- 2023 could be the worst year for IPOs and new listings since the great financial crash, as unfavourable conditions and valuation challenges deter companies from going public.
- Many of the big names that listed in 2020 and 2021 – like Rivian, Coinbase and Roblox – set the bar too high and have since plunged in value.
- Semiconductor firm Arm and grocery delivery giant Instacart could provide a catalyst with their upcoming listings, with a raft of other companies waiting to follow.
- Big test for valuations. Companies need to find the right balance between maximising value for existing investors while providing attractive upside potential for IPO investors.
US IPOs in 2023: Will it be the worst year since 2009?
The IPO market has been in a drought over the past two years, with fewer companies going public since the record-setting year in 2021, when over 1,000 companies took the plunge on US exchanges alone!
Read on: What is an IPO and how does it work?
We saw a drastic change in 2022, when all the largest IPOs were launched outside the US, and that trend has only got worse in 2023. In fact, this could be the worst year for the US IPO market since the great financial crash derailed markets back in 2008 and 2009.
Among the slim pickings for US investors this year, the highlights have been Johnson & Johnson’s carve-out of consumer healthcare unit Kenvue and, more recently, Vietnamese electric vehicle maker VinFast’s public debut.
(Source: Stock Analysis, compiled as of August 30, 2023)
Why is the IPO market in a drought?
Companies have become more reluctant to go public since 2021 because they have faced less favourable market conditions, prompting them to delay or cancel their listing plans altogether.
Let’s take a look at some of the reasons companies are reluctant to go public…
End of cheap money
Inflation started to take-off in mid-2021 and this forced central banks into action in early 2022, when they started to hike interest rates and dramatically changed the mood among markets that have been accustomed to much lower interest rates since the financial crash. The Federal Reserve has hiked rates from almost zero in early 2022 to over 5% today.
Rampant inflation pushed up costs for businesses and weighed on profitability, while higher interest rates pushed up the cost of servicing debt and ultimately made funding harder and more expensive to obtain. Tighter monetary policy has been gradually causing the huge sums injected into the economy during the pandemic unwind, which has caused spending to slowdown.
The pandemic and geopolitics
The global landscape has also been shaken in recent years. The pandemic initially led to a rally in stock markets as appetitie for tech stocks increased as consumers relied on technology during lockdowns, but this unravelled as valuations became lofty. For example, the tech-heavy Nasdaq 100 was trading at a price-to-earnings ratio of 39x when it hit its peak in 2021, and we have seen that take a big tumble toward around 28x today.
While the end of the pandemic was welcomed, businesses faced fresh problems such as rising inflation and a slowdown in spending. The prolonged lockdown in China and Russia’s invasion of Ukraine also caused chaos for global supply chains.
The pandemic and most of the supply chain problems are now be behind us, but other headwinds remain. Inflation still remains elevated even as it cools, markets are still mulling whether interest rates have peaked, China’s economic recovery since reopening this year has been lacklustre to say the least, and the war in Ukraine shows no signs of abating.
The situation has, generally speaking, improved compared to what we saw last year but the outlook remains uncertain.
Poor IPO performances
One of the biggest deterrents for companies considering going public is seeing others fail to deliver, and the newest members of the US markets have, generally speaking, been a disappointment.Read more: What happens on the day of an IPO?
Below is an outline of how some of the most watched listings in 2020 in 2021 have performed compared to their issue price. It also shows how the price has moved compared to the opening price on the first day of trading to demonstrate how most of them saw huge hype build upon listing before quickly falling back down. Airbnb is one of the best examples, having gained ground compared to its IPO price but still down from the peaks a few months after it listed.
(Data as of August 30, 2023)
It is also worth noting that some of the winners, namely Palantir and Snowflake, were both in negative territory until interest in artificial intelligence erupted this year, which has given them enough of a boost to return their shares above their IPO prices.
The fall of the SPAC
One of the reasons we saw so many listings in the US in 2021 was the revival of the Special Purpose Acquisition Vehicle, better known as a SPAC or a blank-cheque company. These are shell companies that own no assets and raise money from investors that is then used to acquire an established business, which then becomes a publicly-listed as a result.
Read more: What is a SPAC and how does it work?
Lucid Group, Fisker, Canoo, Mullen, Gingko Bioworks, Cazoo, Virgin Orbit, WeWork, IonQ, Archer Aviation, Microvast, SoFi and DraftKings are just some of the most well-known names that have joined US exchanges by merging with a SPAC in recent years. Even former US president Donald Trump is trying to take his social media platform and technology company public by merging with a SPAC named Digital World Acquisition Corp, although it has faced a number of major hurdles and still hasn’t completed the deal almost two years on.
The SPAC market has since slowed down. They only have a couple of years to find and purchase a target to maintain their listings, but a combination of factors has made matters much more difficult. The explosion in the number of SPACs looking for a deal happened just before we started to see a slowdown in dealmaking and more hesitancy from companies considering going public. This combination of more intense competition and fewer options means SPACs are finding it much more challenging to find a target, causing a rise in the number of failures.
Still, SPACs aren’t dead. Vietnamese electric vehicle maker VinFast has become one of the latest firms to go public using a SPAC and has, surprisingly, become one of the world’s most valuable automakers as its tiny free float makes it vulnerable to sharp and volatile price movements. However, that may haunt the markets that saw so many listings in 2020 and 2021 come to market with sky-high valuations.
What is the outlook for the IPO market?
The US IPO market remains quiet but there are some green shoots emerging. The good news is that there is strong pent-up demand. There are plenty of big names that want to go public, they are simply waiting for the right time. This should provide the fuel needed to drive a strong recovery in the IPO market once it does take-off again.
Can Arm and Instacart revive the IPO market?
We are now seeing signs that some of the biggest IPO contenders are finally willing to test the waters, with British semiconductor designer Arm and American grocery delivery giant Instacart set to launch their highly-anticipated IPOs in the near future.
That is significant as their IPO valuations and their initial performance after listing will ultimately decide whether more companies will follow, lifting hopes that they could help revive the IPO market before the end of 2023.
Any signs that big, profitable names like Arm and Instacart can’t secure the confidence of the markets will be a big turn-off for other IPO contenders, especially those that are still in the red and underpinned by growth prospects. The hope is that they can strike healthy valuations, but not so high that they slump after listing. The puzzle is finding the right balance.
Arm and Instacart to test IPO valuations
Arm has finally provided a price range for its upcoming IPO, with the firm targeting a price of $47 to $51 a share. That will see it raise up to $4.87 billion and should give it a valuation of over $52 billion! That would make it the biggest US IPO since electric vehicle maker Rivian managed to earn a valuation of $70 billion when it went public in 2021. However, it was previously expected to try to earn a valuation of up to $80 billion, and it is also far below the $64 billion price tag earned when owner Softbank bought the remaining shares in Arm it didn’t already own earlier this year. It is, however, a large premium to the $32 billion spent by Softbank on taking Arm private back in 2016!
Still, that looks very lofty considering Arm generated just $524 million in net profit in the year to the end of March. That potential valuation could give it a multiple of somewhere around 99x earnings. That would be sky-high compared to US semiconductor stocks. For context, there is a debate about whether NVIDIA’s multiple of 34x is too high, and that is underpinned by the huge tailwind coming from AI.
Confidence is high because Arm is a well-respected and established business operating on a global scale. The fact it was also previously a publicly-listed firm also helps. Its chips are used in virtually every smartphone on the market, and about 70% of the world population has an Arm chip in their hands. A flurry of big names have also said they are interested in buying shares through the IPO, including AMD, NVIDIA, Apple, Cadence Design, Alphabet, Intel, MediaTek, Samsung, Synopysys and TSMC. They could buy up to $735 million worth of Arm shares, although none of them are obliged or committed to purchasing them. Having such stalwart backers should help keep its price stable after listing and sends a sign to the market that there is strong appetite at the IPO price.
However, it is not all rosy. Some analysts have flagged Arm has a major job to do in finding new growth considering it has conquered its existing markets, and others are worried about its high exposure to China, where it makes almost one-quarter of its sales that are made through a business it doesn’t control.
Things look a bit more sensible at Instacart, which is growing at a faster pace and targeting a more reasonable multiple. The latest figures taken from 2022 showed Instacart showed it made its maiden annual net profit of around $428 million. With reports suggesting it is aiming for a $10 billion valuation, that would suggest it is targeting a multiple of around 23x. That seems reasonable when you consider the valuations touted by similar but less-profitable companies like Uber, DoorDash and Just Eat.
Top upcoming IPOs of 2023
There are a wave of companies that have signalled they will go public and they are likely to be paying close attention to the upcoming Arm and Instacart IPOs to see how hungry markets are for new listings.
Payments firm Stripe, fintech outfit Chime, software and AI play Databricks, social platform Reddit and text-and-voice messaging service Discord are just some of the potential IPO candidates that could take the plunge this year or next if the IPO market gets a much-needed jolt.
They could face different levels of difficulty going public considering some are thought to be comfortably in the black while others are still in the red, with markets showing signs they are much more interested in reliable and profitable businesses in the current climate compared to riskier bets that are all about growth.
Conclusion: Finding the right valuation is key
Businesses have been reluctant to go public over the past two years because they have seen the newest additions to the US market deliver a poor performance after setting their valuations too high while market conditions deteriorated.
Some of the major headwinds that held them back have disappeared. Covid-19 and supply chain problems are, for the vast majority of companies, a thing of the past. Still, conditions are far from perfect as inflation remains elevated, the debate over whether interest rates have peaked rumbles on, and growth is slowing down.
However, the US economy and corporate earnings have proven more resilient than expected after years of being battered by various problems. The metrics are moving in the right direction. Inflation is cooling and markets are convinced rates will start to be cut in 2023, while hopes of a ‘soft landing’ remain high.
Plus, the IPO drought cannot last forever, especially as other forms of funding dry-up or become less attractive. Venture capital that usually funds early start-ups requiring lots of cash to grow and develop is drying up and debt has become more expensive. Meanwhile, those investors looking to cash-in by selling shares through an IPO may also believe that the markets will give them a better price than can be achieved elsewhere, given appetite for dealmaking has plummeted this year.
Unfortunately, no company wants to be the first out the gate without knowing what to expect but it looks like Arm and Instacart have bravely stepped-up to test the waters. The pair could decide whether a wave of IPOs will follow or if the drought continues.
Ultimately, the success of failure of upcoming IPOs boils down to valuations. Those launching IPOs want to achieve the highest value possible, while those investing in IPOs want the opposite so there is more upside potential on their investment. Finding the right balance between the two is the key to ensure they perform well after listing and avoid suffering the same fate as many of the big names that went public in 2020 or 2021.