The IPO drought could end soon—if these factors convergeFebruary 24, 2023
When these factors converge, the return to public listings will likely be swift and explosive—when that may happen depends on who you ask.
For now, tumbleweeds continue to blow through the NYSE.
"You've got to stop saying that, Jessica—that the IPO window is closed," David Ethridge, US IPO services leader at PwC, said to me in a call last week. "The market isn't closed. It's just difficult."
He's right: It's not closed—it's slightly ajar. Activity has picked up a bit this year with nine US PE- and VC-backed IPOs so far, up from Q4 2022's paltry five IPOs.
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IPO activity came to a virtual halt in 2022. By the fourth quarter, total US PE- and VC-backed IPO exit value hovered at $1.7 billion, a steep decline from Q4 2021's $171.1 billion—albeit it was an outlier year. Using a fairer comparison, this also marks a dramatic decline in IPO activity between 2019 and 2022, with total US PE- and VC-backed IPO exit value dropping by $211.4 billion and exit count falling from 120 to only 42 by the end of last year.
The few recent PE- and VC-backed public listings we've seen so far this year are much smaller than the exits we saw during the market's heyday. From 2018 to 2022, median US PE- and VC-backed IPO exit size dropped by over $300 million. So far in 2023, the median IPO size has climbed back up slightly, but the exits are still pretty small.
Healthcare companies Structure Therapeutics and Mineralys and insurance business Skyward Specialty Insurance are so far the only PE- and VC-backed IPOs sized above $100 million this year. Other companies like B2B shop MGO Global and B2C business 1606 hit the market at much smaller figures, $7.5 million and $800,000, respectively.
The challenging IPO market and small exit sizes are the products of a few factors:
- Macroeconomic volatility: With inflation, uncertainty about the future of interest rates and geopolitical turmoil, PE and VC firms aren't willing to let their pre-IPO assets go amid the chaos.
- Firms can't agree on valuations and pricing: It's a buyer's market, and the supply side is on strike. Asset managers don't want to let go of their trophy assets—strong companies they've held in their portfolio for a long time and have helped scale—in an environment where they won't get the biggest bang for their buck.
- The specter of recession: An impending and enduring recession is the most "vexing" ingredient for IPOs, Ethridge said. In a downturn, investors tend to stick with what they're comfortable with: businesses with a balance sheet strong enough to survive, according to Kyle Walters, associate PE analyst at PitchBook. This also means they move away from riskier, higher-growth options in IPOs.
So when will IPOs come back? While talking to sources for this piece, I heard just about every iteration of "no one has a crystal ball" known to industry jargon. But we do have economists, historical data and boatloads of well-documented speculative discussion.
Historically, IPO market recoveries have been more "V-shaped," meaning they don't stay down for long, Mark Schwartz, EY's IPO and SPAC capital markets advisory leader, told me. "Investors generally want IPO products," he added.
Late last year, Schwartz and EY's head of US equity capital markets, David Brown, put out a report that looked at three historical periods of heightened market volatility and the resulting IPO retrenchments and recoveries over the last quarter century.
In the early 2000s, the reverberations from the dot-com crash into the IPO market lasted about two years, with retrenchment in IPO activity starting in H1 2001 and recovery following in the second half of 2003. IPO retrenchment during the global financial crisis lasted around 18 months. In 2009, government interference with fiscal and monetary policies helped rebuild the public markets, and the US IPO market came back to life by the second half of the year. The COVID-19 pandemic's retrenchment period lasted only six months and its recovery took only three, and was then followed by the most active IPO market in the past two decades.
The ongoing decline in IPO activity has lasted about a year. Some industry figures anticipate the recovery period will begin in the second half of 2023, while others, like Nash Waterman, Morgan Stanley's head of PE secondaries, don't expect IPOs to return to their full glory for years to come.
"This is the third [market] cycle in my career, fifth in my life, and my view is that the IPO market is not opening up in any material way in the foreseeable future," Waterman told me. "I think it's going to take not months, but years, for it to come back."
Whether it's six months or six years, a few (or all) of the stars need to align for IPOs to round out their comeback story. For one thing, the macroeconomic environment needs to recover. There is a positive correlation between public stock market performance and public listings, so if stocks climb back up, so will IPO activity.
Also, buyers and sellers need to come to a pricing agreement. In short, sellers will have to make concessions, but this is unlikely.
"The buy-side is wearing the pants right now, and that will continue," Ethridge said.
A final factor is for a game-changer company to come onto the scene. For example, a company goes public, prompting similar competitors to flock to the public market. Ethridge said he's been eyeing a promising tech company for the role.
Featured image by Jenna O'Malley/PitchBook News
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