Activity has all but dried up in the riskiest part of the stock market

Bob Bryan

Sat, Mar 5, 2016, 4:01 AM

Man with his dog in a dried up lake in Brazil

(REUTERS/Roosevelt Cassio)

Big initial public offerings are one of the most attention-grabbing moves in the stock market.

And for the most high profile of IPOs — think Alibaba and Square — it is very much the day's big event.

IPOs mark not only a new era for companies that may have been small or nonexistent just a few years ago, but also serve as a barometer for investor sentiment.

Newly issued stocks are often deemed more risky, and so more IPOs indicate a higher risk appetite from stock investors and can reflect confidence throughout markets and the economy.

In 2016, however, the IPO market has almost completely dried up, and there have been no big new issues coming to market.

There were no IPOs in January and just five in February, Andrew Birstingl at FactSet wrote in a recent note, making 2016 the slowest year for IPOs since 2009.

The waters are too choppy

The biggest factor behind the decline in IPOs is the heightened volatility in the stock market, which has created a disincentive for companies for jumping into the public markets, according to Neil Dhar, head of the Capital Markets and Deals team PricewaterhouseCoopers.

"Market volatility is generally not a good thing for IPOs," Dhar told Business Insider in an interview. "IPOs are a higher-risk proposition because the market isn't totally sure of their value. So you want a relaxed market when you enter with that higher risk."

Dhar's team advises and executes deals such as IPOs, mergers and acquisitions, and spinoffs for PwC, and he harped on the risk premium of an IPO for a company.

Bringing a company to market opens them up to exposure for the first time and initial pricing can be risky as the market has never valued its business before and has a only few years of financial results and management assurances to work with.

So when the broader market is thrashing up and down — and especially down — this can scare off companies and underwriters, who risk holding the bag on unsold shares if the offering doesn't have enough demand, from going for it.

And these market conditions haven't just impacted new announcements and issuances, but companies that were planning IPOs have backed off as well. According to Birstingl's report, 12 companies have called off planned IPOs so far this year, the highest number since 2008.

Additionally, Dhar said there's another, simpler reason for the slow start.

"January and February are typically bad months for IPOs anyway," he said. "Typically, these companies have financial periods ending in March so they wait for that next set of statements before going to market."

Add up these two factors, and it explains why so few companies are deciding to ring the opening bell on a public stock.

A bit of a sea change

There are also some long-term issues that have held back IPOs recently.

For one thing, many high-profile IPOs such as Square, Ferrari, and even Alibaba have taken it on the chin and have traded below their initial offering prices. And these broader struggles can scare people off from the market, said Dhar.

"Success feeds success," Dhar told us. "You had a situation where some IPOs have struggled, so when you're trying to set up comparable deals it may not look as attractive."

Dhar also reiterated that pricing IPOs is an "art, not a science," so a company may not want to go public when the previous run of IPO paintings, if you will, look pretty ugly.

(FactSet)

Additionally, taking a company public may no longer even be the most lucrative option for a business. Private tech companies such as Uber have public-company-size valuations but are choosing to stay private.

"If you have a robust private-investment market, there may not be as much of an incentive to do an IPO," said Dhar. "Gone are the days where it's the best thing to do to go public."

While some of these companies have had this come and bite them in recent months, as large investors like Fidelity have written down the value of their stake in private tech companies — which Dhar said could help kick the IPO market up a bit — there has still been robust demand for private investment.

Just give it time

All this, however, doesn't mean that IPOs are totally done for, said Dhar.

"There's still a relatively low-interest-rate environment," said Dhar. "People are still looking around the market for yield and IPOs usually yield more."

While riskier, this also means that stocks of companies that IPO are more likely to outperform and could be attractive to investors. More importantly, there are companies primed to make the move.

"There are a lot of really good companies out there that are going to need access to capital," said Dhar. "IPOs are a good way to get to some of that capital, so I don't think that IPOs will stay as depressed as they have been."

So a pickup is coming, but it's not hard to accelerate when you're starting from zero.

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