A tale of two IPO markets
31 October 2016
“The best of times…the worst of times”
Observers of current UK and European IPO market activity are understandably perplexed – on the one hand, we see some high profile deals failing to price and generating a slew of negative column inches in the financial press; on the other hand, a number of sizeable IPOs are carrying on, quietly pricing and trading up in the aftermarket. I thought it timely to set out a few thoughts and to try to make sense of this tale of two markets, and to do so in a way which provides some answers to our current frequently asked questions.
Is the IPO market closed?
The answer to that question, both in terms of deal volumes and sentiment, remains a clear “no” – the IPO market is still open. We should remind ourselves that over the past month alone eight IPOs over £50m have successfully priced in Europe, raising a total of £6.7bn. Some of these IPOs have required a high degree of effort and pragmatism to get over the line; but in many cases successful IPOs have been oversubscribed within a few days by high quality investors and traded up comfortably in the aftermarket. At present there are two sizeable IPOs in the market, the €500m IPO of DNA in Finland and the €200m IPO of Alain Afflelou in France. The UK’s smaller AIM market also continues to be active, with Van Elle pricing last week and Filta and FreeAgent both in the market this week.
Are market conditions making IPOs more difficult?
It’s a general rule of thumb that IPOs get done in periods when we see a combination of high equity market valuations and relatively low volatility – and in headline terms we currently have both of those. More broadly, the investment backdrop remains supportive, with investors continuing to search for compelling returns in a sustained low-interest rate environment.
But, of course, there are issues. Notwithstanding recent positive economic data, the big concern is around UK growth and to what degree that is impacted by Brexit – which of course has barely begun to take effect. That means investors are applying a higher degree of scepticism to earnings forecasts, and in particular finding reasons to discount equity stories which are heavily reliant on high growth.
What this translates to, therefore, is a materially higher degree of selectivity among investors, and an increasingly robust debate on valuations. Private equity backed companies have lately been subject to a higher degree of pushback than founder-owned businesses; though we are a long way from the stand-off which prevailed a few years ago.
What type of business can successfully IPO in this market?
The companies which can successfully IPO in this market are those where both the quality of the business is high; and where investors can readily see the evidence of that.
What are the factors which make for a high quality business? Perhaps firstly a demonstrably strong, sustainable and defensible market position – demonstrated by quality and differentiation of product, and breadth and depth of customer relationships. Secondly, a well-run business, with a long-standing and experienced management team and a disciplined approach to all elements of delivery. Thirdly, a demonstrable track record of strong and/or improving returns, whether measured by margins or RoCE. In a more selective market, financial discipline, and cash returns, become materially more important.
The key is to reduce or eliminate any ‘leap of faith’ required by the investor – a sustainable return on capital which benchmarks strongly to peers, coupled with very secure earnings growth, will likely get greater traction than a dazzling growth story which may look harder to deliver.
How should we approach the market?
There are two key observations from the deals which have been successful recently:
Build a bulletproof equity story. This means taking a very hard look at all aspects of the business plan and ensuring both that it stacks up and that there is the evidence to support it. It is vital for example, over and above financial disclosure, to ensure that you have an authentic and robust set of KPIs to support the story and allow for benchmarking to peers.
Allow for a meaningful period of investor education. Those businesses which have successfully priced their IPO have in some cases had several interactions with investors, starting with an introduction to the business and progressively disclosing more data and building a high degree of confidence in the quality and the delivery. If you plan to IPO in a year, or longer, the time to appoint advisers and start that process off is now.
In this tale of two IPO markets, it is a far, far better thing to prepare early, form a plan, identify and address the weaknesses, and allow a run-up to marketing; than simply to get into the bunker and risk losing the option to go to market.