IPOs and Index Inclusion - Kailash Concepts

Introduction: Is the New IPO Boom Really Improved?
The Atypical Nature of Current IPO Index Inclusions
Price to Sales = Problems
Simple Measures for Good Measure
More Rubble to Come
Conclusions

Introduction: Is the New IPO Boom Really Improved?

In our December 2018 paper Private vs. Public Markets Kailash highlighted the boom in Private Equity capital raising post an atypically long period of high returns in the asset class. The paper documented the elevated valuations of recent and potential acquisitions as well as the munificent market conditions for selling via IPO. Worth noting again, in Fig. 6 of that paper we highlighted work from Jay Ritter showing that the percent of money losing IPOs had eclipsed the level seen at the prior peak of 2000. Our conclusion then was that we believed IPO valuations represented a prime opportunity for PE firms to liquidate aging portfolio firms but asserted that these liquidity events in public markets might be suboptimal for buyers of these IPOs. Our concern stemmed from extensive external research that private market valuations were stretched and that a “…stampede of Unicorns” might trample naïve investors.

With that in mind and recognizing that over half of US stock fund assets are now controlled by index funds¹ we began to research the historical returns of IPO additions to indices. Our concern stems from the fact that this historic shift in assets to index products is coincidental with record valuations as documented in Better a Seller than a Buyer Be?. These unforgiving valuations are exacerbated by an influx of atypically large IPOs listings at stratospheric valuations that will inevitably end up in various index products.

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At the tail end of this research Barron’s published a cover story about “Piping Hot IPOs” with the internal article titled “THE NEW – AND IMPROVED – IPO BOOM, The surge of new stocks reflects a shift in how companies are created and investors’ insatiable hunger for growth stories.”² Kailash found the article fascinating and a fantastic precursor to our research. In the interest of brevity, bullets 1 through 6 below synopsizes what Kailash believes were the article’s primary points about today’s IPO boom vs. the disastrous ones at the peak of the internet bubble:

2019 could break the IPO capital raising record set in 2000
Despite noting numerous analogs between today and the 2000 IPO boom, the current period is not nearly as dangerous because today’s boom “…reflects a shift in the way that investors and entrepreneurs approach company creation…” and “…the IPO market has simply grown up.”
Evidence for this can be seen in the fact that “…the median age of tech companies going public in 1999 was four; last year, it was 12” and “…having been burned in the bubble years by IPOs…investors have tightened their standards…” and “now want established businesses with substantial revenue and high growth…” but “…most members of the recent class are not profitable.”
The “…average listing-day return for [IPOs] this year is at the highest since 2000.”
Due to the $628 billion invested in venture deals over the last 10 years “Many new issuers have been in business for a decade or more” and there are “…362 companies…with private-market valuations of more than $1 billion, with 18 worth $10 billion plus…” and “…at some point, almost all of them will seek liquidity.”
There is a “…striking new way to think about valuing growth…” as “…many companies [are] trading at 25 to 30 times projected current-year revenue. Not earnings – revenue. In fact few are profitable.”

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ADDITIONAL READING

The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.

Disclaimer

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