Are the Canadian Public Markets Broken? J. Ari Pandes CIRANO (Montreal) Presentation October 25 th, 2016

Transcription

1 Are the Canadian Public Markets Broken? J. Ari Pandes CIRANO (Montreal) Presentation October 25 th, 2016

2 Motivation: US IPOs in Decline since Yearly Number of Initial Public Offerings in the US ( ) Source: Professor Jay Ritter s Website

3 What about Canada? 90 Yearly Number of Initial Public Offerings on the TSX ( ) Source: Tingle, Pandes and Robinson (CBLJ, 2013) and FP Advisor database.

4 Some Other Interesting Statistics Average Number of IPOs per Year Average Aggregate Proceeds per Year Average Mean IPO Size (in Proceeds) per Year Average Median IPO Size (in Proceeds) per Year ( 8 Years) (15 Years) $4.75 Billion $2.23 Billion $ Million $ Million $43.89 Million $97.89 Million Note: Proceeds are inflation adjusted ($2015).

5 Reasons Cited for IPO decline in the US Regulatory Overreach Sarbanes Oxley Act of 2002 (SOX) increased cost of public market compliance, especially for small firms The US Litigation Climate Cost of litigation and overly aggressive enforcement Changes in Market Structure Reduction in tick sizes decimalization; Reg FD in 2000, and the Global Settlement in 2003 have led to a drop in analyst coverage for small firms, lowering their P/E ratios Fundamental Economic Change Small companies are worth more as parts of big companies than they are on their own economies of scope hypothesis

6 What about Canada? None of the above reasons applies to Canada Canadian regulators did not adopt SOX reforms Canada is not as litigious Canada also reduced tick sizes, but we did not lose mid market and boutique investment banks (see Tingle, Pandes, and Robinson, 2013, Table 3) Tech and biotech are not the driving force of Canadian IPOs. Moreover, we ve seen massive increases in the prices of nearly every commodity Canada produces in the 2000s YET, we have also experienced a decline in IPOs. Public market pressures?

7 Public Market Pressure Hypothesis (Tingle, Pandes and Robinson, CBLJ, 2013) Have we gone too far in the alignment of incentives? Increased scrutiny and pressure being placed on the executives of publicly traded firms Investors are much more short term oriented, activist, hostile, and higher maintenance than in previous years CEOs claim that managing shareholders and satisfying various gatekeepers (securities commissions, stock exchanges, proxy advisory firms, auditors) now take up most of their time Management s fatigue in dealing with the public marketplace

8 No Formal Tests But Anecdotal Evidence Fortune Magazine article (May 17, 2016): Modern scourge of public companies: the activist investor Public companies that go private rave about their newfound ability to invest for the long term and focus on the business rather than on Wall Street In an informal online survey recently, Fortune asked CEOs: Do you agree or disagree with the following: It would be easier to manage my company if it were a private company rather than a public company. 77% agreed with the statement. When explaining why Randy Eresman, the CEO of Encana had suddenly announced his retirement, his interim replacement reported, Randy expressed to a number of board members his fatigue in dealing with the public marketplace. (Globe and Mail, 2013)

9 Recent Media Attention on Decline of Public Companies Public companies in Canada are going the way of the Dodo: The grinding decline of the public company in Canada is the quietest crisis facing the economy today, by Jason Kirby, Maclean s Magazine, August 2, 2016 Cites Tingle, Pandes and Robinson (CBLJ, 2013) Majority of listings on the TSX are not operating businesses instead they are ETFs, closed end funds and SPACs. i.e. Frankenstocks

10 Frankenstocks as a share of all new IPOs

11 Number of Companies and Frankenstocks on TSX

12 Why is the decline in Canadian IPOs important? An IPO enables Canadian companies to access significantly more capital than is available in Canada s private markets More investment, more jobs, more tax revenues, etc. IPO is an exit for early investors a decline in the IPO market is usually matched by a decline in the capital available for new entrepreneurial ventures Decline in IPOs often matched by an increase in acquisitions In Canada, acquirers tend to be large foreign companies Lose culture and distinctive character Lack of revolutionary new corporate giants Solutions to Canada s well documented problems with innovation and productivity are intimately connected to the health of its public markets

13 Other Trends in the US Small firm IPOs are defined as IPOs with less than $50 million in LTM sales ($2009) Source: Professor Jay Ritter s website

14 European Junior Stock Markets (Vismara, Paleari and Ritter, EFM, 2012) Europe s four biggest countries set up a total of eleven second tier markets since 1995 and only five are still in existence today. Very weak long run returns performance Liquidity issues (institutional investor oriented) Few firms graduate to the senior markets 3 regulatory regimes: Sequential: Securities Commission Regulated Sectorial: Securities Commission Regulated Demand side Segmentation: Exchange Regulated Demand side segmentation model, like the London AIM, is (relatively) the most successful model (although still exhibits very weak long run returns)

15 Canada s Junior Equity Markets (Source: FP Advisor database) 250 Yearly Number of TSXV Initial Public Offerings ( ) IPO CPC 854 Regular IPOs and 2,024 CPC IPOs (excludes trust units ETFs, REITS, and income trusts)

16 Canadian vs. European Junior Market IPOs ,642 IPOs ,210 IPOs IPOs 461 IPOs TSX V Paris B./Euronext Deutsche Borse Borsa Italiana London Source: Pandes and Robinson (Handbook of Research on IPOs, 2013)

17 Capital Pool Company (CPC) Program Two stage process: (1) CPC IPO to raise initial capital to identify a deal (2) Qualifying transaction to turn firm into a regularly listed TSXV firm CPC Private Company Qualifying Transaction (QT) New TSXV Company

18 CPCs and fraud (you would think) (Pandes and Robinson, FAJ, 2013) Blind pools popular in the US in the early 1980s Led to significant fraud US response: Securities Enforcement Remedies and Penny Stock Reform Act (1990) essentially shut down the market Brought the concept to Canada (Alberta) in 1986 Early fraud moratorium placed New CPC program initiated in late 1986 Struck the right balance between investor protection and access to capital for junior companies VC like restrictions on founders Protection for shareholders

19 VC Like Restrictions on Founders Initially, could not exceed $500,000 in total post IPO capital (seed + IPO capital) now it is $2 million Founders could draw no salary or perquisites 70% of proceeds must be used for the identification, evaluation, and completion of the QT If no QT in 18 months (now 24 months), firm would be suspended and delisted Seed shares escrowed and released 1/3 on each anniversary of QT

20 Protection for Shareholders Initially, restricted geographically (investors and assets) All IPOs needed to be conducted by a registered investment dealer bound by know your client rule Active investment banks to support program Each IPO needed at least 300 individual purchasers No shareholder able to buy more than 2% of IPO shares QT required Information Circular with prospectus level disclosure and approved by stock exchange and investors Ironically, many years later, US introduces SPACs, with similar features of the CPC program

21 What does data show on fraud? First Commonwealth Calendar Period Criminal Charges (%) Criminal Convictio n (%) Regulator Hearing (%) Regulator Sanctions (%) Criminal or Regulator Charges (%) 04/18/ /10/ Blind Pool Only 04/18/ /30/ ASE JCP Only 12/31/ /29/ VCP/Keystone Only 8/27/1998 3/26/ CDNX/TSXV CPC 03/01/ /14/ TSXV CPC 06/15/ /31/ Source: Pandes and Robinson (FAJ, 2013) Conviction or Sanctions (%) : US 347 allegations of financial fraud investigated by SEC out of 9,428 US public firms (3.68%) Beasley et al. (2010) CPCs: 930 taken public over same time period and there were no criminal investigations or convictions; 11 hearings (1.18%) and 5 sanctions applied (0.54%) : average annual fraud of 1.83% (NYSE), 4.41% (NASDAQ), 1.99% (US pink sheets), 0.33% (TSX), 0.10% (TSXV), 0.38% (LSE), and 0.10% (AIM) Cumming and Johan (2013)

22 Goal of TSXV Graduate to the TSX 80 Yearly Number of Graduations to the TSX IPO CPC Source: TMX Group

23 Junior Equity Markets: Regulatory Structure TSXV IPOs are regulated by the provincial securities regulators Whereas, CPC IPOs are exchange regulated As noted, Vismara, Paleari and Ritter (2012) argue that exchange regulated model works best In Canada, we can examine both

24 Does Spending Time in the Minors Pay Off? (Meoli, Pandes, Robinson and Vismara, Working Paper) We compare the long run post graduation performance of firms that had a TSXV IPO, traded on the TSXV, and then graduated to the TSX against the long run performance of VCbacked firms that had a straight IPO on the TSX. i.e. is the TSXV an effective incubator market for companies.

25 Why might TSXV graduations perform better? Companies learn how to operate a public company, which is very different than operating a private company Learn how to deal with: diverse shareholders analysts regulators public market governance requirements Media Etc. A more seamless transition to the TSX compared to a private company that directly goes public on the TSX

26 What do we find? Positive post graduation performance on the TSX, contrary to IPO literature, which finds underperformance About 20% buy and hold market adjusted return in the 3 years after the TSX listing Graduations outperform VC backed IPOs in the 1, 2, and 3 years post TSX listing About 30 percentage points on a buy and hold market adjusted basis following the TSX listing

27 What about CPC Graduations? (Pandes and Robinson, Forthcoming in Cumming and Johan Book) About 10% of CPCs have graduated to a senior exchange, on average within 3 years of their QT. The CPCs perform well on the TSXV, both before and after the QT transaction. Average IPO to QT Return: 39.30% Average QT to Pre Graduation Return: 47.54% However, the post graduation performance is weak in the 3 and 5 years post graduation. Average Buy and Hold Market Adjusted Return: 42.04%

28 What do these results suggest? The underperformance of CPC graduations is not dissimilar to US small cap findings: Ritter (2016) reports 3 year market adjusted returns of 42.1%, 35.1% and 22.2% for the 3 smallest market capitalization groups of US IPOs Results on the effectiveness of the demand side segmentation market are mixed Provides access to capital to help junior firms grow, but weak performance post graduation.

29 Some Final Thoughts Canadian IPO market is down, similar to the US, but for different reasons This is an important issue for policymakers: implications for jobs, growth, productivity, tax revenues, etc. Smaller senior market IPOs are down by more; however, the TSXV in Canada has been an important contributor to smallcap financings Given the relative lack of private market access, consider if the TSXV was not around Also, this is the only way retail investors can often access investments in early stage companies Supporting and adapting the TSXV should also be an important policy objective