For IPO investors, some of the substantial gains from the prior decade were wiped out by a flurry of poorly performing IPOs that were issued in 2020 and 2021. There are several bright spots, including the strong performance of software and internet IPOs even when including 2020/2021 vintages. In this special issue Eye on the Market, we look at the wild ride of IPO performance, the SPAC disaster, IPO flipping, insider lock-up expirations, striking findings on IPO performance erosion in healthcare and some data on financial sponsors with the best performing IPOs.
Watch the Podcast
00;00;00;14 - 00;00;30;44
Michael Cembalest
Okay. Good morning, everybody. This is Michael Cembalest with the Eye on
the Market podcast, which is now both in audio and video versions. So
thanks for listening. Every couple of years I write a deep dive paper on
private equity and venture capital from the perspective of limited
partner investors in those investment vehicles. And I decided to switch
it up this year instead and write about the IPO market, which are the
companies that all of those financial sponsors bring public.
00;00;31;20 - 00;01;00;39
Michael Cembalest
And I decided to do it now because enough time has passed for us to
assess the impact of the crop of 2020 and 2021 IPOs on the investment
universe. And it's not pretty, but it's not as bad as you might think. So
that's what this IPO paper is all about. It's called Mr. Toad's Wild Ride
and is drawn from a Disney RKO short film from “The Wind in the Willows”
in 1949.
00;01;00;41 - 00;01;22;57
Michael Cembalest
So with that, let's get started. And obviously you can look in the Eye on
the Market for all the details. I just wanted to hit some of the
highlights on this podcast. So for many years, here's the irony. There
was a lot of hand-wringing in the industry and by academics that there
was a slowdown in the pace of new listings and IPOs.
00;01;23;14 - 00;01;44;23
Michael Cembalest
And my answer is be careful what you wish for. You just might get it.
Because we had an explosion of IPO activity in 2020 and 2021, both of
which have now collapsed in large part because of the poor performance of
some of those recent vintages. And that's what we discussed and analyzed
in this paper.
00;01;45;06 - 00;02;13;31
Michael Cembalest
So the thing to remember about IPOs is they're a very skewed asset class.
Here we're looking at net returns of IPOs over two years. And net means
net of an equity market benchmark. Right. You always have to analyze IPOs
relative to something. What's your opportunity cost? And here we're using
the Small Cap Growth Index as a benchmark because there's lots of tech
and biotech and healthcare that dominate IPO issuance.
00;02;13;31 - 00;02;36;18
Michael Cembalest
And so that's why we're using a Small Cap benchmark. And here you can see
the skew. The vast majority of these lose money over a two-year basis
relative to the benchmark. But then you've got this tail of mega-winners,
which offsets that. And the value proposition for long-term investors in
IPOs has always been, do the handful of winners offset the bulk of the
losers?
00;02;36;32 - 00;03;04;12
Michael Cembalest
And until 2020, the answer to that question was generally yes. But then
this recent crop of IPOs really kind of damage that story because there
were so much of them. So let's take a closer look. And here, look what I
mean by the skew in the market. If we take away just the top 3%, best 3%
performing IPOs, look what happens to your average absolute return and
your average net return.
00;03;04;56 - 00;03;30;55
Michael Cembalest
They get hit pretty hard. And so that's an example of a very skewed
market. So here is another way of looking at things. This is the share of
all IPOs that either have negative absolute or net returns two years
later. Obviously, relative to that benchmark, we're talking about, even
in good times, somewhere between 30% to 50% or a little more of these
IPOs generate negative returns.
00;03;31;18 - 00;03;59;10
Michael Cembalest
Look what happened in 2020 and 2021. We had a surge in the number of
underperforming IPOs. So, this was unfortunately the confluence of
monetary stimulus, fiscal stimulus, lots of risk appetite, and a lot of
companies that were brought public that probably shouldn't have been. And
here, this is another way that we track how the IPO market is doing.
00;03;59;41 - 00;04;25;28
Michael Cembalest
The orange line is the average return, and the blue line is the median
return. Any skewed universe is always going to have a much higher average
than median return. Activist investing is another great example of that.
And from 2010 to 2019, even though the median deal that you might have
invested in didn't make any money, on average you did because of those
handful of winners.
00;04;25;51 - 00;04;53;49
Michael Cembalest
So on a two-year basis, the value proposition of IPO investing for the
decade of the 2010s was a positive experience. And then look what
happened from those 2020 and 2021 IPOs. They really kind of decimated the
history of this thing. To understand the impact on an IPO investor, we
can't simply compound these annual returns because in 2020 and 2021,
there were so many more IPOs that got issued.
00;04;54;18 - 00;05;19;34
Michael Cembalest
So we use a simplified portfolio framework to say, well, what if somebody
put $100 into every IPO, held it for two years before selling and then
measured their performance versus that Small Cap Growth Index? Here you
can see that you would have made money for the vast majority of that
2010s decade. And then you would have given a bunch of it back in 2021
and 2020.
00;05;19;54 - 00;05;45;40
Michael Cembalest
And specifically, if you invested in all sectors, you would have given
back all of your gains from 2019, which are substantial, but you would
have still retained those gains from the prior decade. And so, let's dig
into this because there's a big difference between tech and healthcare
and specifically biotech. If we look at technology, this is really the
brightest spot of the entire IPO market.
00;05;46;04 - 00;06;14;02
Michael Cembalest
And even with the 20, look at this chart, even with the 2021 and 2020
vintages, you only gave back a half a year versus your accumulated gains.
And so, in other words, yeah, the crop of 2020 and 2021 IPOs and the
technology sector had their issues, but they only mildly dented the
historical returns a long-term IPO investor would have had. Looks very
different in the healthcare sector.
00;06;14;11 - 00;06;42;34
Michael Cembalest
The chart on healthcare shows you gave back not just half a year, but two
years of accumulated gains. And biotech and pharma is an interesting
place as it relates to the IPO market. The premise is to give investors a
chance to recognize the value creation associated with the proof of
concept on the drug. So that would be phase three trials.
00;06;42;52 - 00;07;20;11
Michael Cembalest
FDA adoption, entitlement program coverage and things like that. But
since you're exposing investors to those positive events, whenever they
don't happen, you can lose a lot of money. And that's part of what
happens in the IPO market. And the longer you hold some of these IPOs in
the healthcare sector, the worse they actually do. So the table that
we're showing here that obviously you can look at in the Eye on the
Market as we increase our holding period from one year to two years to
three years, the technology sector returns go up, whereas the healthcare
returns actually go down.
00;07;20;56 - 00;07;41;56
Michael Cembalest
The first table that we have shows the average returns. When you can
really see this, is the median returns. And so when we look at the median
returns, they really get hammered in the healthcare sector, whether we're
looking at healthcare services or pharma and biotech as we go from one to
two to three years.
00;07;42;27 - 00;08;02;32
Michael Cembalest
So as I said, what is happening between years one, two and three in the
healthcare sector to make these IPOs underperform so much? And what we
did was we looked at all of the hundreds of healthcare IPOs over the last
13, 14 years and between years one and two, an enormous number of them
crash and burn.
00;08;03;04 - 00;08;27;44
Michael Cembalest
So we have a chart in here that looks at them by decile, right? So we
take all these pharma biotech IPOs and we decile them. Even the 70th
percentile biotech IPO didn't make any money. It was flat. Right. So you
actually go to the 80th percentile of IPO performance to make money. The
rest of them were either flat or lost a lot of money.
00;08;28;02 - 00;08;53;27
Michael Cembalest
And so, again, there's a lot of drug development failures that take
place. And you're really participating in this for the handful of
winners. In contrast to all of this analysis, we also looked in this
study at IPO flipping, right. So IPO flipping is a casual way of saying
that people buy IPOs and sell them within a few days, and a few days
either meaning literally the end of the first day close or within seven
days.
00;08;54;07 - 00;09;16;59
Michael Cembalest
And this is kind of a remarkable investment Opportunity said, I haven't
seen too many things that look like this in terms of just how stacked in
favor of the investor is. So this chart, we have a bunch of different
charts in the paper on IPO flipping, but this one shows the distribution
of returns. Overwhelmingly, 80% of the time, IPO flipping has worked.
00;09;17;22 - 00;09;39;40
Michael Cembalest
Now, when it doesn't work, you can still lose a serious amount of money.
But when you look at the weighted average outcomes from IPO flipping,
they're extremely beneficial to investors. And not only that, even with
the bad crop of 2020 and 2021 IPOs, they didn't really do a lot of damage
to the history of IPO flipping. So it's been a very successful category.
00;09;41;21 - 00;10;09;53
Michael Cembalest
I do want to spend a couple of minutes on the SPACs because more than the
metaverse and more than unprofitable hydrogen and EV companies and crypto
and things like that, SPACs are probably the best example of too much
policy, too much risk appetite, and people completely losing sight of all
their underwriting bearings. And I wrote about SPACs during the peak of
the boom in early 2021.
00;10;10;29 - 00;10;34;58
Michael Cembalest
It was a piece called Hydraulic Spacking that was very critical of the
adverse selection of companies that were coming public. And everything
that's happened in the SPAC market since then has been borne out by that
initial fear I had about what was going on. We have a chart in here that
shows that SPACs grew to be the same size as the entire IPO market in
2020 and 2021, which is ridiculous, since it barely existed before that.
00;10;35;29 - 00;11;03;21
Michael Cembalest
And if we take a look at the average returns on SPACs relative to the
market, they've lost almost 60% versus the stock market. I mean, I've
rarely seen anything as bad as this. And so I anticipate that there's
going to be a permanent demise of this particular financing approach, say
for a handful of these things every year.
00;11;04;08 - 00;11;32;11
Michael Cembalest
So that is a very quick overview of some of the more important and
interesting parts of this IPO analysis. We also looked at the consumer
sector, the diversified sector. We looked at mainland China, we looked at
renewable energy IPOs, which has been have been a very difficult place to
invest. We've looked at size effects and we also looked at financial
sponsors because I wanted to see how the sponsors are doing themselves.
00;11;32;26 - 00;11;56;01
Michael Cembalest
Now, it's not the job of a financial sponsor to generate great returns
post-IPO, right? Financial sponsors job is to deliver high returns to the
limited partners in their vehicles. But as investors in IPOs and as
people who manage money in public equities, I was interested in whether
there were any consistent patterns of financial sponsors bringing good
deals to market or not.
00;11;56;46 - 00;12;16;01
Michael Cembalest
And so we get into that a little bit in the paper, and we do show a list
of the financial sponsors that have had the best track record of bringing
IPOs to market that maintained their value two years later. So anyway,
thank you very much for watching and listening. The Eye on the Market is
available to look at today.
00;12;16;37 - 00;12;27;31
Michael Cembalest
In early September, we'll revisit the business cycle and whether or not
this recent immaculate disinflation is sustainable. But until then, thank
you very much for listening, and we'll see you next time.
(DESCRIPTION)
J.P.Morgan, Disclaimer, Products are not insured or guaranteed.
(SPEECH)
Good morning, everybody. This is Michael Cembulest with the Eye on the Market podcast, which is now both an audio and video versions. So thanks for listening.
Every couple of years, I write a deep dive paper on private equity and venture capital, from the perspective of limited partner investors in those investment vehicles. And I decided to switch it up this year instead and write about the IPO market, which are the companies that all of those financial sponsors bring public.
And I decided to do it now, because enough time has passed for us to assess the impact of the crop of 2020 and 2021 IPOs on the investment universe. And it's not pretty, but it's not as bad as you might think. So that's what this IPO paper is all about. It's called Mr Toad's Wild Ride, and is drawn from a Disney RKO short film from the Wind in the Willows in 1949.
So with that, let's get started. And obviously, you can look in the Eye on the Market for all the details. I just wanted to hit some of the highlights on this podcast.
So for many years, here's the irony. There was a lot of hand-wringing in the industry and by academics that there was a slowdown in the pace of new listings and IPOs. And my answer is, be careful what you wish for. You just might get it.
Because we had an explosion of IPO activity in 2020 and 2021, both of which have now collapsed, in large part because of the poor performance of some of those recent vintages. And that's what we're going to be-- that's what we discussed and analyzed in this paper.
So the thing to remember about IPOs is they are a very skewed asset class. Here, we're looking at net returns of IPOs over two years. And net means net of an equity market benchmark.
You always have to analyze IPOs relative to something. What's your opportunity cost? And here, we're using the small cap growth index as a benchmark, because there's lots of tech and biotech and health care that dominate IPO issuance. And so that's why we're using a small cap benchmark.
And here, you can see the skew. The vast majority of these lose money over a two year basis, relative to the benchmark. But then you've got this tail of mega winners, which offsets that. And the value proposition for long term investors in IPOs has always been, do the handful of winners offset the bulk of the losers?
And until 2020, the answer to that question was generally yes. But then this recent crop of IPOs really kind of damaged that story, because there were so much of them. So let's take a closer look.
And here, look what I mean by the skew in the market. If we take away just the top 3%, best 3% performing IPOs, look what happens to your average absolute return and your average net return. They get hit pretty hard. And so that's an example of a very skewed market.
So here is another way of looking at things. This is the share of all IPOs that either have negative absolute or net returns two years later-- obviously, relative to that benchmark we're talking about. Even in good times, somewhere between 30% to 50% or a little more of these IPOs generate negative returns.
Look what happened in 2020 and 2021. We had a surge in the number of underperforming IPOs. So this was unfortunately the confluence of monetary stimulus, fiscal stimulus, lots of risk appetite, and a lot of companies that were brought public that probably shouldn't have been.
(DESCRIPTION)
Line graphs.
(SPEECH)
And here, this is another way that we track how the IPO market is doing. The orange line is the average return, and the blue line is the median return. Any skewed universe is always going to have a much higher average than median return. Activist investing is another great example of that.
And from 2010 to 2019, even though the median deal that you might have invested in didn't make any money, on average, you did because of those handful of winners. So on a two year basis, the value proposition of IPO investing for the decade of the 2010s was a positive experience.
And then look what happened from those 2020 and 2021 IPOs. They really kind of decimated the history of this thing.
(DESCRIPTION)
Both lines fall.
(SPEECH)
To understand the impact on an IPO investor, we can't simply compound these annual returns. Because in 2020 and 2021, there were so many more IPOs that got issued.
So we use a simplified portfolio framework to say, well, what if somebody put $100 into every IPO, held it for two years before selling, and then measured their performance versus that small cap growth index? Here, you can see that you would have made money for the vast majority of that 2010s decade.
And then you would have given a bunch of it back in 2021 and 2020. And specifically, if you invested in all sectors, you would have given back all of your gains from 2019, which were substantial. But you would have still retained those gains from the prior decade.
And so, but let's dig into this. Because there's a big difference between tech and health care, and specifically biotech.
If we look at technology, this is really the brightest spot of the entire IPO market. And even with the 20-- look at this chart. Even with the 2021 and 2020 vintages, you only gave back a half a year versus your accumulated gains.
And so in other words, yeah, the crop of 2020 and 2021 IPOs and the technology sector had their issues. But they only mildly dented the historical returns a long term IPO investor would have had.
(DESCRIPTION)
Next chart.
(SPEECH)
Looks very different in the health care sector.
The chart on health care shows you gave back not just half a year, but two years of accumulated gains. And biotech and pharma is an interesting place, as it relates to the IPO market.
The premise is to give investors a chance to recognize the value creation associated with the proof of concept on the drug. So that would be phase III trials, FDA adoption, entitlement program coverage, and things like that.
But since you're exposing investors to those positive events, whenever they don't happen, you can lose a lot of money. And that's part of what happens in the IPO market. And the longer you hold some of these IPOs in the health care sector, the worse they actually do.
So the table that we're showing here, that obviously, you can look at in the Eye on the Market, as we increase our holding period from one year to two years to three years, the technology sector returns go up, whereas the health care returns actually go down.
And this table is-- the first table that we have-- shows the average returns. When you can really see this is the median returns. And so when we look at the median returns, they really get hammered in the health care sector, whether we're looking at health care services or pharma and biotech, as we go from one to two to three years.
So as I said, what is happening between years one, two, and three in the health care sector to make these IPOs so much? And what we did was, we looked at all of the hundreds of health care IPOs over the last 13, 14 years. And between years one and two, an enormous number of them crash and burn.
So we have a chart in here that looks at them by decile, right? So we take all these pharma and biotech IPOs, and we decile them. Even the 70th percentile biotech IPO didn't make any money. It was flat. So you actually have to go to the 80th percentile of IPO performance to make money. The rest of them were either flat or lost a lot of money.
And so again, there's a lot of drug development failures that take place, and you're really participating in this for the handful of winners.
(DESCRIPTION)
Line graph.
(SPEECH)
In contrast to all of this analysis, we also looked in this study at IPO flipping. So IPO flipping is a casual way of saying that people buy IPOs and sell them within a few days-- in a few days either meaning literally the end of the first day close, or within seven days.
And this is kind of a remarkable investment opportunity set. I haven't seen too many things that look like this, in terms of just how stacked in favor of the investor is. So this chart-- we have a bunch of different charts in the paper on IPO flipping. But this one shows the distribution of returns.
Overwhelmingly, 80% of the time, IPO flipping has worked. Now, when it doesn't work, you can still lose a serious amount of money. But when you look at the weighted average outcomes from IPO flipping, they're extremely beneficial to investors.
And not only that, even with the bad crop of 2020 and 2021 IPOs, they didn't really do a lot of damage to the history of IPO flipping. So it's been a very successful category.
I do want to spend a couple of minutes on the SPACs. Because more than the metaverse, and more than unprofitable hydrogen and EV companies and crypto and things like that, SPACs are probably the best example of too much policy, too much risk appetite, and people completely losing sight of all their underwriting bearings.
And I wrote about SPACs during the peak of the boom in early 2021. It was a piece called Hydraulics SPACing, that was very critical of the adverse selection of companies that were coming public. And everything that's happened in the SPAC market since then has been borne out by that initial fear I had about what was going on.
We have a chart in here that shows that SPACs grew to be the same size as the entire IPO market in 2020 and 2021, which is ridiculous, since it barely existed before that. And if we take a look at the average returns on SPACs relative to the market, they've lost almost 60% versus the stock market. I mean, I've never I've rarely seen anything as bad as this.
And so I anticipate that there's going to be a permanent demise of this particular financing approach, save for a handful of these things every year. So that is a very quick overview of some of the more important and interesting parts of this IPO analysis.
We also looked at the consumer sector, the diversified sector. We looked at mainland China. We looked at renewable energy IPOs, which has been a very difficult place to invest. We've looked at size effects.
And we also looked at financial sponsors. Because I wanted to see how the sponsors are doing themselves. Now it's not the job of a financial sponsor to generate great returns post IPO, right? Financial sponsor's job is to deliver high returns to the limited partners in their vehicles.
But as investors in IPOs and as people who manage money in public equities, I was interested in whether there were any consistent patterns of financial sponsors bringing good deals to market or not. And so we get into that a little bit in the paper, and we do show a list of the financial sponsors that have had the best track record of bringing IPOs to market that maintained their value two years later.
So anyway, Thank you very much for watching and listening. The Eye on the Market's available to look at today. In early September, we'll revisit the business cycle and whether or not this recent immaculate disinflation is sustainable.
But until then, Thank you very much for listening, and we'll see you next time.
(DESCRIPTION)
Michael Cembalest, Chairman of Market and Investment Strategy, Logo, J.P.Morgan.
