The IPO market is heating up: Should investors jump in?
To much fanfare, ride-hailing firm Lyft went public on March 29—the opening salvo in what many believe will be a blockbuster year for initial public offerings, or IPOs. Although the much-ballyhooed IPO was oversubscribed and received breathless media coverage, Lyft shares fell 22% from their intraday high on the first day of trading.
For investors hungry to get in on an IPO, we offer some words of caution: IPOs are inherently risky, and wall-to-wall publicity is no guarantee of a positive outcome.
The ABCs of IPOs
Private companies go public primarily to access capital. By issuing shares in a public offering, firms can raise funds to purchase equipment, expand manufacturing capacity, or acquire other companies. Additionally, a company might conduct an IPO to provide liquidity to its owners.
However, going through an IPO is a rigorous process that requires extensive oversight. For that reason, firms planning to go public hire investment bankers, lawyers, and accountants to assist in the offering process. These advisors steer issuers through the maze of regulatory hurdles, help structure terms of the deal, and sell shares to the public on behalf of the company.
The underwriting syndicate allocates shares, with institutional investors generally awarded the vast majority. Once shares begin trading, the public can begin buying them in the secondary market. That’s where things can get tricky. While the stock’s value can rise rapidly in the primary market, it can falter in the secondary market, leading to volatility.
IPOs in 2019 could set a record
In 2019, more than 225 US companies are expected to go public.1 The roster includes high-profile “unicorns”—companies valued at more than $1 billion—so named because valuations that rich were once considered as rare as the mythical creature.
At this rate, they may as well be called rabbits: They are seemingly everywhere, some are bigger than others, and all are vulnerable to a slew of life-threatening hazards. Of the firms expected to go public this year, more than half are categorized as unicorns.
Renaissance Capital, which tracks IPO activity, predicts that IPO proceeds in 2019 are likely to surpass $100 billion.1 A look at recent history reveals just how massive that figure really is.
Data set includes IPOs with a market cap above $50 million, and excludes closed-end funds, unit offerings, and SPACs. IPO data does not include Spotify, which completed a direct listing. Proceeds totals do not include the exercise of underwriter overallotments. Source: Renaissance Capital
Since the dawn of the millennium, IPO proceeds have only once approached $100 billion, but 2014 was skewed by Alibaba Group’s gargantuan $22 billion US offering. By comparison, last year saw $46.8 billion raised in public offerings, as depicted in the chart above.
How have recent IPOs performed?
We’ve all heard stories about IPO millionaires. But for every lucky soul who picked up Apple shares for $22 in 1980 (they’re now worth more than nine times that and have split many times over), there are just as many who’ve lost their shirts in IPOs.
More recently, IPO performance has been uneven at best, with performance varying by sector. For example, last year, IPOs in the consumer staples space generated an average return of more than 30%, while newly issued shares of utilities companies averaged -44.2%. Technology IPOs managed a modest 2.2% gain for the year.2 Translation: Keep the Maalox handy.
Data through 12/31/18. Source: Renaissance Capital
For investors considering IPOs, it’s helpful to understand the landscape.
• Expect volatility: IPOs come with significant risk and often see huge price swings, especially in the early days of trading.
• Beware hot new issues: Despite their significant appeal, hot new issues are no sure thing. Famed value investor Warren Buffet recently told CNBC that he hasn’t invested in an IPO since Ford Motor Co. went public in 1956—and he’s especially wary of hot new issues. “I think buying new offerings during hot periods in the market … I don’t think it’s anything the average person should think about at all,” said Buffet.3
How to indirectly access IPOs
IPOs—especially those that are oversubscribed—can be difficult for the average investor to access. Here are some tips for participating, even if shares of the initial offering aren’t readily available.
• ETFs: Exchange-traded funds (ETFs) provide an ancillary way to participate in IPOs—without the single-stock risk. ETFs that invest in initial public offerings can be bought and sold on the secondary market, providing broad exposure to IPOs. But it helps to do some homework. Each fund’s methodology varies, and these ETFs aren’t for the faint of heart.
• Look for public-company investors: Publicly traded companies may take positions in start-up companies that eventually go public—and they can reap a windfall in the process. Investing in these stakeholder firms can allow investors to indirectly participate in IPOs that may otherwise be off limits to most retail investors. In the case of Alibaba’s 2014 IPO, Yahoo! took a 24% stake and saw its profits and stock price surge as a result.4
Ultimately, deciding whether or not to invest in IPOs boils down to one’s tolerance for risk. Are you a risk-taker by nature, or more like the Oracle of Omaha?
With all the IPOs waiting on deck, the coming year should provide a clue.
1. “A giant IPO wave is coming as ‘unicorns’ whet investor appetite,” CNBC, February 4, 2019, https://www.cnbc.com/2019/02/04/a-giant-ipo-wave-is-coming-as-unicorns-whet-investor-appetite.html
2. “US IPO Market 2018 Annual Review,” Renaissance Capital, January 2, 2018, https://www.renaissancecapital.com/Review/2018_US_Review_Press.pdf
3. “On eve of Lyft’s much-hyped debut, Warren Buffet says regular investors shouldn’t buy hot IPOs,” CBNC, March 28, 2019, https://www.cnbc.com/2019/03/28/warren-buffett-says-regular-investors-shouldnt-buy-hot-ipos.html
4. “Alibaba profit nearly triples as revenues rise,” BBC, May 8, 2013, https://www.bbc.com/news/business-22445231