An IPO, or Initial Public Offering, is when a company lists its shares on the stock market for the first time.
The UK IPO market boomed last year as vaccine launches added to optimism for a strong recovery in the economy. Accompanied by low borrowing costs and growing business confidence in the UK, the IPO market raised £16.8bn in 2021, the highest amount since 2007.
However, this year has provided us with a different economic environment. Multiple headwinds have affected the prospects for companies looking to go public, with many delaying their IPO until conditions improve.
To understand more about IPOs, We recently looked at the IPO process, how to invest, and what investors should be aware of..
This article is for people who understand the risks of investing in stocks, not personal advice. Investing in IPOs and individual companies is not suitable for everyone: it is a higher risk since your investment depends on the fate of that company.
All investments and any income they produce will go up and down in value, so you could incur losses. If a company goes bankrupt, it risks losing all of its investment. Investors should make sure they understand the companies they are investing in, the specific risks of the company, and ensure that any business they own is held as part of a diversified briefcase.
Increase in interest rates
Companies need a high valuation to justify an already costly IPO process. Higher valuations equate to more money raised at the IPO, a key reason to go public. One way to value a company is to predict future earnings and convert them into today’s money. Interest rates play a key role in this calculation.
Higher rates, as we’ve seen this year, mean future cash flows are worth less today. That translates to lower valuations, meaning the IPO process would raise less cash now than it did last year.
So, a decision has to be made. Stick with the original plan and raise less cash or put a larger portion of the business up for sale; Neither option is particularly attractive to the company seeking an IPO.
Low investor confidence?
The success of an IPO comes down to how much investors are willing to invest in the first place. The recent lackluster performance of the global economy has made investors more defensive in their stock selection, opting for companies with strong earnings here and now. But remember, it’s important to take a long-term approach when you invest.
Low investor confidence can affect a company’s decision to make an IPO as they weigh whether now is the right time to raise money through the public markets. Alternatively, they may decide to raise funds through the private marketplaces with the option to go public later.
Conflict in Ukraine
Timing is everything for an IPO, and the increased market volatility caused by the conflict in Ukraine has made it difficult to value a company that wants to go public.
This essentially put the IPO market on hold earlier in the year. With no clear signs of coming to an end, upcoming IPOs could continue to be shelved until the markets calm down and the outlook changes.
A closer look at the UK IPO market
Blockbuster initial public offerings on the UK stock market have been few and far between. Between 2015 and 2020, the UK accounted for just 5% of global IPOs. Aside from some high-profile names in 2021, the UK struggled to attract exciting growth companies. These are companies that are expected to grow faster than others, which could deliver above-average growth as measured by factors such as earnings, revenue or cash flow in the future.
Instead, companies are choosing to list on exchanges with a history of higher valuations and deeper cash pools, such as in the US. This has not been helped by Brexit, where leaving the EU cast doubt on the The UK’s longstanding status as a global financial center of the world.
In fact, the UK IPO market is on track for its worst first-half performance since 2009, raising just over $800 million so far this year. This reflects the global IPO market as a whole, which has seen a dramatic slowdown so far in 2022.
UK IPO Market: H1 IPO Proceedings ($ Billions)
Source: Bloomberg, 05/30/22.
Nearly two-thirds of UK companies that went public in 2021 are now worth less than their IPO price. This is perhaps the main reason companies are avoiding the UK market: a string of poor results does not bode well for business founders.
There are other factors contributing to this drop in IPO activity. The recent departure of Prime Minister Boris Johnson has clouded the UK’s economic outlook with uncertainty. Until a new leader is decided, the IPO market could remain disappointing.
Changes in the UK IPO market
The decline in IPOs has not gone unnoticed by the Financial Conduct Authority (FCA), the UK’s financial regulator. A new plan launched at the end of 2021 has simplified IPO rules to attract more companies, something not done since the 1980s.
The new changes allow companies to sell a minimum 10% stake to the market, well below the previous 25% imposed by regulators. This offers an attractive proposition for founders, who typically own a decent chunk of the company alongside early-stage investors. By having more control over how much they sell to the market, founders have more options to choose from when going public.
Another key approach focuses on simplifying the two-tier listing structure. Previously, a company could go public through a ‘premium’ or ‘standard’ listing. The premium carries the highest level of regulatory requirements and allows inclusions in the FTSE index, a luxury that the “standard” listing does not have.
The new simplified version allows companies to list under a minimum set of requirements, leaving the decision to shareholders whether they want the company to opt for an additional set of obligations.
The success of this plan remains to be seen and the competition to attract businesses is heating up. Once the global IPO market starts to recover, a key indicator for success will be based on how much money the UK can attract relative to its European and US counterparts.
What this means for investors
IPOs provide a great source of opportunity for investors and more and more IPOs are becoming accessible for retail investors to get involved with.
With blockbuster IPOs still on hold in the first half of 2022, the pipeline for future IPOs looks solid. If economies gain a dominant foothold in runaway inflation and a recovery looks more promising, this could pave the way for more companies to go public in the future.
If you want to keep up to date with upcoming IPOs, you can subscribe to our email alerts.
However, investing in IPOs carries risks, and the media attention will add to the hype as the company gets closer to listing day. It is important to do a lot of research about the company and its competitors. This means reading the company’s prospectus to understand its financial records, projections for the future, and a summary of risks. It is the most useful tool to decide whether to invest or not.
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