China, U.S. and Private Equity Driving IPOs

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 |  Includes: AONEQ, MJN
by: Renaissance Capital IPO Research
  • Global IPO volume continues to rise thanks to Shanghai and US issuance.
  • Large Chinese companies and private equity-backed US companies raise the average deal size.
  • Performance is mixed as valuations become more aggressive.
  • We expect deal flow to continue to rise thanks to pent-up IPO demand and the return of venture capital.

For the second consecutive quarter, global IPO activity rose significantly as equity markets rallied and investor risk appetite increased. The first US IPO of the year was large, stable baby-food manufacturer Mead-Johnson (NYSE:MJN); by contrast, the most successful recent US IPO was A123 Systems (AONE), a vastly unprofitable battery-maker with possible exposure to the potentially huge hybrid and electric car market. While these two deals represent extreme ends of the spectrum, we believe we are in the early stages of a trend back toward traditional growth IPOs that will solidify further in 2010 and beyond. In the meantime, larger IPOs from infrastructure/construction firms or private equity-backed companies are contributing to growing IPO issuance.

Global issuance continues to rise

Global deal volume, which by our definition includes companies that raise over US$100 million in gross proceeds, continued to improve in 3Q09 with 49 companies going public, more than double the 22 deals in the prior quarter. The deal volume also compared favorably with the 20 companies that went public in the prior year period. Average deal size grew to $687 million, up from $460 million in 2Q09 and $464 million in 3Q08, and was boosted by several billion-dollar IPOs.

China dominates deal flow as the Shanghai market opens up; activity also broadens in Asia Pacific

After the Chinese government lifted a nine-month freeze on IPOs in mid-June, the Shanghai Exchange led the IPO charts with 14 companies going public, some of which had been waiting to raise capital for over a year. Deals on the Shanghai market accounted for 40% of the total global proceeds and Hong Kong made up a further 28%. The US continued to gain momentum with 13 IPOs raising $6.3 billion, up from $1.4 billion in 2Q. As with Shanghai, the US saw several companies go public after a long wait; five of the 13 companies to go public had originally registered more than a year ago and two made their initial SEC filings way back in 2007. In addition, IPO activity broadened throughout the Middle East and the Asia Pacific regions, as India, Saudi Arabia, South Korea and Australia all saw their first IPOs in over nine months.

Average deal size increases thanks to large China IPOs and US private equity-backed companies

3Q09 IPOs were larger compared to prior quarters; the ten biggest IPOs raised $22.2 billion, 2.6 times the $8.4 billion raised by the second quarter’s top ten. Eight of the top ten IPOs were Chinese companies (although Shanda Games listed on the NASDAQ instead of in China), with India’s National Hydroelectric and the US’s Talecris Biotherapeutics rounding out the list.

Performance was brought down by Hong Kong deals and mortgage REITs

Although deal volume was up significantly in the third quarter, performance was mixed and weaker than it had been in the prior quarter. The average IPO returned a solid 14% from its IPO price, but this figure was down from 25% in the 2Q. Furthermore, the median IPO return was only 3% since over one-third of the deals to begin trading during the quarter ended it below their IPO prices. Performance was brought down by the Hong Kong IPOs as more than half of that market’s listings fell, which may be attributable to increased investor scrutiny on fundamentals and valuations; Hong Kong’s deals on average were down 3% at the end of the quarter.

US IPO performance was generally disappointing, especially compared with the strong second quarter. Although the weak REIT performance was an issue, there were also lackluster debuts from several companies because of more aggressive valuations, and half of the new issues ended the quarter below their IPO prices. By far the strongest US performer was A123 Systems, which is developing batteries for hybrid and electric cars. The deal was the only true US venture capital-backed IPO of the quarter and the first unprofitable US IPO this year. Since 2008, investors have generally been looking for more established companies in the IPO space with a track record of growth and profitability, but A123 is the first IPO this year whose prospects are entirely on the come. Its success may be a harbinger of a shift back toward riskier IPOs, especially as the more established companies completing US IPOs in the third quarter did not produce outsized returns.

IPO issuance should continue to grow thanks to a large backlog both in the US and internationally

We expect the trends of rising IPO volume and proceeds to continue in the US as we believe investors are gaining confidence in economic recovery and increasing their risk appetite. Furthermore, the recent uptick in filing activity suggests that there is a large backlog of companies looking to raise money now that the capital markets have opened (40 companies filed for IPOs in the 3Q compared with 14 in the first two quarters combined). While deal flow will likely be driven by private equity and spinoffs throughout the next few months, filing activity for venture-backed companies has recently come back after almost two years in the wilderness and may start to contribute to deal flow early next year if not in the 4Q. China will likely continue to produce a significant number of IPOs, though a pullback in deal flow is possible if disappointing Hong Kong returns continue, or if the government stifles Shanghai issuance after a robust 3Q. Looking beyond the US and China, other regions, such as Europe, are showing signs of life but are unlikely to see much deal flow until 2010. We expect the global infrastructure theme to continue as many countries prepare for rebounding economic growth. Private equity companies in Europe and Latin America may also contribute to IPO growth.

Overall, the third quarter shows a continuation of the slow recovery process for IPOs. As long as company fundamentals are strong and valuations are reasonable, we expect this trend to continue as investors return to unseasoned equities with renewed risk appetites.

For our full 3rd Quarter Global IPO Review, please visit www.renaissancecapital.com.