Why IPOs Are In the Dumpster

2010 started with high hopes for IPOs. The economy had been recovering since the summer of 2009, and investment bankers combed through the ranks of venture capitalists to drum up filings for tech IPOs. Early on over 9x more IPOs were filed than in recent years, but as it has turned out, US IPOs have raised the least amount relative to filings since 1999. More than half the filings have yet to complete, and over 60% have left IPO buyers with a loss, with 2/3 of them raising less than desired.

This isn't just a Silicon Valley story. Many of these IPOs are private-equity backed and come from across America. The WSJ ran an op-ed called The IPO and the American Dream, observing that "access to capital markets remains the most reliable job creator we know." Is it a surprise that more IPOs came out in Chinese than US capital markets? The op-ed urges policies changes in taxes, regulation (Sarbanes-Oxley of course) and immigration (more visas for the best & brightest), all good ideas. 

A very insightful study by the accounting firm Grant Thornton takes a deeper look at what troubles US IPOs. They first issued their findings in Why Are IPOs in the ICU? and followed up with a final report, embedded below. You can read summaries from CFO magazine and the WSJ. The disturbing conclusion:

The market for underwritten IPOs, given its current structure, is closed to 80% of the companies that need it ... We've killed the feeder system to the big leagues

They point to culprits beyond Sarbanes-Oxley, including the loss of analyst support (than you, Elliott Spitzer) and the rise of electronic exchanges, which reduces trading spreads and make it hard to make money on small cap issues. We used to have the 'Four Horsemen", investment banks which specialized in small cap IPOs, but they have been gone since 2001 due to unfavorable economics. Grant Thornton recommend a new "opt-in" market be created that fits the economics and needs of small cap IPOs. 

IPO Crisis June 2010 FINAL

In spite of all of this, chirpy optimism about what lies ahead is still prevalent. The pending list of VC-backed companies is over 4x higher than a year ago. 

It is clear, however, that markets do not stand still. With the absence of IPOs, besides increased m&a activity, venture-backed companies are seeing the rise of a new Secondary Market, so named as the investors do not buy the whole company but buy shares of early investors and management. Facebook and Zynga, two very successful start-ups, have delayed IPOs until at least 2012 and accepted secondary capital. This trend is poised to accelerate in the years ahead, creating new paths to liquidity for emerging growth companies that run around the blockages of excessive financial regulation and the huge policy failure of killing the small-cap IPO. 

Note: The Scream photo courtesy NYT The Haggler

Comments

[Mamma Boom Boom]

>Why IPOs Are In the Dumpster<

If I told you I would have to charge you.

[Mamma Boom Boom]

The day started weak and ended pretty strong. Can't argue with that.

[Mamma Boom Boom]

I just thought of a new market indicator: survey hospitals to find out how many recent heart attack victims were bears.

[twitter.com/DrBubb]

The list of winners and losers says it all : wealth to the machines, and remove the "old fashioned" investors to China, where the real wealth is being created.

The problem is: about a decade or so ago, everything in the US went virtual: people started monetizing "eyeballs" and other esoterica. Investment banks were allowed to gear at ridiculous levels, and people everywhere caught the speculative bug, seeing it was easier to make money speculating on dotcom stocks and flipping houses than it was to do real work.

Massive amounts of "fictitious wealth" were created, and for a few years everybody felt rich, and that they could buy whatever they wanted, and not worry about repaying the debts.

The fictitious wealth is being rolled back, even though the Fed is trying to resist that process, because it means painful writedowns and debt repayments. They want to protect the banks by propping up unsustainable valuations in homes, mortgage backed securities, and the like.

But bit by bit gravity is winning, as home values start drifting down again DESPITE near zero rates. The liquidity that is still sloshing around seems to get channeled in to advanced hyper-speculative activities, like High Frequency Trading.

Isn't it clear that the present system needs simplifying in almost every way. Old fashioned valuation metrics need to be restored, and they need to turn off the speculation machines.

[twitter.com/DrBubb]

For those of you who have not studied the report:
Winners:
Speculators, Hedge Funds, Trading-oriented institutions, Day traders, Electronic trading, Volatility, Black pools, Expert networks, Private equity, Big company acquirers, PIPEs- reverse mergers- SPACs, Asia- (especially China and India)

Losers:
Issuers, Mutual funds, Long-term institutions, Mom & Pop investors, Stockbrokers (advice), Market makers (Nasdaq), Liquity (from LT investors), Transparency, Company fundamental research, Investment bankers, Venture capital, IPOs, United States

Caption: Is this what Congress really intended?

[yelnick]

DrBubb - yes, the US needs to go back to earning its way by real production, not using gimmicks and debt to create the illusion of prosperity. The Hitler video may have been excessive inside-baseball (again, a US term!) but when a Hitler remix mocks something, that something has hit the radar screens beyond the local niche. Hitler is angry that the SuperAngels - who were his last, best hope for financing whatever crazy idea he had in mind - were now colluding and acting as badly as other financial sources. The message should be taken to heart: the last remaining bastion of funding real productivity and growth is the VC industry, and it has gotten too risk averse, leaving the field open for SuperAngels. If they get house-broken, well, the only returns left are to invest in China ...

[twitter.com/DrBubb]

And meantime, the Chinese are learning about the Venture business, and seeing that it is easier to make money through investing, rather than through the "hard graft" of industry.

Yesterday, I sat in the top floor of a major Hong Kong hotel, listening to the CEO of a mining company talk about how he was going to build one of the world's largest copper mines in Minnesota (!) And at the next table, two Indian guys were pitching their investment project to a wealthy Chinese investor.

In the background floated Kowloon, the most crowded place on the planet.

Those sorts of conversations that used to happen in Wall Street and in Silicon Valley, are now happening in Hong Kong and Shanghai.

[yelnick]

DrBubb, they are back amidst the SuperAngels, on a smaller scale.

[Whitebear]

"But bit by bit gravity is winning, as home values start drifting down again DESPITE near zero rates."

Whenever I heard people saying how dire the housing situation is in the US, I can't help pointing out that it is the location that matters. Those prime location in San Francisco is still selling at > 3M for a measly 2500 sqf. lot.

Housing crash? Not in San Francisco.

http://tinyurl.com/23ho7mm

[Whitebear]

DrBubb, any take on the real estate market in HK? I believe it is now selling for $1500 USD per sqf easily for even the less prime lands in Kowloon.

[twitter.com/DrBubb]

I am selling my HK property.
We sold most of them. We have one left: the flat we live in, and it is for sale too. But we will want a very high price, since we need to live somewhere, and rents are sky-high.

Mortgage interest rates here are around 1% versus yields of about 3%, so (on a cash flow basis) it is still cheaper to own than it is to rent.

We sold down because we didn't want to be exposed if the market turns. Property prices move very in Hong Kong.

[twitter.com/DrBubb]

Y.,
It is tragic to see the VC's getting beat up in the US. And that is part of a bigger tragedy of Wall Street and the financial sector in the US which has moved from being "in service to the economy" to being merely parasitic.

"Long Term greedy" means that you need your customers to thrive (so you can do repeat business),
rather than "killing" them to gain an immediate profit.

Wall Street switched from being "long term greedy" to "short term greedy" over the last decade or two.

[yelnick]

DrBubb, until we end ZIRP, capital will be crushed, and US business will continue to underinvest. You couldn't design a more destructive cluster of policies than QE (weak Dollar) / ZIRP (capital destruction) / Deficits (crowding out) / Regulation (hidden tax) / Imperial wars / Feckless leadership

[twitter.com/DrBubb]

I agree completely, Y.

From today's Asian WSJ, article by Andy Kessler, ex Hedge Fund Mgr:

What's the Matter with Wall Street?

"The financial industry has certainly seen slow periods of stock and bond trading and sparse banking before... but banks made up for it by inventing new products*...
. . .
In my estimation, there are too many traders, bankers and salesmen to support the new level of business. Wall Street firms also have too much capital that they scramble to generate returns upon. Both need to shrink over the next five years.
. . .
We are at the bitter end of a 30-year interest rate cycle...
. . .
At some point, the powers that be will figure out that rising rates will be the cure of all that ails the U.S. economy by driving the dollar higher, commodities back towards their extraction values, and encouraging commitments of capital based on market mechanisms (DB: cash flow, rather than speculative momentum), not the wishes of the government and the Federal Reserve. That will not be good news for Wall Street, which doesn't do well in a rsing rate environment. See the 1970's. Time to hunker down, and get back to basics."

*(Many of those products were toxic, ripping off their clients. Or involved leveraged soeculation. He goes on to talk about how banks are losing their prop trading desks, and the profits associated with them.)

Meantime, yesterday we saw: Morgan Stanley froze hiring.

[twitter.com/DrBubb]

Whitebear:
More on HK property prices. The papers here have a story about a new development just launched in Wanchai (not the mid-levels!) at HK$15,000 psf. That's almost US$2,000 psf. And guess what, the seller is a JV, where the Urban Renewal Authority is a part owner. That's a public sector company cashing in on high current prices. But they are all now rushing to sell now, because the HK Govt may launch new measures in early October to cool off the market.

[Zendo]

Dr. Bubb, I speculate when US congress slap some sort of tariff against china export and cause the yuan and hkd to unpeg, that will be the day of all these real estate bubble burst!

[Whitebear]

Yup. The HK property market puzzled me a lot. There have already been two restrictive measures taken by the HK gov in March and in July and the effect so far is zip. The property developer bid up the land in Ho Man Tin and recently Hung Hom, in defiance of whatever measures administered by the gov. I suspect the upcoming measure will face the same fate.

One thing is certain, HK people are borrowing to the brim while mainlanders from China are buying with cash.

Regarding mainland chinese investment outside, I heard that they are now buying up lands around Mt Fuji, in Hokkaido, fueling concerns from the locals. Apparently, the Dubai tower became their dinner as well. Sydney and Melbourne are on their radar. And of course Vancouver, where I live. High-end wines like Lafite were snatched up by them like there is no tomorrow.

When will this end? Or, is it just the beginning?

[twitter.com/DrBubb]

If China property is a bubble, it is not a conventional one with the usual excesses of excessive gearing from banks. There may be gearing on the developer side, but on the property owner side, there is plenty of equity. A chinese property investor can presently get some decent gearing on purchase #1: like 75%, but #2 is now limited to 50%, and #3, if one is allowed to buy it at all, will come in less than that.

How will this play out? If there is a price drop, I think the owners will wind up holding, and holding for years, with their capital tied up at a low return. This is different than the US where the high debt levels, and the burden of interest rates, have forced people to sell, or default. And there's a rising tide of supply coming to the market (at cheap prices) after foreclosure. We are unlikely to see that in China.

Whitebear, how are people "borrowing to the brim" in HK?. We owned X HK properties at one stage. And I stopped buying because the bank told me they would only lend me 60% rather than the 70% they had offered on the first (X-1) purchases. (As I said, we have now sold all but one of those, each at a profit now - I don't like the risk/reward from here.) I don't think that 60-70% is "borrowed to the brim". Even in the HK property crash of 1997-2003, no HK banks went bust, thanks to these prudent principles.

Yes, Mainlanders often pay cash when they buy secondhand in HK, but when they buy new properies they often take the "deferred payment schemes" on offer in HK. And that's where the vulnerability lies.

More on HK property, check out this site: TinyUrl.com/AX prop

And here's a chart for those who want one:

Note that prices are still below the 1997 parabolic peak. I wish I could say the same about the US and the speculation-ridden UK property market (which now set for a spectacular bonbe-rattling crash.)

[Zendo]

I think your chart only demonstrate the rise up till end of 2009, given the rise of the market in 2010, I won't be surprised it's already near the top of 1997.

[Chabazite]

I wish I could say the same about the US and the speculation-ridden UK property market (which now set for a spectacular bonbe-rattling crash.)
-----------------------------------
Very interesting exchange Dr Bubb. Anyway, here are a few articles on UK property from the BBC. I read that some are dismissing the coming downturn as a minor correction. Well, no surprise there then!

- Mortgage lending 'remains tight' for first-time buyers http://www.bbc.co.uk/news/business-11282287
- House prices: Surveyors expect property values to fall http://www.bbc.co.uk/news/business-11288763
- Mortgage lending falls again, lenders say http://www.bbc.co.uk/news/business-11368953
- Mortgage plan will force house prices down, CML warns http://www.bbc.co.uk/news/business-11390764

[Chabazite]

Hey - any EW experts out there ... is there anything to stop the long run up to from Mar '9 to April '10 being an 'A', the flash crash and low to end June being a 'B' and the rally since July being a truncated 'C', in which case we could embark upon P3 at any time. The flash crash being just a warning of whats to come. I don't like it because it lacks symmetry and I am not certain about whether or not it breaks any rules so any constructive comments would be welcome. But you know the more bullish everyone is becoming about QE2, the more bearish I feel.

[yelnick]

Zendo, here is a chart of IPOs per year vs S&P. As it shows, we are in a death valley. 

[twitter.com/DrBubb]

Chabazite,
I am sure your know where the BBC is coming from. They will be amongst the last to see the UK property crash as it arrives. It is already arriving, and you can see it in the data: http://www.tinyurl.com/UKtrap