Recent macro data offers little help for an equity market recovery
At the September Federal Open Market Committee (FOMC) meeting, Fed Chairman Jerome Powell’s comments hinted at the possibility of one or more Fed funds rate increases in 2023 and ultimately “higher rates for longer.” The shift to a more hawkish stance and its impact on broader market sentiment made it difficult to (1) draw deeper conclusions about the initial wave of post-Labor Day IPOs and, more broadly, (2) evaluate the true state of the new issue market. Additionally, the depressed performance of US equities in September (S&P traded down 5%, representing the worst-performing month of the year) did little to support aftermarket performance for these IPOs. The three high-profile technology IPOs traded at or below issue price within the first few weeks of pricing, despite substantial demand and oversubscription during marketing, suggesting that support for equities in general and specifically new issues was wavering.
In mid-October, economic data for September was released, revealing higher-than-expected Consumer Price Index figures and the largest monthly increase in employment since January 2023.¹ These data points showcased the resilience of the economy and labor market, which has helped to keep consumer spending strong. However, despite this “positive” macro news, the equity market read-through was the data would keep rates elevated for longer, as it suggested inflationary pressures in the economy would persist. As a result, risk assets experienced a sell-off, with the Russell 2000 and small-cap growth stocks leading the decline.² These stocks, which are typically more leveraged and with outsized exposure to economic fluctuations, face additional headwinds that certainly could impact potential IPO issuer supply. Most recently, an October gauge of consumer sentiment dropped to its lowest level since May. The combination of challenging economic data, depressed equity markets and lackluster performance out of the new IPO class is certain to impact the IPO calendar into year-end and in the first quarter of 2024.
Looking ahead
While macroeconomic data and the aftermarket performance of recently priced transactions will influence, other factors will play a key role in driving supply going forward, including:
Prevailing public and private market valuations
Valuation levels are the primary driver for equity deal activity across cycles, and as such, improved valuations would certainly drive deal activity. A down cycle for multiples has and will likely continue to impact deal volumes. Businesses in sectors that are unlikely to reclaim peak valuations soon may be more inclined to push through and transact despite the valuation backdrop. When valuations are lower, deals tend to be smaller to minimize the dilutive impact and drive the supply/demand balance in the marketing process.
Capital needs
Not all growth businesses can wait for ideal market conditions to solidify ahead of capitalization decisions. Companies that raised capital 2–3 years ago in a historically low interest rate environment may need to explore funding alternatives, including the traditional IPO route. Turning to the public markets to fund growth initiatives, expand operations, fund acquisitions, repay debt and strengthen balance sheets is historically consistent with IPO deal drivers, and the capital-constrained environment over the past few years will likely require more companies to consider this path. Capital-intensive businesses with significant capex needs such as home builders, or serial equity issuers such as REITs, are subsectors that could help sustain IPO volumes going forward.
Investor/employee liquidity
Many companies and management teams use publicly traded stock and options issuance as a tool to reward, retain and compensate employees. Significant and attractive employee liquidity events are more difficult to conduct in the private market. Employees can become discouraged by the inability to monetize their stock, particularly when an IPO is perpetually delayed. Additionally, venture firms and financial sponsors have fiduciary obligations to their limited partners to return capital within a defined time/investment horizon. An IPO can facilitate both issues through the ability for employees and pre-IPO investors to sell shares and access liquidity through the public markets and can drive companies to push through less-than-ideal market conditions to get public.
The next significant IPO wave likely not arriving until ~2Q 2024
Now that 3Q 2023 is complete, the next tangible window for launching IPOs will open once issuers move past third quarter blackout periods and have insight into quarter and year-end financial information. Taking into account holiday slowdowns, the IPO window in 2023 is limited. The first quarter of 2024 is a narrow launch window and, thus, typically lighter in terms of IPO volumes due to audit staleness for calendar year-end companies in mid-February. If macro conditions become more constructive (including visibility on Fed rate peak and forward path) and the IPO market can support new issues, we could see a building pipeline post-2023 audit season into the back end of 1Q and 2Q 2024.
While Wall Street messaging on the prospect of 2023 IPOs has been unanimously bearish, we have consistently highlighted that sentiment can change quickly with potential drivers including a market uplift, visibility on an end to rate hikes (with a bias to cut), and positive pricing outcomes as IPOs come to market. During extended periods of favorable market conditions, IPOs came to market and traded relatively well. This emboldened larger, bellwether prospective IPO issuers that were in the pipeline to launch their transactions. As higher-profile IPOs garnered investor attention, more issuers considered moving forward with IPO plans. Recent market headwinds, driven by persistent inflation data, have countered this momentum.
There have been enough positive market data points over the past few months to encourage the next set of issuers in the shadow backlog to consider executing their deals in the next open window relevant to them. Companies with strong management teams, differentiated product offerings, competitive moat, strong financial positioning, and growth on the horizon should be able to navigate a route to the public markets if desired. The last 60–90 days of deal activity demonstrated that investors are not on “strike” and are willing to invest in the IPO asset class — for the right companies, at the right price. While the next substantive class of IPOs is probably 4–6 months away, if markets pick up over the next 6–8 weeks it will not surprise us if we see a spate of issuance both ahead of audit staleness in late January/early February or post audits in March/April.
Accordingly, our IPO-oriented client dialogue has increased over the past several months. With most projecting a volatile political and election cycle, the traditional September and November issuance windows in 2024 are likely to be impacted. Most companies are targeting 1H25 IPOs, with many considering preparations that could provide late 2024 IPO optionality if warranted.
As markets evolve, EY Capital Markets team can be impactful. Prospective issuers that dismissed the IPO track for the foreseeable future due to business and market conditions may now rekindle their thinking and approach Wall Street in an accelerated but practical manner. Preparing for these conversations and getting support across processes and workstreams could be valuable. Additionally, companies counting on the M&A market for an exit may find that an elevated rate environment impacts acquisition valuations in a way that makes incorporating a dual-track IPO path a sensible mechanic to increase optionality, pricing tension, and ultimately value to stakeholders. Please let us know if a discussion around any of these potential processes or market conditions would be well-timed and helpful.
