Trader Talk

Here's what is needed to get the IPO biz going again


There's a Wall Street Journal front page story about how bad the IPO market is. They're certainly right, but they may be a bit behind the curve, because the seeds of a potential recovery have already sprouted.

The IPO market is in tough shape: they note that of the 175 companies that went public last year, 70 percent are below their IPO prices.

And the year has started out terribly: only 4 IPOs, 85 percent fewer than last year, according to Renaissance Capital, which runs the Renaissance Capital ETF, a basket of roughly 60 of the most recent IPOs. That "basket" is now down 16 percent for the year, far underperforming the S&P 500's drop of 6 percent.

There are three things that have to happen for an IPO recovery to take place:

1) The market has to stop going down. Every time we have had even a two-day rally in the last two months, there has been selling into it, on heavy volume. This week is the first time that hasn't happened. That's a good start.

2) The prior crop of IPOs have to outperform the market for a period. That's happened this week: the IPO ETF is up 6.2 percent, far outperforming the 2.6 percent the S&P 500 is up. That's a start, but it's not enough. We have to see this happen for several weeks.

3) Once the IPO market does open up, the quality of the first companies floated will be critical. Investors burned by the prior cycle will be looking for relatively established companies that have real topline growth and cash flow. And they will be looking for attractive "discounting," meaning pricing below the range that had been talked about before the slowdown.

Who might those companies be? Let's look at prior history.

We have been here before. We are now in a two-month IPO drought, but it's been much worse. After the 2008-2009 financial crisis, from September 2008 and March 2009, there was a 6-month period where there were only two IPOs. One company that broke the logjam was OpenTable (now owned by Priceline) which went public in May and popped 60 percent on its first day.

Think about that. Two IPOs in six months.

In 2011, there was a three-month period from August to October during the European financial crisis when the IPO market also dried up. One of the first IPOs to come out of that drought was Workday , another company with topline growth that priced at $28 and opened on October 12, 2012 at $48.05.

So, who might fit these criteria? First, there are a lot to choose from. There's 126 companies trying to raise $28.9 billion who have already filed to go public, according to Renaissance Capital.

Others—perhaps an equal number—are percolating under the radar under "confidential" filings, meaning they have filed with the SEC but don't have to disclose that fact until a few weeks before they go public.

But coming up with names that might lead the IPO charge is a tough call. Perhaps a tech name, like security firm SecureWorks, the Dell subsidiary. No debt. Revenues growing year over year, but they still have losses, though they are declining year-over-year. But the whole tech sector has been plagued by worries about multiple contraction.

How about other tech/media darlings? Spotify? That's a possibility. Pinterest? Sure. But these stocks have again been plagued with multiple contraction concerns.

Perhaps well-known consumer companies. Albertson's, perhaps, which postponed its IPO? It's well-established, but it has a lot of debt. US Foods? Again, a lot of debt, but the food sector has been holding up. Maybe. Univision? More debt.

A better choice in the consumer space might be fitness company SoulCycle, a high-growth consumer name.

This is the bottom line: all these names could go public soon if market conditions improve. But the investing public has been so burned that they are going to demand bargain prices, especially for the first few that come out of the gate.