The sputtering initial public offering market may never again be as robust as it once was because there's much more incentive for the owners of growing, young companies to sell out than to go public, suggests one study.
“I am of the opinion that venture capitalists will not be taking many companies public for the foreseeable future, even if the stock market rallies,” says Jay Ritter, a University of Florida finance professor and co-author of the paper “Where Have All the IPOs Gone?”.
The lack of IPOs would be a concern because economists say fast-growing, young firms are more likely to add jobs than established older corporations.
And this has already been a challenging year, with companies folding their IPO plansin record numbers. Only two firms, Zeltiq Aesthetics and Ubiquiti Networks , made market debuts since mid-August. It also remains to be seen how investors will receive a high-profile offering from daily deals website Groupon, expected to start a roadshow next week.
Ritter says compared to the heyday levels of the 1980s and 1990s, IPO activity has been slow for a decade and is bound to stay that way because of structural changes in the economy.
On average, 103 companies went public every year between 2001 and 2009 compared to an average of 311 firms between 1980 and 2000, says the study, which was co-authored by Xiaohui Gao of University of Hong Kong and Zhongyan Zhu of Chinese University of Hog Kong.
The IPO volume has been especially low for small firms with annual sales of less than $50 million.
Many have blamed the prolonged decrease in IPO activity on additional compliance costs imposed on publicly traded firms by Sarbanes-Oxley Act of 2002 and a decline in the number of analyst covering smaller companies.
Ritter’s study offers an alternative explanation, attributing the drop in number of IPOs, particularly from small firms, to structural changes in the economy that have given large companies the advantage of economies of scope and ability to bring products on the markets faster.
This in turn has reduced the profitability of small companies, making it much more attractive for them to sell out to bigger firms rather than go public.
To illustrate the point, the study looks at Apple’s ability to quickly launch or update its iPads and iPhones. “No small independent company could implement new technology so rapidly and sell tens of millions of units to consumers in a matter of months,” argues the study.
It goes on to say: “A small private company that develops valuable new technology for consumer electronics would find that its value-maximizing strategy would be to sell out to Apple rather than go public and start hiring more workers.”
The study also notes that there has been a dramatic decline in the number of small firms that are profitable within three years of an IPO. It also points out that investors in small company IPOs saw disappointing returns over the last three decades.
The study says another period of high IPO volume is possible, “if “irrational exuberance” pervades the market, or if one or more exciting new technologies develop that result in many small and independent firms becoming profitable.”
But this would be “just a temporary phenomenon”, concludes the study.
Only 98 IPO deals priced so far this year, with 28 of them from small companies, according to Renaissance Capital. And more than one-third of the withdrawn IPOs were from small firms.
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