Why a Severe IPO Drought Is Actually Extremely Bullish

Although I’ve previously touched on the predictive quality of the IPO market, I wanted to bring it up again because what last year was a slow trickle has now dried up to an outright drought.

So far in the first quarter of 2008 we’ve had only 12 IPOs: 5 in January, 4 in February and 3 in March. The last one being the high profile initial public offering of Visa (V). It added an enormous $18 billion to the quarterly value number, leaving less than a billion dollars for the other 11 IPOs.

Visa has also provided the best IPO performance this year with a 50% rise from its $44/share offer price. BioHeat (BHRT) has been the worst performer, with a return of -24%.

Although this lack of activity can be interpreted by some as being negative because it means less business for Wall Street, less money for companies that are growing, and less opportunity for investors to fund new enterprises, in actuality it is a sign of good things to come.

To understand why, we’d have to put on our contrarian goggles: a drought of IPOs means that there is a total lack of ‘froth’ in the market; it means that VCs are holding off on selling their equity because they know that it won’t get a bid; it means that most investors are in a retrenchment mode and are in no mood to put new money in unproven companies, instead preferring to hold more conservative securities.

From a simplistic point of view, when you restrict the supply of something, the effect is that, demand being equal or growing, prices go up. Economics 101. So as public companies continue to buy up their shares and private ones refuse to go public, the ‘float’ of equity decreases, pushing up average aggregate share prices.

Also, historically, periods of IPO drought have not meant that new companies do not grow or find funding. Instead they have denoted incredibly opportune times to invest in the stock market.

As the maxim goes, “Be bold when others are fearful and fearful when others are bold.” And right now it doesn’t take a genius to see that with a lack of IPO filings, nervous companies pulling their filings and an empty roster of secondary offerings, fear is rampant on Wall Street.

I remember learning the predictive power of IPO trends during the height of the bubble. It was one of the most powerful arguments that convinced me we were indeed in a bubble and would soon see a bear market correction.

But right now its message is the opposite. Just as it was in early 2003.

Comments

[User 168848]

(OT)Can you please remind your friends who wrote negative articles about visa that the stock passed 71 dollars mark?