Equity capital markets update Early 2018 IPO activity and market outlook. March 26, 2018

Transcription

1 Equity capital markets update Early 18 IPO activity and market outlook

2 Executive summary The early 18 IPO market benefited from broadly positive market sentiment after the passage of the Tax Cuts and Jobs Act in late December The S&P 500 was up 5.4% in January, with 18 of 27 trading days in positive territory IPO issuance from January 1 to February 14, 18 (the window before 17 audits were required for December 31 year-end filers), totaled $10.1 billion from 22 issuers the highest volume over the past 10 years Primary observations: Issuers represented a broad range of sectors and market capitalizations, and chose to execute during this window despite the complexities of going public while closing year-end financials Pricing power remains balanced between issuers and investors with about 60% of IPOs in 18 YTD pricing within the initially marketed range On an offer-to-current basis, 18 IPOs have outperformed the S&P 500 by a median of 7%, influenced by outsized outperformance from the biotech sector The market experienced a sell-off and spike in volatility in early February, largely driven by profit taking. For perspective, at their lowest point, the indices were still trading above their levels from Thanksgiving 17 Based on deal activity, diversification across issuer sectors and sizes, and our anecdotal view of the pipeline, we are optimistic with respect to near-to-medium term IPO issuance We are encouraged that a number of issuers have already priced in March, with filings indicating more are on the way Despite the early February spike in volatility, issuers were confident enough in the underlying fundamentals of their business and the market that they were willing to accelerate audit completion to access the market in March Primary risks to the IPO market include the ability of recent IPO issuers to meet or exceed quarterly financial expectations set at the time of their IPOs, equity fund outflows from mutual funds that drive IPO demand, and potential negative reactions to fiscal and monetary policy or geopolitical events The midterm congressional election will impact IPO timelines and activity in 4Q18, which may lead issuers to either accelerate or delay their targeted offering windows In the current environment, execution risk is heightened by the potential for crowded issuance windows, distracted/conflicted advisors and unpredictable exogenous shocks. Issuers can benefit from an independent perspective to help navigate the transaction process; EY s Equity Capital Markets team can tailor a distinctive value proposition to potential IPO issuers 2 P a g e

3 IPO activity off to a strong start in 18 The first few months of the calendar year can be a challenging time to evaluate IPO activity. December 31 fiscal year-end filers only have until mid-february to price their transactions. After this date, Form S-1 filings must include the most recent completed year s audited financials, which typically are not available until early-to-mid March at the earliest, often creating a largely dead period between mid-february and mid-to-late March. As we have noted in previous market commentaries, there are a variety of factors that can drive issuers away from targeting this early annual window, including: A desire to focus on closing books and completing audits Investor questions / financial disclosure around recently completed periods Higher underwriter diligence requirements 13 to 14 months post-prior year audit Limited valuation credit given by analysts and investors for the next forward year of projections Given these broader considerations around the window, January and February are generally imperfect indicators for annual volume projections and trends. However, when this window is active, such as it was earlier this year, it can be indicative of issuer and investor appetite. From January 1 through February 14 18, there were 22 IPOs in the U.S., raising $10.1 billion, representing the highest level of volume during this period over the past 10 years and approximately double the average activity. The market has been inactive since then, largely because of the dead period mentioned above. ` Exhibit 1: January 1 February 14 IPO issuance since 06 # of IPOs $7 24 $7 10 year average # of deals 15 $ volume $4bn % of annual 9% volume 7 1 $1 $1 11 $2 $9 15 $2 $6 32 $7 $4 4 <$1 13 $5 # of IPOs IPO volume $10 IPO volume ($bn) $12 $10 $8 $6 $4 $2 $0 As % of annual volume 14% 13% 4% 3% 5% 22% 3% 10% 8% 13% 2% 13% Source: Note: Dealogic. As of February 14, 18. Includes SEC registered IPOs $30mm+ that priced between January 1 and February 14. Excludes business development companies (BDCs) and special purpose acquisition companies (SPACs). This deal market strength was a continuation of strong issuance and investor appetite in the fourth quarter of 17. More IPO proceeds were raised in 4Q17 than in the other quarters last year, and November was the most active month in 17, with 22 IPOs priced. 3 P a g e

4 The IPO environment in January also benefited from the positive market backdrop, largely driven by passage of the Tax Cut and Jobs Act at the end of December 17. The S&P 500 index increased 5.4% (through January 31), and the index was up on 18 of 27 trading days. With respect to the deal data from early 1Q18, there are several interesting trends that highlight the strength of the market as well as suggest potential for strong new issue market conditions to continue. Factors we are tracking include: Sector diversity. Traditionally, the January/February window is weighted toward biotechnology and other early-stage issuers that do not have overly complex financials to close from the prior fiscal year. This was not the case in early 18, as deal activity was diversified across sectors, driven by more developed companies raising significant proceeds. Cyclical sectors such as energy and consumer products pursued more transactions in this window relative to averages. It is indicative of the market s strength that these companies elected to manage year-end issuance complexities in order to capture the potential upside currently accessible in the market. Exhibit 2: January1 February 14 IPO issuance (by # of deals) YTD Finance 10% Healthcare 8% Consumer 5% s Biotech 27% Consumer 9% Real Estate 9% Industrials 9% Biotech 27% Real Estate 11% Industrials 11% Energy & Utility 13% TMT 15% Finance 9% TMT 14% Energy & Utility 23% Source: Note: Dealogic. As of February 14, 18. Includes SEC registered IPOs $30mm+ that priced between January 1 and February 14. Excludes business development companies (BDCs) and special purpose acquisition companies (SPACs). 4 P a g e

5 Pricing power has remained balanced between issuers and investors. Through February 18, despite heightened market volatility in February, 77% of IPOs priced within or above the initial marketing range, which would represent the highest annual percentage in at least 10 years. At the same time, investors remain disciplined, with most of these offerings priced within the range. Exhibit 3: IPO pricing vs. initial marketing range 100% 80% 22% 29% 11% 19% 14% 28% 21% 26% 19% 26% 17% 18% 18% 60% 40% 44% 43% 46% 54% 47% 37% 37% 47% 42% 41% 51% 55% 59% % 33% 28% 43% 27% 39% 35% 41% 27% 39% 34% 32% 27% 23% 0% Below Range In Range Above Range YTD Source: Note: Dealogic As of February 14, 18. Includes SEC registered IPOs $30mm+. Excludes business development companies (BDCs) and special purpose acquisition companies (SPACs). Heightened volatility in the first half of February negatively impacted this data. Market uncertainty diminishes investor appetite for new risk, which IPOs inevitably represent. Companies that have already launched roadshows when volatility arises often end up with lower than anticipated pricing outcomes, through no fault of their own. Between February 1 and February 14, three IPOs priced below the marketed range and a further four deals were postponed indefinitely (potentially to reapproach the market later in 18, depending on each particular situation). Trading continues to be strong. Aftermarket returns are one of the most closely watched indicators when evaluating IPO market health. Average returns from IPOs historically have outperformed the broader benchmarks, and tend to be a leading indicator for investor appetite and in turn, IPO activity. As we have covered previously, subpar returns in 15 were a key reason that IPO activity slowed in 16. In 16, issuers began to offer more attractive valuation entry points to capture investor interest, and generate better returns. With 16 as a positive backdrop, 17 transactions took a largely constructive tone, which has continued in early 18 (see Exhibit 4). 5 P a g e

6 Exhibit 4: IPO aftermarket outperformance vs. S&P 500 (medians) % 15% 10% 5% 7% 5% 11% 8% 11% 7% 7% 0% (5%) YTD (10%) (15%) (%) (25%) (21.0%) Offer to 1-day Offer to current Source: Note: Dealogic, S&P Capital IQ As of March 13, 18. Includes SEC registered IPOs $30mm+. Excludes business development companies (BDCs) and special purpose acquisition companies (SPACs). Within the 18 IPOs to date, there is a wide variance in performance. The three best performing IPOs of 18 are biotech IPOs, which can have unique dynamics that impact price performance. For instance, insiders are often allocated a significant portion of the shares in biotech IPOs, which limits aftermarket trading liquidity and can skew price performance. Without the biotech transactions, the median offer-tocurrent outperformance over the S&P 500 in 18 is about 3%, still positive but significantly lower than when including biotech deals. It is important to note that the sample size of only 22 IPOs completed through February limits the ability to draw definitive conclusions. Significant volatility returned for the first time in over a year The broader market had two consecutive weeks of negative returns in early February, including several days when the Dow traded in a range greater than 1,000 points across the day. At the lowest point, the market was down over 10% from its highs, the traditional definition of a correction. Despite the 2,500- to 3,000- point decline in the Dow, the index was still trading above its level from Thanksgiving of last year, effectively just giving back December and January gains. With that context, our interpretation is that the market volatility and downward pressure were more attributable to profit taking than a shift in market fundamentals. The correction coincided with a spike in the Chicago Board of Trade VIX Index (VIX), which typically has an inverse correlation with IPO activity. When market uncertainty becomes prevalent, investors tend to shy away from the incremental risk inherent in IPOs. For much of 17 and January 18, the VIX traded at historically low levels (see Exhibit 5). During the February correction, the VIX spiked into the 50s on an intraday basis and traded in the 30s for a few days levels that typically are not conducive to IPO issuance. While the VIX has not returned to its pre-correction historically low level, it has stabilized in the mid-to-high teens, in-line with the 10-year average and more conducive to issuance. 6 P a g e

7 Exhibit 5: SPX, DOW and VIX performance SPX and DOW 160 VIX /1/17 3/1/17 5/1/17 7/1/17 9/1/17 11/1/17 1/1/18 3/1/18 5 S&P 500 DOW VIX Source: S&P Capital IQ Note: As of March 13, 18. Over the years, investment strategies have developed that use the VIX to express views on market uncertainty. As these vehicles increased in size, the impact of their trading on the actual VIX measurement may have distorted its value as a gauge of investor sentiment. Therefore, in addition to volatility indices, we also look at the number of trading days in which the indices move plus or minus 1% as another important indicator of market and valuation uncertainty. 17 saw the fewest such moves in more than 10 years (see Exhibit 6), creating an environment where issuers largely had access to the market throughout the year. However, volatile trading in early February has already driven more plus or minus 1% days in 18 than occurred for the full-year 17, and the year is currently on pace to be the most volatile since 11. Exhibit 6: SPX trading +/- 1% vs. VIX # of days S&P +/- 1% change 80 VIX (Avg) YTD Source: S&P Capital IQ Note: As of 13 March P a g e

8 Despite the February volatility, our new issue market outlook for 18 remains constructive Based on early 18 IPO activity, we are optimistic that the deal environment can match or exceed last year s production. We are encouraged not only by the number of deals and volumes, but also diversity across sectors. And the IPO activity slowdown that would have followed February s market correction happened to coincide with the post-february 14 staleness period, when IPOs are typically uncommon anyway. Anecdotally, the volume and tone of conversations across our client base with respect to plans for IPO execution over the next six to 18 months continue to increase. Looking to the immediate future, several issuers have made public filings in recent weeks indicating that IPO flow will continue throughout March, on the heels of a number of March IPOs that have already priced. This is a positive sign that issuers are confident enough in the underlying fundamentals of their businesses and the market to accelerate audit completion and get to market as soon as possible. Success across these transactions will encourage a much longer list of companies targeting 2Q18 or beyond to move ahead with their processes. Typically, the May/June window (post-march 31 results) is the longest and one of the most active IPO windows on the annual deal calendar. From a process perspective, it allows ample time to complete year-end audits and the first quarter review. It is also traditionally the first window of the calendar year that investors assign valuation credit for the next full calendar year projections, which increase enterprise values (i.e., in May 18, investors will use estimated 19 projections to determine value). The combination of these factors typically draws issuers to market during this window, and 18 would seem to be no exception. While the post-march 31 financial results window is always a key driver of annual IPO activity, it is poised to be an even larger contributor to 18 volumes, as we suspect that the IPO windows calendar in the second half of the year could be compressed. The midterm congressional elections may introduce both market uncertainty as well as timeline/logistical issues in November; issuers will likely factor this risk into their targeted timelines. Second-half IPO activity is traditionally impacted by the August slowdown and year-end holiday break; however with November potentially becoming a challenging window in 18 as well, we project that most post-labor Day issuance will need to fit into September, potentially October and the first half of December. If market volatility spikes in any of those periods, the impact on annual issuance activity could be exaggerated, irrespective of the fundamental market conditions and issuers desire to hit the market. While our IPO outlook remains constructive, there are risks to deal flow, including: Underprepared companies rushing to market before their enterprise is ready. Urgency to take advantage of business momentum and financing conditions is encouraged, but sacrificing readiness can have ramifications if it impacts longer-term performance and market creditability. A series of deals that trip up and trade down in their first several quarters in the public eye could taint the new issue market. Domestic equity funds (excluding exchange traded funds) have experienced negative outflows in both January and February, totaling $15.6 billion. This reduced the amount of unallocated capital institutional investors have at hand to make IPO investments. Continued outflows could negatively impact investor appetite for new issues as the year progresses. The market reaction to the Tax Cuts and Jobs Act has been largely positive, driven by an anticipated increase in corporate earnings growth and distributable free cash flow. If growth underperforms expectations, M&A activity stagnates, and/or expected increases in dividend and share repurchase activity do not materialize, the market environment will be negatively impacted. An exogenous macro/news event impacting the May/June window would crowd issuance into tight 2H18 windows which will also be impacted by the midterm congressional elections. 8 P a g e

9 Direct listings add a potential wrinkle to IPO activity There has been much anticipation and discussion in the press about direct listings as an alternative to traditional IPOs. In a direct listing, a company completes the same SEC registration process and listing application for a national exchange. However, the company does not offer stock directly to the public in an organized offering, and no investment banks serve as underwriters. This results in lower costs and fewer restrictions (such as lock-ups), but potentially subjects the company and its shareholders to added volatility as price discovery is realized. A direct listing has always been an available path to market, but one that issuers typically have not pursued given unfamiliarity and a variety of other considerations. When notable/high profile issuers pursue unique paths such as a direct listing, the process and mechanics get significantly more attention, and potentially draw more activity. While the path can make sense for select companies, we believe it is a small set of potential issuers, and does not impact our broader outlook on traditional IPO activity. In order to successfully direct list, an issuer must attract institutional investor interest without the assistance of underwriters. Large, well-known companies in well understood businesses may be able to do so efficiently and effectively, but the bulk of the IPO market sponsor-backed, biotech and small/mid-cap growth companies will continue to benefit from traditional IPO mechanics to drive investor interest in their transactions. Conclusions We continue take a long-term view of the IPO markets and recognize that predicting annual IPO volumes is a reliably difficult task. However, given the strong start to the year and underlying trends, we anticipate a strong year for IPOs. Several trends that bear watching include: Aftermarket performance of recent transactions has the largest impact on future investor receptivity 1Q18 earnings season in April and May will have a high number of newly public companies reporting and being marked against expectations set at the time of their IPO Issuer ability to hit growth and projection targets will be critical to the tone of the IPO market and can impact future access It appears that the market has returned to more normalized volatility in recent weeks. As the market adjusts to Washington policy announcements, and tightening monetary policy globally, periods of market uncertainty seem inevitable. When these events occur in relation to IPO windows is unpredictable, and could therefore have an outsized impact on traditional market statistics at year-end The best course for motivated issuers is to aggressively pursue and complete preparations as soon as practical, enabling a real-time read of market conditions which in turn maximizes optionality In the current environment, execution risk is heightened by the potential for crowded issuance windows, distracted advisors and unpredictable exogenous shocks. As such issuers can benefit from an independent perspective to help navigate the transaction process. EY s Equity Capital Markets team can tailor a distinctive value proposition to potential IPO issuers including: Designing an efficient transaction process (strategy, options, timing) Perspective on transaction structuring alternatives and market conditions Preparation for communications and meetings with external constituencies such as investors, research analysts, and bankers Providing additional resources to leverage throughout transaction preparation, planning and execution 9 P a g e

10 As always, prepared prospective issuers have option value and the ability to access the market opportunistically, creating leverage with investors. We look forward to working with clients to help create this flexibility and advantage. Please reach out with any questions. EY Equity Capital Markets David A. Brown Bill Johnson Principal/Senior Managing Director Managing Director EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. Ernst & Young Capital Advisors, LLC (EYCA) is a registered broker-dealer and member of FINRA ( providing sector-specific advice on M&A, debt capital markets, equity capital markets and capital restructuring transactions. It is an affiliate of Ernst & Young LLP serving clients in the US. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, investment or other professional advice. Please refer to your advisors for specific advice. Some of the materials contained herein are copyright 18, S&P Capital IQ (S&P). Reproduction and distribution of referenced S&P data in any form is prohibited except with the prior written permission of S&P. Use of S&P information is intended for the recipient s internal use purposes only. None of S&P, its affiliates or their suppliers (together, S&P parties) guarantee the accuracy, adequacy, completeness or availability of any information nor are responsible for any errors or omission, regardless of the cause or for the results obtained from the use of such information. In no event shall any S&P party be liable for any damages, costs, expenses, legal fees or losses (including lost income or profit or opportunity costs) in connection with any use of S&P information. ey.com eyinvestmentbanking.com 18 Ernst & Young LLP. All Rights Reserved. EYG no Gbl ED None 10 P a g e