“De-equitisation” is a topic we’ve discussed regularly at MoneyWeek in recent years.
It refers to the phenomenon whereby companies – particularly in America – have shunned joining the stockmarket in favour of raising money privately from venture capitalists, or just borrowing it.
It’s not ideal, because it means that access for ordinary investors (ie, the likes of you and me) to the “hottest” companies is made even trickier than it already is.
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The good news is that this trend changed last year.
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The bad news is that this might spell tricky times ahead for equity markets.
Going public is popular again
US IPOs (initial public offerings – when a company sells its shares on the stock market for the first time) have had a record-breaking year in 2021.
As Luisa Beltran notes in US financial paper Barron’s, 2021’s “new issues market will go down in the record books as the busiest ever, outpacing even the go-go days of the 1990s dotcom boom.”
According to data provider Dealogic, at the tail-end of December more than 1,000 companies had listed, raising $315.6bn. That’s the most seen since Dealogic’s records began in 1995.
Now it’s worth noting that Spacs – cash shells – accounted for the majority of that figure. But the number of “traditional” IPOs still hit record levels, with nearly 400 companies raising over $150bn in total. In terms of the number of companies, that’s the most since 2000. And in terms of value, it’s the most ever, beating the record of $108bn set in 1999.
This excitement over new listings is not limited to the US. It’s a global phenomenon, with total equity issuance up 24% on last year, at more than $1.4trn, reports the FT.
What’s even more interesting is that the US equity market actually grew last year. As Corrie Driebusch noted in The Wall Street Journal back in November, “the number of publicly listed companies in the US rose above 4,000 for the first time in more than a decade”.
In other words, it’s boom time. Or at least, it is in terms of the number of deals done.
However, if you look at performance, we’re a long way from the heady days of 1999 and stocks acting like cryptocurrencies (not that crypto was a thing back then).
During the tech bubble, IPOs saw spectacular returns (though a lot of them collapsed not long after). In 2021, however, things were rather less frenzied. In fact, two-thirds of 2021 IPOs in the US are now trading below their listing value, notes a recent article in The Wall Street Journal.
So what’s going on?
The two factors holding back IPO performance
The Wall Street Journal argues that two main factors have been affecting IPO performance.
One is the point we’ve discussed on several occasions in the past – the “long duration” or “jam tomorrow” problem. This is the fact that many new listings are of companies which don’t make profits now, but hope to make a huge pile of money in the future. As interest rates rise, the appeal of this future pile of money diminishes compared to smaller but more certain pots of money that don’t require a great deal of faith from investors.
That’s one factor. The other is pure supply and demand. When equity markets go up, and valuations of stocks rise, it becomes more appealing (and easier) to list them. Demand is high, so why not give people what they want?
This has been given added impetus by rising valuations in private markets. This might be the age of the unicorn (the $1bn unlisted company) but even the biggest private market buyers eventually reach a limit and balk at shelling out even more for arguably already overvalued companies. That’s when they turn to public markets instead.
As Eddie Molloy of Morgan Stanley put it to Corrie Driebush in the WSJ: “For a period of time, private equity and venture capital cannibalised the IPO market. But now it’s driving the IPO market.”
So on the one hand, you’ve got fear of rising interest rates. And on the other, you’ve got a rush to market as private owners look to offload.
It’s hard to see either factor going away next year. Interest rates might not rise by much (indeed I don’t think they will). But they will rise a bit, which makes a difference when they’re at such low levels.
Perhaps more importantly, inflation has an impact on the future value of money too. Markets seem to be assuming that this doesn’t matter right now. But if that view changes – if investors decide that inflation might be stickier than they currently believe – then they might start using inflation as the discount rate instead of artificially low interest rates. In other words, they might start valuing their money based on inflation rather than opportunity cost.
Meanwhile, if sellers of private companies feel that the good times are approaching an end, they’ll be keener than ever to make for the exit door before it slams shut in their faces.
None of this is to say that we’ll be seeing a stockmarket crash imminently. But when you see record levels of deal-making it does tend to point to a market that’s closer to a top than to a bottom. If you’re interested in IPOs, then tread even more carefully than usual.
In fact, you might be better off eyeing up some private equity investment trusts given that they tend to be selling into this strength rather than buying from it. My colleague Max took a look at some promising options in the Christmas issue of MoneyWeek. If you’re not already a subscriber, get your first six issues free here.
