A Turning Point for the Struggling US IPO Market

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The year 2023 has been a challenging period for the IPO landscape, marking possibly the worst performance in new stock offerings since the financial crisis of 2008. A confluence of unfavorable conditions and valuation challenges has deterred companies from going public, resulting in a dismal atmosphere across capital markets, from Hong Kong to Wall StreetDespite a significant rebound in U.Sstock markets since the beginning of the year, the primary market continues to show a declining trend, contributing to a wave of layoffs in major financial hubs, including New York and Central Hong Kong.

When examining the U.Sstock market, it is evident that many high-profile companies that went public in 2020 and 2021, such as Rivian, Coinbase, and Roblox, faced inflated initial pricing, leading to substantial declines in their stock values after their debutsHowever, there is hope that the upcoming IPOs of semiconductor giant Arm and grocery delivery service Instacart could inject some vitality back into the market, alongside a slew of other companies poised for public offerings.

The valuation situation is particularly dire

Stakeholders find themselves caught between the necessity to maximize returns for existing investors, while simultaneously attracting IPO investors by presenting appealing growth potentialTherefore, determining the right pricing strategy remains crucial for the future resurrection of IPO opportunities.

This year could turn out to be the worst for IPOs in the U.Sin nearly a decade and a halfThe preceding two years witnessed a parched IPO environment, with the number of listings dropping significantly from the record highs observed in 2021 when over 1,000 companies ventured onto American exchanges.

The year 2022 highlighted a significant shift where most major IPOs were launched outside U.Smarkets, and 2023 is likely to exacerbate this trendSome analysts contend that 2023 may represent the nadir of the U.SIPO market since the disarray caused by the financial crises of 2008 and 2009. Among the few notable offerings this year has been Johnson & Johnson's spin-off of its consumer healthcare division, Kenvue, and the initial public offering of VinFast, an electric vehicle manufacturer from Vietnam.

So, what has caused the IPO drought? Since 2021, companies have become increasingly reluctant to pursue public listings due to a backdrop of unfavorable market conditions, which have compelled many to postpone or entirely abandon their IPO ambitions

The reasons for this hesitance are multifaceted.

Firstly, the cessation of easy money has played a pivotal roleRapid inflation, which began to trend upward in mid-2021, prompted central banks to initiate aggressive interest rate hikes starting in early 2022. The shift created a stark contrast to the ultra-low interest rates that had characterized the market since the financial crisisThe Federal Reserve has since raised rates from near-zero to above 5%, significantly altering the financial landscape.

Consequently, high inflation has inflated corporate costs and squeezed profit margins, while soaring interest rates have increased the cost of servicing debt, making capital acquisition both more challenging and expensiveThe tapering of monetary stimulus that characterized the pandemic period has contributed to slower spending and economic activities.

Secondly, the interplay of the pandemic and geopolitical tensions has significantly shifted the global landscape

Initially, the pandemic catalyzed a stock market recovery as consumers leaned on technology during lockdowns, driving up the valuations of tech stocksHowever, this trend eventually unraveled as valuations reached unsustainable heightsFor instance, the NASDAQ 100 index peaked in 2021 with a price-to-earnings ratio of 39, but this has since plummeted to around 28.

The end of the pandemic may have provided short-term relief, yet new challenges are surfacing, such as persistent inflation and decreased consumer spendingThe pandemic and ongoing conflicts have also disrupted global supply chains, further complicating recovery efforts.

While many of the pandemic-related issues and supply chain disruptions have eased, several adverse factors persistInflation, though cooling, remains stubbornly high, and markets are still contemplating whether interest rates have peakedFurthermore, China's economic revival continues to unfold, and there are no signs of de-escalation in wartime tensions

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Overall, while conditions have improved since last year, the outlook remains uncertain.

Thirdly, the poor performance of recent IPOs has instilled caution among prospective issuersMany companies have been disheartened by watching their peers struggle to garner market interest or achieve satisfactory returns post-IPOThe disappointing performance of newly minted stocks has made many potential IPO candidates wary.

Examples abound with companies that saw their stock prices plummet after an initial, exciting debutAirbnb serves as a prime example; its shares surged initially but experienced a significant drop within months, accentuating the risks associated with going public during tumultuous market conditionsA few successes stand out, however, such as Palantir and Snowflake, whose stocks benefited from a resurgence in demand for artificial intelligence—helping them regain and surpass their IPO levels.

Fourthly, the decline of SPACs (special purpose acquisition companies) has contributed to the downturn in IPO activity

In 2021, many companies found success going public via SPACs, which allow companies without assets to raise capital from investors intending to buy existing business entities and list on stock exchangesWell-known entrants through SPAC mergers include Lucid Group, Fisker, and WeWork, among many others.

However, the SPAC market has since cooled, as many of these investment vehicles face pressing deadlines to identify and acquire suitable targets to retain their listing statusThis has compounded the difficulty of finding reputable deal opportunities, leading to an uptick in failed SPAC transactions.

Nonetheless, SPACs have not entirely disappearedFor instance, VinFast entered the public market via a SPAC and unexpectedly became one of the world's most valuable automakers, although its low free float makes it susceptible to significant price swingsThis aspect could also pose complications for the broader market still recovering from many high-valuation IPOs in 2020 and 2021.

As investors remain cautious towards IPOs, it is critical to note that several large companies are preparing to enter the market

Arm and Instacart are two such companies expected to make headlines with their upcoming IPOs, which will undoubtedly test current market conditions for valuations and investor sentiment.

The implications of these IPOs stretch beyond the immediate offering; their valuations and subsequent performances will set the tone for other companies considering going public this yearIf established companies like Arm and Instacart struggle to win market confidence, it may deter additional companies—especially those still operating at a loss but with potential for growth—from stepping into the limelight.

Arm is reportedly seeking an estimated valuation of between $60 billion and $70 billion, potentially making its IPO one of the largest in the U.Ssince Rivian achieved a $70 billion valuation in 2021. Comparatively, this figure is more than double the valuation of $32 billion at which SoftBank acquired Arm in 2016.

However, this valuation stands in contrast to its net profit of $524 million for the twelve-month period ending in March

This suggests a staggering price-to-earnings ratio of 114 to 134, marking it as relatively high among U.Ssemiconductor stocksArm's global reach and established history of success—being the chip designer essential to nearly every smartphone—does lend some support to its stabilization post-IPOStill, some analysts express concerns that Arm's near-saturation in its current market could limit future growth prospects.

In contrast, Instacart appears to have a more optimistic outlookWith reported net profits of $428 million in 2022, it anticipates an estimated valuation of $10 billion, implying a more manageable price-to-earnings ratio of around 23. When benchmarked against similarly valued companies like Uber and DoorDash, which have been under pressure, this figure appears more reasonable.

As numerous companies signal their intention to go public, many may closely monitor the IPOs of Arm and Instacart as critical indicators of investor appetite for new listings

Potential candidates include payments technology firm Stripe, fintech company Chime, data and AI firm Databricks, along with social platforms Reddit and DiscordShould market enthusiasm continue to build, these companies might consider going public later this year or early next year.

It is worth noting that the anticipated IPO cohort includes both profitable entities and others still grappling with lossesRecent trends in the market suggest an inclination toward companies demonstrating solid profitability prospects, whereas those in high-growth, high-risk territories may attract more skeptical scrutiny.

In conclusion, the downturn in IPOs is unlikely to persist indefinitely, and the key factors at play will be valuationsOver the past couple of years, numerous firms have opted against going public, primarily due to witnessing many newly listed companies suffer from inflated valuations in a turbulent market environment

However, the resilience of the U.Seconomy and corporate profitability continues to surpass expectations.

Various economic indicators are trending positively, suggesting that inflation may gradually ease and potential interest rate adjustments could emerge in 2023, paving the way for a "soft landing." Consequently, this weak period for IPOs may not endure too long—especially as alternative methods of raising capital become less appealing or feasible.

Early-stage startups typically rely on venture capital for funding; however, this capital is diminishing while debt costs are on the riseFurthermore, investors looking to exit through an IPO maysoon conclude that public markets could provide more enticing pricing compared to other methodsNo company is keen to charge recklessly into the public realm, but the bold moves from firms like Arm and Instacart may define the industry's trajectory moving forward.

Ultimately, the success of newly listed companies hinges fundamentally on valuations

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