

In one word the answer is (again!): sentiment.

Overall dull economic conditions and new regulatory issues have not helped the situation either. On the regulatory front, the Securities and Exchange Board of India’s (Sebi) demand for offering a safety net for retail investors in the IPO market has acted as a big dampener on any new listing aspirations. Currently, the IPO market is at a 12-year low. There were just three big main board listings in 2013 and this might not change till after the 2014 general elections

According to a news report (in the Economic Times), about Rs 72,000 crore (USD 12m) worth of IPOs already cleared by the Sebi are still in limbo or have been called off completely. About 900 companies have made their IPO plans public but are doubtful about going forward. Uncertainty on the economic front and a volatile secondary market do not make an IPO revival likely in the very near future. However, this could be different with a change in investor sentiment.

Bottom line:
Increasing levels of investor optimism are making way for revival of IPOs in equity markets across the world. The large volume of IPOs are not a sign of any real economic revival or sound market fundamentals; they merely denote investor optimism.


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