The IPO (initial public offering) market is a good barometer of investor sentiment. IPOs require healthy investor appetite, so IPO activity highlights what sectors are hot and, more broadly, follows the ebb and flow of the market cycle.
In 2019, IPO activity in Australia has been noticeably sluggish: the number of IPOs and dollars raised is significantly down on last year and sits around decade lows.
Many of the IPOs earlier in the year were of small-cap tech companies like Splitit and Sezzle that delivered big returns for investors. This has clearly been the hot sector this year, albeit with signs more recently of cooling.
Nowadays, debt is all the rage. Recent months have seen a majority of new listings comprising mortgage trusts, credit funds, debt funds, global income funds, and even UK banks’ bond issues. Clearly, investors are hungry for what they see as safe yield.
Importantly, these debt listings have done well in the after-market, with most trading at a premium to their listing price and underlying value.
The risk is that investors do not fully appreciate the risks of these new listings – as resident bond expert Christopher Joye has explained – and that issuers possibly begin to push the boundary on credit quality, liquidity and other risks.
As a sign of how the cycle can play out, most of the slew of listed investment companies floated by equity fund managers in recent years now trade at decent discounts to underlying values. Investor appetite has clearly waned.
Elsewhere, a number of IPOs have been pulled in recent months in a sure sign of investor push-back. Examples include Latitute, PropertyGuru, Retail Zoo and Onsite Rental Group. Indeed, 2019 has been the worst year in a decade in terms of the value of pulled IPOs.
All of this suggests a level of investor scepticism that is actually a healthy sign for equity markets.
A common theme of these pulled IPOs was private equity cashing out. Around the same time, Prospa, Damstra, Viva Leisure and Mader Group successfully floated in industries and with similar pitches to those pulled. In general, they were founder-led businesses looking to an IPO as a means to raise money to fund their growth – that is, more noble intentions than simply maximising an exit price.
The scepticism towards private equity IPOs is understandable. There have been some successes over the years, but investors’ perceptions have been shaped by the likes of Myer, Dick Smith and other duds. One has to question whether their mandates allow them the generosity to leave much on the table for new investors.
Prospa succeeded despite its private equity backing, although the private equity firms didn’t sell down. As it turns out, investors shouldn’t have been so supportive. The company downgraded prospectus numbers, which shook investor confidence and saw its share price almost halve.
Opportunities in demergers
Investors are more likely to win from an IPO in which maximising the exit price is not the sole motivating factor.
A topical example is a demerger, which involves separating out a non-core subsidiary in a new ASX listing. Normally, no additional funds are raised – the shareholders remain the same as before – and this means there is less incentive to talk up the new listing. Mostly, it is about improving managerial focus and transparency, and allowing investors to distinguish between different businesses.
While it hasn’t been all one way, demergers have been a rich source of opportunity for Australian investors, with recent examples including Treasury Wine Estates and IDP Education.
In the early days, the demerged entity comes under selling pressure as shareholders re-assess their investment in the new entity, which is usually quite a different proposition. And then, as research shows, the demerged entity generally outperforms quite materially.
In recent years, there has been activist impetus for demergers to release trapped value. These efforts have had success: Graincorp has announced a demerger of its malts business, Iluka is looking at a demerger of its lucrative iron ore royalty, and Cardno has just demerged Intega Group.
Woolworths is also planning to demerge its Endeavour pubs and drinks business, following the successful demerger by Wesfarmers of Coles Group.
Investor appetite for IPOs suffers with disappointments like Prospa, which can sometimes even mark the end of an IPO cycle. As it is today, the IPO market certainly remains open, but IPOs will need to be of quality, well priced, and come with good intentions. Investors are advised to pay particular intention to the latter before they participate.
Julian Beaumont is the investment director of Bennelong Australian Equity Partners.
