2022 has been a dismal year for initial public offerings (IPOs). And I think that’s a good thing.
Generally speaking, the fall months are supposed to be the busiest time in the finance world, with a flurry of new offerings, mergers & acquisitions, and debt raises. But this year has been anything but. IPO volume fell to $1.6 billion in October, marking a 95% year-over-over decline and the weakest showing since 2011. M&A performance was not much better, with total deals plummeting 43% to $219 billion (for September and October).1
This sizable decline in fundraising marks a dramatic shift from 2021 when IPOs (including SPACs) raised over $300 billion, which was almost double the previous record set…the year before. Private equity also saw massive capital flows, with investors pouring $93 billion into early-stage and ‘seed-stage’ startups.
We know now that many of these companies didn’t do well or outright failed. In the traditional IPO world, of the 384 companies that went public in 2021, 255 ended the year trading below their offer price.2 In the private markets, we saw investors sometimes pouring millions of dollars into companies that didn’t even have a product or a staff – just a big idea. Remember when investors were paying millions for highly speculative digital art, or NFTs? Also consider the state of the cryptocurrency markets today, when a bankruptcy headline is a daily occurrence.
The fact that froth is being drained from the markets is a good thing, in my view. Excess liquidity in the markets kept moving investors further onto the risk curve in hopes of bigger returns, and any time that happens, there is usually a reckoning waiting at the other end. We’re seeing that now in the form of a capital drain for companies with negative cash flow, and at the riskiest end of the curve, in the form of bankruptcies, debt defaults, and an implosion of the crypto markets.
By some estimates, we could see some 2,000 credit-rating downgrades and hundreds of junk bond defaults in the 2023-2024 credit cycle. The highest that missed junk-debt payments have ever reached is $200 billion in 2008 and 2009, and I believe that record will be broken since so much new junk debt was issued in the heyday following the pandemic.
To understand why I think debt defaults and rising caution in the IPO markets are a good thing, an investor simply needs to think back to the 2000 – 2002 tech bubble and the 2008 Global Financial Crisis. Investors were overpaying for startups in 1999 and 2000 like they were in 2021, and the IPO market in the second half of 2008 and the first half of 2009 was among the worst in history. Proceeds from IPOs were less than $1 billion from July 2008 to March 2009, a dismal figure just like we’re seeing today. But remember what else happened in March 2009 – a big new bull market was entering its first year.
Bottom Line for Investors
When investors see a flood of IPOs and billions of dollars flowing to speculative asset classes and startups with negative cash flow, the response unfortunately is not to run for the hills. Instead, investors can’t help feeling the ‘fear of missing out,’ which often lures even the most disciplined to get in on the action. Many end up making risky bets at just the wrong time, and as we’re seeing in the headlines today, the result can be heavy losses in the riskiest corners of the capital markets.
But when we start to see the opposite happen—i.e., enthusiasm for risky companies and asset classes dries up alongside investor capital – I tend to view it as the market washing out excesses, which oftentimes means that great companies are trading at attractive prices relative to expected future cash flows. To me, that’s bullish.
Disclosure
1 Wall Street Journal. November 6, 2022. https://www.wsj.com/articles/raising-money-on-wall-street-hasnt-been-this-hard-in-a-decade-11667730621
2 Nasdaq. 2022. https://www.nasdaq.com/articles/a-record-year-for-ipos-in-2021
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