Markets Insight

November 28, 2012 5:27 pm

Post-crisis flaws to blame for IPO slump

The decline may result from deeper changes in financial markets’ functioning

If you want to know whether capitalism is alive and kicking, watch company share launches. Initial public offerings allow investors to profit from business success stories, provide finance for job creation and economic growth, and reinvigorate global equities markets.

The latest news is not encouraging. Wednesday’s $1.7bn London debut of Megafon showed European equity capital markets still have a heartbeat. But the poor reception for the Russian mobile phone operator’s shares, which fell below the offer price soon after trading started, will only fuel fears that the runaway IPO success has become an endangered species.

Global IPO volumes have fallen this year to levels scarcely better than in 2008 and 2009, when the world economy reeled from the collapse of Lehman Brothers investment bank. Even in a weak market, Europe is underperforming, accounting for just 11 per cent of global IPO proceeds so far this year. That is less than half last year’s proportion, Thomson Reuters data show. The result has been soul-searching among banks and stock exchanges. The future of the IPO is not just about how well capital markets are functioning. At stake is the sustainability of banks’ equity markets departments, which depend on IPOs spinning off other business but face severe competition in a shrinking industry.

If the cause was simply the poor economic climate, there would be less concern: we could just await the turnround. The particular weakness of the European IPO market suggests this is at least part of the explanation; the continent is lagging behind the US in producing any kind of economic recovery. When European companies have had international growth stories to tell, the temptation is to list elsewhere. Prada, the Italian luxury goods group, listed last year in Hong Kong.

The danger, however, is that the IPO slump is the result of deeper changes in financial markets’ functioning in a post-crisis world.

IPOs have a seriously tarnished reputation. The impression is of IPOs being about existing owners cashing in. Investors have been sold short, with prices pitched too high and insufficient attention to ensuring a profitable after-market. Facebook’s jinked US IPO is etched in investor’s minds globally; the social network’s shares are still a third below May’s $38 listing price.

Of the main share listings in London since the start of 2010, more than half are trading below the issue price, according to figures compiled by Deloitte. “The days are over when something was left on the table, and both bankers and investors took a longer term view. We are in a different world,” says Paul Woolley, senior fellow at the London School of Economics.

Not just investment bankers are to blame. Investors are accused of expecting an excessive short-term pop. Continental Europeans, wary of the pressures of capital markets, have hang-ups about slashing prices to get an IPO away.

But participants in the IPO market react to incentives. Macroeconomic uncertainty in an era of historically low interest rates has encouraged short-termism. Passive, index-tracking investment strategies have dulled pricing mechanisms. Computerised high-frequency trading could have convinced potential investors that the system is gamed against them by eating away at profit opportunities and liquidity. “It is as if we have unleashed flesh eating bacteria on the market,” says David Weild, equity market specialist at Grant Thornton. “The flesh is the broker-dealer intermediaries who were supporting growth businesses.”

At the same time investors have been encouraged by the apparent “death of equities” to shift into bonds. While banks’ equity market divisions scramble for business, their corporate bond departments are enjoying a renaissance. With bond issuance there is no need to build a relationship between issuers and investors. Everyone knows the game is about securing funding at the lowest possible price. But bonds cannot substitute for equities in corporate financing.

IPOs require marketing and a story about the future. They are about taking ownership. To help revive the IPO market, the US has taken steps to loosen procedures, especially for start-up companies, and the UK is taking similar steps. The past year has also seen banks rethinking their approach to IPOs by creating investor “fan clubs” earlier, re-examining fee structures, selling smaller chunks and tightening timetables. The aim is to rebuild trust. “When you invite new people into your house, you want to be nice to them,” says one IPO veteran. Encouragingly, IPO volumes have accelerated modestly in the past few month – with Megafon part of that trend. But a longer-term revival will require more than just bankers being a little nicer.

ralph.atkins@ft.com

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