After 2 Tough Years, Will Falling Rates Boost IPOs?

If you relish the excitement (and risk) of trading initial public offerings (IPO), the last two years are ones you might rather forget.

Sure, the 52% increase in IPOs from 71 in 2022 to 108 in 2023 sounds good, but considering how soft things were in 2022, the total remains low versus historic trends, and the diagnosis for 2024 remains unclear.

In 2023, 108 IPOs priced, raising proceeds of approximately $19.4 billion, according to Renaissance Capital. That was up from 71 IPOs and $7.7 billion in 2022. Leaving out the astonishing 397 IPOs that priced in 2021, last year’s IPO tally was well below the 2014 to 2020 average of 184.

Things look slightly brighter with 2023 in the rear-view mirror, but 2024 remains an open question with interest rates still elevated. 

Small steps toward earlier IPO growth

Several high-profile IPOs, including Arm Holdings (ARM), Instacart (CART), and Birkenstock (BIRK), made their Wall Street debuts in recent months, with Arm representing the largest info tech IPO since 2019, according to Renaissance. Arm’s IPO raised $4.9 billion of the $7.8 billion total raised in 30 IPOs for Q3. That $7.8 billion figure outpaced all funds raised through IPOs for the full year of 2022. Arm shares performed well following the IPO, but some other well-publicized IPOs in 2023 landed with a thud on Wall Street.

Smaller issuers continued to dominate activity, with just seven IPOs raising $100 million or more in Q3. The smaller an IPO, typically the less opportunity to trade it and with possibly more risk. By contrast, if you turn the clock back to Q3 of 2019, before the pandemic, IPOs raised nearly $11 billion. At the time, that was considered disappointing.

Tech IPOs have grabbed the most headlines in recent years. That sector might enjoy a better 2024 for a number of reasons, including venture-backed companies that need cash, possible Federal Reserve rate cuts that could make investors more interested in tech growth stories, and venture firms’ need to show public market success if they want to continue raising funds, Barron’s recently reported.

While IPOS aren’t for everyone, some traders enjoy getting on the ground floor of a newly listed company, and the relative absence of IPOs the last two years arguably took some excitement out of the stock market. New shares can sometimes surge on their first day of trading and keep traders on their toes.

For instance, between 1980 and 2023, the average IPO “pop” was 18.9%, according to the University of Florida.

Of course, there’s a risk of IPOs flopping and leaving you with empty pockets.

Take Uber (UBER), for example. It was one of the most anticipated IPOs of 2019, but its shares lost more than 7.6% on its first trading day. Home security company ADT (ADT) lost 11.5% in its 2018 debut, and China Petroleum & Chemical Corp. (SNP) lost 4.4% on its first day of trading in 2000.

While pricing IPOs isn’t necessarily a science, buying them on the first day can be risky if the company and its underwriters put the initial price of shares higher than the market decides they’re worth. Overpricing may not be deliberate, but it can reflect caution on the company’s part to not leave money on the table. Anyone investing in an IPO should keep in mind the company and its banking partners aren’t putting shares on the market to do investors any favors.

Many investors have limited IPO exposure

But just as some skiers like the challenge of steep black diamond runs, some traders accept the inherent risk of IPOs. They’re ready for possible bumps and ice, knowing that sometimes the thrill is in the ride.

Even if you’re a long-term investor who’d never consider trading an IPO (and as a long-term investor, that could be too much risk to take on), it could be beneficial to monitor the IPO market.  

If you mainly own index funds, you probably have exposure to IPO activity through the financials sector’s shares, a sector that’s felt the impact of the relative absence of both IPOs and mergers and acquisitions in particular and higher rates pressuring deal and lending activity in general.

The S&P 500^® Financial Sector Select Index (IXM) rose nearly 10% in 2023 versus 24% gains for the S&P 500 index (SPX), ranking mid-pack of 11 S&P sectors in terms of 2023 performance. There’s a long list of reasons why most of 2023 was tough for banks and other financial firms, but the soft environment for IPOs is arguably among them. 

Some U.S. investment bank leaders think things are looking up on the IPO front even if a healthy outcome isn’t assured.

“I do think you’re going to see some more meaningful IPOs in 2024,” said David Solomon, CEO of Goldman Sachs, speaking in the company’s January 2024 earnings conference call. “And we are just, across debt and equity issuance, seeing more activity, more engagement. At the end of the day, people had done a lot of funding that takes them out for a period of time, but they’ve got to start thinking about their capital structures and accept the reality of the market, and we’re seeing that come through.”

Private companies need incentives to go public, like the chance for a major cash infusion. However, some recent IPOs performed poorly, dampening enthusiasm. High interest rates are another factor discouraging companies from going public, because higher rates tend to depress earnings growth potential and sap investor interest in buying shares of young companies that may have to rely on borrowing to grow their business. However, borrowing costs are down from last October’s 16-year peaks.

Sharon Yeshaya, CFO of Morgan Stanley, said in the company’s January earnings call that equity underwriting revenues were flat for the company because “activity remained muted” in the final months of 2023 but sounded optimistic about the future.

“Corporate confidence will ultimately drive the cycle forward, and we are encouraged by signs the CEO and boardroom optimism is growing, evidenced by the build of our advisory and IPO pipeline,” Yeshaya said.

Also in January, Adena Friedman, CEO of Nasdaq®, told Barron’s that close to 100 companies have filed confidentially with the Securities and Exchange Commission (SEC) for IPOs and plan to list on Nasdaq. Friedman said she expects to see at least a few companies attempt IPOs in the first quarter, in both health care and technology, Barron’s reported.

Though major investment banks and the Nasdaq sound hopeful, keep in mind that just a year ago, financial media headlines suggested the IPO market could bounce back in 2023. Though it did improve from 2022, it still wasn’t an impressive performance.

When it comes to investing in IPOs, investors should consider proceeding with caution. Often in recent years, an IPO with lots of publicity and hype cratered soon after its opening day. Sometimes investors confuse a company brand with its business. In other words, you may love the product, but that doesn’t necessarily mean you have to love the stock too.

One potential problem with IPOs is that many investors might rush in. People can be excited to invest in these companies, but it’s good to keep the potential downside in mind.

Just as with any other investment, it’s important to do your homework and make sure you understand IPO basics and risks and that education, not hype, drives your decision-making.