Wall Street's self-inflicted IPO woe

The army of New York investment bankers charged with generating huge profits on initial public offerings last night buried their heads in their hands – they faced a ‘perfect storm'.

According to The Wall Street Journal, Goldman Sachs analysts had just recommended that clients establish short positions in the S&P 500, setting a targeted market decline of 4 per cent lower than the levels seen a few hours before last night's US market close.

Goldman believes that the US economic decline is accelerating as enterprises prepare for the huge spending cuts scheduled for next year (America's very own Greek crisis, June 10).

And the big fall in oil and copper prices underline that the US problems have had a global effect as speculators sell out and go short.

But in US IPO land the problem is much deeper than a simple fall in the market. Just as the inflated Myer priced float evaporated Australian investors' appetites for IPOs, so Facebook has had a similar devastating effect on the American IPO market.

Next week, Wall Street investment banks and advisory firms will be watching to see if they will have to pencil in June 2012 as the worst month for IPOs in the last 40 years. There's been not a single float to speak of for the whole month.

With the IPO market effectively closed it means that the big, well-capitalised American companies are now more likely to take over smaller companies hoping to enter their next growth stage.

The IPO perfect storm has been created by a combination of short- and long-term diseases.

The short-term disease is, of course, the aftermath of the failed Facebook float. The social network's shares had lost about 34 per cent of their value after the disrupted float on May 18 and the entire IPO market has gone quiet since then.

Not a single company has floated in the month since Mark Zuckerberg ‘virtually' rang the opening bell from the social network's headquarters in Melno Park, California. So while journalists like to focus on the concept that the US will go a calendar month without an IPO, Wall Street has already gone 34 days without one.

This is particularly significant because the US market had previously shown a remarkable resistance to poor IPOs from the tech sector.

Daily-deals website Groupon is down a disastrous 60 per cent, market leading mobile gaming company Zynga has shed 39 per cent and tearaway review app company Yelp has lost 15 per cent.
But despite the track record, the appetite for tech floats had seemed inexhaustible. That is, until Facebook exhausted it.

While the first few days and weeks after a float is what defines whether an offering is overpriced, longer-term underperformance, particularly from well-branded companies, weighs on market appetite for IPOs.

And so back in Australia, Myer shares yesterday hit their lowest point since the float, 55 per cent beneath the issue price – the Myer shadow is still casting its shadow over our IPO market.

Additionally, the decision by TPG Capital to take its winnings to the Cayman Islands, while unrelated to Myer's performance as a company, simply reinforced the perception that the IPO playing board is stacked against the buyer.

The same unease was kindled in the US by news that, following a call with Facebook executives just before the float, Morgan Stanley started advising clients to wind back their growth expectations for Facebook. Again, the subsequent poor share price performance doesn't give potential buyers much confidence when the next IPO comes along.

Facebook's share price has begun to recover, but it's still 16 per cent below the issue price. Until last night's big falls on Wall Street there have been tentative signs that tech companies could be preparing to retry the IPO market, but on a much more modest scale.

Enterprise software maker ServiceNow has reportedly set itself up for an IPO next week. But it's only expected to raise a very modest $186 million. Another company said to be thinking about floating is Exa Corp, which develops driving simulation products. It's looking at a $75 million float.

These numbers are tiny, particularly for a market that's as enormous as the US. And the equally paltry float ambitions in other sectors brings us to the long-term environment that the American IPO market is grappling with – ongoing uncertainty and volatility.

Since April last year the VIX, or 'fear' index (the Chicago Board Options Exchange Market Volatility Index), had two distinct episodes where it has breached the 40-point barrier. Given that when the VIX fear level reaches 30-points it is considered by many to be panic territory this is a dangerous pointer. Both of these fear peaks have been brought about by Europe – Greece, specifically. But now the US economy is adding an extra dimension to Europe.

The ongoing debacle in Europe plus the US problems are therefore making it harder for up-and-coming American companies to secure capital in the most efficient manner.

According to research reported by Reuters, just 27 companies have floated in the US this quarter. That's 36 per cent lower than the same period last year, which itself was a poor result (and it should be noted that the Greek political crisis of 2011 came during the third quarter of last year).

When you're relying on private investors, capital comes at an extra cost. It's commonsense. The more exclusive the pool of providers of capital, the greater the expected return.

Australia's IPO market is in a similar funk. The relative strength of our economy isn't enough to overcome our small comparative investment pool and market uncertainty from Europe – and Canberra.

But as a plethora of market onlookers in the US have suggested, 'it only takes one'. One big, successful float, that is, to reignite the market.

Back in Australia, all eyes are on the planned float of TRUenergy, owned by Hong Kong's CLP Holdings. While CLP has appointed advisers, nothing is likely to happen until deep into the second half of this year.

So like American investors, we wait.

Alexander Liddington-Cox is Business Spectator's North America correspondent.