IPOs often amplify the direction of the broader market, so the 4Q18 IPO market is not off to a great start. After outperforming the S&P for most of the year, the IPO Index has tumbled -11.1% since the start of the 4Q, compared to the Russell 2000's -7.1% and the S&P 500's -4.4%. The VIX Volatility Index has shot up to its highest level since April.
Some of the biggest drivers of IPO activity during 2018 - biotech, tech, and China - have all suffered particularly heavy losses over the past two weeks.
Several recent high-profile growth IPOs with strong initial pops are now trading below issue, including SurveyMonkey (SVMK), Farfetch (FTCH), Sonos (SONO) and Arlo Technologies (ARLO). Spotify (SPOT) is nearing its first day close of $149 from April.
Why the sell-off?
Much of it comes down to valuation. After previously placing a high premium on growth, investors are trimming VC-backed tech companies valued on lofty growth projections. Performance is worse for biotechs, with just 35% of the 2018 class trading above issue. This year, we've noted that biotechs have been able to complete IPOs despite being at early stages with large valuations. Meanwhile, the Chinese stocks have been hammered over concerns about China's economy and the impact of a trade dispute.
With renewed concerns over rising interest rates, heavily-levered companies backed by private equity have also hit turbulence.
What does it mean for the IPO market?
The market sell-off will likely cause new IPOs to delay launching, impacting November activity. For deals currently in marketing, expect to see a few postpone or slash the proposed valuation.
The silver lining
The IPO window isn't closed. While tech IPOs have sold off over the past two weeks, this year's tech sector as a whole still averages a 20% gain from the offer price, with 64% above issue. US tech has held up particularly well: the year's 22 US-based tech IPOs average a return of 36%, with 17 (77%) in positive territory (excluding the 2 micro-caps). Fast-growing companies with recurring revenue still appear to be in demand, and Anaplan (PLAN) responded by raising its range on Wednesday.
In addition to high-quality tech, pre-sold deals, including some biotechs and China-based companies, should still get done. Casino operator Studio City (MSC), for example, has disclosed that insiders intend to buy 89% of the offering. Based on recent filings, the energy sector also looks ready to come back to life; energy has quietly become a top-performing sector in the IPO market with the year's seven deals averaging a 15% gain.
Investing in IPOs during these conditions can be a daunting prospect. However, it's our experience that some of the IPO market's best long-term profit opportunities come after these times, when fundamentally strong businesses are forced to price at attractive valuations.
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