Equities’ death greatly exaggerated

But public offerings may not be all that healthy

CAPITALISM is back — alive and kicking. That, at least, is the impression created by the rush of companies debuting on share markets.

Global initial public offering (IPO) volumes have already exceeded $38billion (about R406-billion) in 2014, more than twice as high as during the same period last year.

IPOs are the lifeblood of equity markets: they replenish share supplies and invigorate investors, as well as providing finance for companies to expand. So their revival is a sign of a return of Keynesian “animal spirits” or commercial risk-taking — and of financial markets functioning efficiently again after almost seven years of crises.

Or is it? Amid all the hype, there are reasons for caution. The animal spirits may be those of bigger companies, bankers and financiers, rather than the smaller beasts in the jungle that will provide the economic growth of the future.

A common fear not long ago was that the dearth of IPO activity seemed to reflect structural changes.

Historically low interest rates and economic uncertainty were blamed for dulling pricing mechanisms. High-frequency traders, eking out profits from the smallest price movements, were accused of gaming the system; regulators of discouraging risk taking; and bankers and advisers of failing to leave anything for investors. The popularity of bonds led to talk of the “death of equities”.

This year’s IPO spurt suggests that some of these worries were misplaced. In hindsight, a big reason there was so little IPO activity was simply that economies were weak. Now that prospects are picking up, the market has reopened. But that is not the same as concluding that the IPO market is back to rude health.

The obvious concerns are that the IPO surge is being driven by inflated expectations about the earnings of digital-age companies — a repeat of the 1990s dotcom mania — and by the global rally in equity prices powered by quantitative easing.

That IPOs are focused in a particular sector is not unusual.

But the surge owes much to the strength of equity markets. As share prices soar, an IPO makes economic sense for more companies; investors spot an opportunity to exit.

Buoyant markets have not just seen companies valued generously. They have meant some large “pops” — a surge in the share price in the days immediately afterwards.

Still, investors have yet to fall in love with IPOs. On average, shares of IPO companies were 23% higher after a year, said Mouhammed Choukeir of Kleinwort Benson. So in the past 12 months they would only just have outpaced global equities.

Fuelling investors’ suspicions are not just the large fees bankers earn, but disputes over share allocations. When AO World, a UK online retailer, was listed last month, 85% of the issue went to just 15 investors.

A broader worry is that the IPO market is still not serving the smallest companies. Although volumes are near record highs, the number of IPOs is on a long-term downward trend, which means the average size is rising. The first months of 2014 have seen about 200 IPOs globally. There were almost 700 in the same period in 1996, although that was in the run-up to the dotcom bust.

The impression remains that illiquid markets, new ways of trading equities, and constraints facing banks and brokers have scared entrepreneurial companies off IPOs. The market is not yet roaring. — © Financial Times, London