Is The U.S. IPO Window Set To Close? by PitchBook
Introduction
How do we determine if the window for U.S. private equity and venture capital-backed public offerings is closing? This is a complex question, so to investigate, we assembled an entire report’s worth of data and analysis. To start, it’s worth noting that completing an initial public offering (IPO) is still by and large an expensive and time-consuming process, even though the JOBS Act in 2012 has ameliorated things somewhat, especially for VC firms.
Consequently, the incentives for PE and VC sponsors to take their portfolio companies public have to outweigh other exit options, particularly corporate acquisitions. The bullish public markets of the past few years incentivized many to choose that route, however, leading to a decade high in U.S. PE and VC-backed IPO activity in 2014. In addition, both PE and VC portfolios contained and still hold a number of companies for which the best option was arguably exiting via an IPO, which only helped boost numbers higher. Examples of such debuts in 2015 include Fitbit, GoPro, La Quinta (NYSE: LQ), and First Data.
But 2015 started off with a dose of volatility as the Swiss franc was unpegged to the euro. Greece’s woes only accentuated volatility several months later. Now, as the year winds down, a more troubling slowdown in China’s growth along with the decline in energy prices has contributed to even wilder swings. With caution on the rise, companies fresh to the market must undergo a more thorough examination by investors, not to mention withstand what could be prolonged turbulence in stock markets worldwide.
Overview
For private investors looking to take portfolio companies public, things were rosy for quite a while before this year. 2013 and 2014 combined saw a massive $70.4 billion raised across 344 PE and VC-sponsored IPOs in the U.S.—a return to more reasonable levels was, perhaps, to be expected. In retrospect, indications that the IPO window was in danger of narrowing first emerged as far back as 1Q 2015. During that quarter, only 19 U.S. companies backed by PE and VC firms went public, raising an underwhelming $2 billion combined—the lowest since the back half of 2011. The drivers of current volatility—slumping oil prices, sustained Eurozone troubles, slowing Chinese growth—were only beginning to accelerate at the start of 2015, but they are truly taking a toll on the current IPO market now.
Amid global turbulence, investors are scrutinizing filings with more critical eyes. Highly leveraged PE-backed companies will have trouble attracting risk-averse institutional investors. As for venture-backed companies, many will have to show impressive metrics just to preserve the valuations seen in the private markets. For example, Facebook is trading at a trailing last-12-months P/E ratio of about 98x, which is relatively inflated yet at least supported by the company’s performance. Many venture-backed companies are hoping to achieve similar results, but how many can point to similar numbers? The example may be a tad hyperbolic, but so are many late-stage valuations; companies going public will have to meet the markets on a middle ground in terms of pricing. 67% of VC-backed IPOs this year have hit or exceeded their range, indicating not only the occasional bursts of optimism seen this year but also how companies have responded to market conditions. Of the companies that do go public in 4Q, similarly responsive pricing is highly likely.
In and of itself, the IPO window squeezing shut wouldn’t be as troubling were it not for what has led up to it. As many have noted, the current PE-backed IPO pipeline holds some of the last remnants of the buyout boom. KKR-backed First Data, which isn’t included in this report’s datasets due to the timing of its debut, is a fitting example. Its debt load not only contributed to KKR choosing to go through with the IPO, but also skewed market sentiment, although how much that will affect future stock performance is uncertain. Other PE firms looking to take debtladen portfolio companies public may well bite the bullet and follow KKR’s lead, relying on longer-term earnings growth rather than initial performance to eventually recoup their investments. As GPs generally opt to exit a substantial portion of their shares in stages, secondary offerings could provide some relief when it comes to exit timing.
For VC firms, the situation is somewhat different. The boom in investment that has led to a surfeit of heavily funded, late-stage companies with valuations of over a billion dollars has yet to truly wind down, although there are signs of slackening. Consequently, VC investors may be able to hold out for a more opportune time to take highly valued companies public. The question is how long they can afford to wait. For many of the most VC-rich companies, an IPO is the best exit option. Strategics have been active in buying up VC-backed startups, but the rate of M&A is insufficient to serve as a source of liquidity for the most highly valued companies still private. It’s not just a matter of strategics being able to afford the most recent private market valuation, but also their willingness to absorb the running monthly overhead, which, for many late-stage companies striving for maximum growth, is sky-high. That same burn rate, usually the result of a lack of regard for unit economics, will be a most pressing problem for VCs, eventually. Some companies may be able to achieve substantial revenue in time to justify going public even in the midst of volatility, but that remains to be seen.
For PE and VC backers, IPO timing now is about how much going public in the current market will weigh on future stock performance. Just how much of a hit companies may have to endure, how long that hit will last, or how long before they can risk it, is the question.
PE IPOs: Activity
Three quarters into 2015, PE-backed IPOs have accounted for just under 36% of all privately backed U.S. public offerings, the lowest percentage in at least a decade. In contrast, PE accounted for 66% of all IPOs in 2005. The drastic disparity speaks to the changing market dynamic nudging PE away from exiting assets through IPOs. As markets have improved in recent years, many PE portfolio companies have become ready for sale, proving ripe targets for growth-seeking corporations that had nursed themselves back to health as well. Consequently, even over the last few years, corporate acquisitions have been more frequent than IPOs.
32 PE-backed offerings have hit the market through September’s end, raising an aggregate $7.2 billion. This number is anemic relative to the same period in 2014, which saw $19.3 billion raised across 50 listings. 2014 saw some of the strongest PE-sponsored IPO activity in the U.S. of late, lifted by swelling total market valuations, and U.S. public equities, which rose over 11% during the year. This year, however, has seen shifts across the board. Valuations are still not cheap, although they have subsided a bit in the private sector. Public market volatility has rapidly increased throughout 2015, with U.S. equities trading sideways, before experiencing a correction recently. Those factors combined with strategics’ eagerness to pay up for growth leaves an uncertain backdrop that provides little incentive for PE sponsors to undergo a complicated and expensive public offering. We saw this evidenced dramatically in 3Q; only $2 billion was raised across 12 completed listings. The count was only off by two from 2Q, yet capital raised was down 51%.
