What Does the IPO Surge Say?

Wall Street was abuzz for a while last month about a new stock offering.  Rivian, listed its shares on a public exchange for the first time.  Founded in 2009, it delivered its first electric vehicle last month.  The company’s initial public offering (IPO) was the biggest since Alibaba’s 2014 listing.  Investors moved the NASDAQ exchange with purchase orders.  They certainly have an appetite for electric vehicle manufacturers, a fact to which the sky-high valuation of Tesla testifies. But as the patterns of the last few months have made clear, that appetite is broader based than just green automotive ventures.  This year has seen a flood of private companies list on exchanges for the first time, most met with almost as much enthusiasm as Rivian’s IPO.

The activity and the greeting shown by investors would seem to carry two seemingly contradictory aspects of business thinking and signals about the future. 

On the one hand, it speaks to business optimism, about the economy and future profits shared by both the listing companies and those buying their offerings.  On the other hand, it signals a belief among managements that stocks today are pricey enough to give listing companies more for their shares than an internal assessment might put their worth. Certainly, firms would not readily list if they thought the reverse were true.

Available figures are staggering to say the least. The eight months through August saw almost 280 IPOs on major exchanges in this country.

If this pace keeps up during the remaining months of the year, some 420 IPOs will have taken place in 2021, almost twice last year’s number.

And barring some major economic or market setback, it looks as though the pace will hold. An informal count among financial people turned up at least 100 companies that have either announced their intention to float an IPO before December or have indicated an interest in doing so. What makes the outpouring that much more remarkable is that none of these figures include the SPAC IPOs.  These, according to an accounting done by SPAC Research, amount to some 473 so far this year, already some 70% higher than all of 2020. 

There can be no denying the optimism implicit in this flow.  Managements raise money in this way because they think the funds can be well deployed in a future, profitable expansion. They certainly do not raise capital on such a grand scale to let it sit idle, especially with inflation now rapidly eroding the real value of money. And with interest rates and bond yields as low as they are, nor are company managements likely to raise equity capital to put into accounts or store in fixed-income investments. The only reason managements would go through the time and expense to raise this capital is because they see it financing that profitable expansion in their company’s business. Each firm, of course, makes its own decisions about its particular products  in its own economic niche, but taken across all this IPO activity, the outpouring suggests the kind of general confidence that fosters real investment in capital goods and productive facilities, all of which drives the overall level of economic activity upward.

The valuation question casts a less welcome shadow over this evident optimism. If the listing decision reflects a positive assessment of long-term opportunities for deploying the equity capital, the IPO’s timing can reflect a wary assessment of market valuations. If management determines that market levels are high, higher perhaps than fundamental internal assessments of the company’s value, they will see an opportunity to raise more than they otherwise could and so rush the IPO.  If enough companies make the same assessments, they will crowd a year with IPOs, as 2021 is. And this year’s outpouring of IPOs surely does also include an implicit vote by diverse managements that stock market prices might have risen above levels that a hard-headed assessment of reality could support.  

Such judgements may have missed some considerations. It could be that the relative valuations only apply to the lisitng companies and perhaps those in similar lines of business. Perhaps those taking the view that market valuations are high have failed to consider certain macro considerations, for instance the commitment by the Federal Reserve (Fed) to continue pouring liquidity on markets despite the increasing inflationary pressure. The IPOs then do not assure market participants of an imminent market correction. But they, nonetheless, offer investors yet another important input when assessing whether the stock market rally can continue unabated.

There are no assurances one way or the other. There never are.

What the IPO flood reveals is that a large and diverse group of presumably savvy business people see a bright economic future and a market that might be pricing itself for something even brighter than the reality they see. It is a view that investors need to consider and one to which the flood of IPOs has called attention.

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