We’ve had a very active IPO market during the past year. A couple of reasons explain this phenomenon. First, institutional investors pulled back from the more risky initial public offerings after the crash of 2008. As the market recovered, the pension funds, mutual funds, and other institutional buyers focused their new investments on less risky large cap stocks. As a result, the large cap market recovered nicely. Institutional investors then started to look for opportunities for greater upside and discovered the IPO market.
At the same time, companies that were unable to go public in the post-2008 era started to realize that the IPO window has again opened. Given the pent-up inventory of IPO-ready companies, underwriting firms were able to pick and choose, and naturally took the most qualified companies to market first.
This confluence of supply and demand – a pent-up supply of highly qualified IPO candidates, combined with institutional money looking for high growth investments – resulted in a series of very successful IPOs. Companies that went public in this phase saw their stock value skyrocket, creating demand for more IPOs.
After a while, the highest quality IPO candidates successfully went public and the pent-up institutional cash committed to IPOs was spent. Then, second tier companies were lining up for their moment in the IPO sunshine. Seeing a string of post-IPO stock run-ups, the individual investors got into the action, creating demand for these second wave of IPOs. However, unlike institutional players, individual investors are quite fickle and move in and out of stocks frequently. Moreover, the second tier of companies going public did not demonstrate the same consistent financial performance as their earlier brethren. As a result, this second wave of IPOs did not experience quite the upside in stock valuations as the initial wave. Suddenly, the IPO market took a significant breather.
Where will we go now? In my view, the IPO market has reached an equilibrium, where companies maturing in the normal course will reach the IPO stage. They will be filtered by institutional investors who continue to seek higher return – and higher risk – investment opportunities, albeit at a more moderate rate. So, IPOs will continue, but at a less feverish pace.
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