Corporate Financing Analysis - US IPO Market On Fire As Drop Draws Ever Closer - 30 OCT 2017

With the ongoing melt-up in US stocks continuing to surprise, the current US IPO rally looks set to continue through to and past the 2017 year-end. In the process, we expect the rally to help record a strong increase in floats y-o-y, and potentially produce the busiest year for deals since 2014 in the process. Despite the short-term positive outlook, our core view remains that the current bull market run in US stock, and subsequently US floats cannot continue over the medium to long-term; as such, it is only a matter of time before sentiment in the market begins to sour. Mindful of this, we expect a steady flow of corporate boardrooms eyeing a potential listing to continue bringing their proposed deal timelines forward while investor optimism remains at a level not far from its highest level in over two decades - as evidenced by the CBOE Volatility 'fear gauge' VIX index's downward retreat, as seen over the past few months. BMI highlights, however, that a number of warning shots have already begun to be fired - including in the VIX index itself, which has started to show signs of volatility over the past week - that will remind issuers that the IPO window in the US will not remain open for much longer.

Fewer Deals Being Shelved
Global Withdrawn IPO Activity By Deal Value, USDmn
Source: Bloomberg , BMI

The Story So Far

According to data from Renaissance Capital (correct to October 20), completed US IPO deal volume is up by 33% y-o-y with 117 successful deals, completed deal value of floats has nearly double (up by 95.8%) y-o-y at USD27.8bn, and as many as 164 companies have filed for a public market listing so far this year - a 57.7% increase from the same stage last year. This all combines to put the US IPO market on track to surpass the USD30.5bn haul of floats recorded across the 2015 full-year period, having already outpaced the paltry tally of USD18.8bn in floats that listed in 2016. Such bullish data confirms our positive view of the current bull run's likely continuation through to the year-end ( s ee ' US IPO Momentum To Continue Accelerating In H217 ' , July 12 2017), thanks to the extended positive environment in the equity capital markets (ecm) arena - a run that seemed unlikely back at the start of the year ( see ' US IPO Market Open For Business In H117 ' , December 21 2016).

In Good Health?

Across 2017 the spread of sectors which have contributed deals has been broad based, a factor which has likely served to help the current rally run longer than many would have predicted. Within this, it is the healthcare sector which has come out on top, having contributed 30% of all deals by total value this year, ahead of the tech sector's 22% share of the market, and the financial sector's third spot effort of 11% of deals by value. This hierarchy has played out in the most recent quarter too, with the healthcare sector contributing almost half of the value of US floats in Q317 - a trend driven by the size and steady growth of the US healthcare industry, which is always likely to provide ecm issuers looking for funds to support growth, while also attracting investors looking for a strong return. Within this, we point to biotech firms continuing to go public with the support of heavy insider buying as key to this success ( see ' US Pharma IPO Potential In Good Health ' , September 19 2017).

What Goes Up, Must Come Down

With every day that passes, BMI believes that we are drawing closer to a turnaround in US equity market sentiment and IPO fortunes. As such, our view of the US IPO arena is altogether more bearish for 2018, with the downside risk in the market for new listings building. We caution that, from a medium-term perspective, extreme - near-record - valuations, sustained bullish sentiment, and extreme overbought price action all contribute to leaving US stocks open to extreme downside risks and that the market could lose its momentum as a result. In sum, we continue to believe that US stocks face among the worst risk-reward profiles in history from a multi-month perspective; this has left us with little choice but to expect a similar outcome to the speculative extremes of 2000 and 2008. To this end, one of the biggest warning shots has already been fired: after five consecutive quarters of growth in combined deal value on US exchanges between Q116 and Q217, the US IPO arena recorded a slowdown in listing activity in the third-quarter. Renaissance Capital data shows that listing activity slowed from USD10.6bn via 52 deals in the second quarter of 2017 (itself a two-year high for deals) to just USD4.1bn across 29 deals in the three-month window ending September 30 2017.

Warning Shots Fired

We highlight that this trend is akin to a warning of what lies ahead, rather than a sign that the impending bear market has already begun. This view is based on the fact that, while activity levels may be low, returns on successful floats still remain extremely high - a factor which will continue to lure potential issuers to market while the window for such deals still remains open. Indeed, Renaissance Capital data show that the average float in Q317 gained 35.7%, which marks a significant increase from an average of 11.2% in Q217 and the highest level of return for US floats since an average of 40.5% for Q316. In our view, this is an indicator that issuers are taking advantage of equities being at the peak of their rally - as evidenced by the Dow Jones Industrial Average (DJIA) passing through the 23,000 mark for the first time on record earlier this month. The story was the same for both first-day returns and the average aftermarket in Q317 too, with floats recording returns of 19.5% and 13.1% by these two measures, respectively. Furthermore, for both measures, this represented a significant increase q-o-q (up from 7.9% for first-day pops and 3.3% for aftermarket returns) and the highest level of returns since the third quarter of 2016.

While many of the headlines which feature IPO figures still presenting positive reading, we highlight that there are other red flags emerging too. We point to the fact that the percentage of US floats that have priced below their range increased - albeit marginally - for the second consecutive quarter in Q317 to a level of 27.6%. We also highlight that the percentage of deals which have endured negative first-day returns has also left up over the period spanning Q217 to Q317, to a level of 31.0% (compared with 20.0% as recently as in Q117). Moreover, Q317 did not even come close to seeing a deal that tapped ecm investors for as much as USD1.0bn. In fact, the largest deal of the quarter only raised just over half that value: the USD508mn float from materials firm PQ Group Holdings on September 18 2017 - a deal which found itself underwater by 1.4% in the one-day aftermarket. In fact, the ten largest deals, combined, raised a collective USD2.7bn - a figure down by 38% from the previous quarter and 28% less than the proceeds raised by the ten largest floats in the third quarter of 2016 - Renaissance Capital data show.

Window Still Open (For Now)

While our core view is of an equities and IPO downturn in US floats early next year, we do not expect the US IPO window to slam altogether. Instead, we expect to see investors become gradually pickier towards which deals they choose to to support as aftermarket performances begin to stutter. One indicator which suggests that the IPO rally has further to run, and will not suddenly drop off a cliff, is the volume of shelved listings. Indeed, as y-t-d Bloomberg data show, there have been as few as 97 potential floats worth a combined USD4,131.2mn which have been postponed, or cancelled, thus far in 2017. This ranks as the lowest tally of withdrawn deals this side of the year 2000 and represents a sharp drop off from the USD60,310.2mn across 412 pulled deals recorded across 2016 and the recent highs of failed transactions recorded by deal value in 2015 - USD88,250.8mn across 591 IPOs - and by deal volume in 2014 - 1,399 shelved deals worth USD58,475.8mn. Furthermore, despite the gloomy outlook for US stocks, we cannot ignore the potential for a further spike, particularly in the tech and financial sectors, which could see the major indicies continue to post new highs. We also believe that energy, tech, and financial stocks are set to outperform, even as the overall market tops out.