What do investors need to know about IPOs?

Key points

• Dozens of technology firms are touted to list publicly via an IPO this year
• Investors must look beyond any hype to companies’ long-term commercial viability
• Patience and selectivity are key

A raft of high-profile, silicon valley companies is predicted to sell their shares publicly this year via an IPO (initial public offering). This has invited much speculation of whether investors should buy shares when these companies float on the stock market.

On the face of it, any IPO offers investors access to new opportunities, which in today’s environment typically means access to a new technology or platform. When it comes to investing in such opportunities, we believe in two key tenets – firstly that it often takes longer for a new innovation to make money than is initially forecast; and secondly, once that innovation does become commercially viable, it can impact far more customers than initially expected.

Read more about when innovation becomes investable 

Accordingly, we believe patience and selectivity are crucial when deciding whether to invest – either at an IPO or on the secondary market. While being an early investor in a company or technology can offer some initial or short-term upside, not all opportunities will be profitable. By waiting to see how well a company can translate innovation into a commercially viable business model and ultimately into profits, you can potentially separate the winners from the losers in any given area.

Granted, you might miss a portion of the short-term upside, but you could also miss out on price-finding market volatility and potentially gain more certainty over which companies are developing the most sustainable and long-term businesses.

For example, Salesforce was once one of many players in the customer-relationship management (CRM) software space, before pulling away to dominate the field. Having the patience to see which companies were best tapping into this field would have held an investor in good stead over the long term.

More specifically at Framlington Equities, we base our decisions on our fundamental, bottom-up stock selection, looking at the details like returns on invested capital and free cashflow generation once a company has been trading publicly for some time – for example we waited for four full quarters of earning before investing in Facebook following its IPO to ensure we saw commercial proof of its advertising platform. These decisions are underpinned by our collaborative research structure, which has been designed to ensure sustainable long-term growth outcomes for our investors.

IPOs by the numbers

+5%. Global IPO volumes rose 5% in 2018 from the previous year, although that was boosted by Softbank Corp’s IPO, the fourth largest IPO on record (source).

-42%. IPO dealmaking has had a more tepid start to 2019: despite bumper deals like Lyft, global IPO volumes are down -42% vs YTD 2018, marking the slowest opening period for IPOs since 2016 (source, data as at 24 April).

$13.5bn. Tech is the leading sector, accounting for more than a third of all deal activity so far this year ($13.5bn out of $32.6bn total) (source)

326 unicorns. There are estimated to be 326 private companies with valuations over $1bn (so-called ‘unicorns’) that could plan to go public

How do IPOs perform?

Short-term: From 2000 to 2016, companies that listed publicly posted, on average, negative absolute and excess returns after their first six months (source). After its IPO on 18 May 2012, “Facebook shares traded below the IPO price for more than 14 months after its first day of trading.” (source).

Longer-term: Most IPOs lose money for investors after five years – more than 60 percent of more than 7,000 IPOs from 1975 to 2011 had negative absolute returns after five years (source) – this encourages selectivity to invest in the winners.