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ANALYSIS: Covid-19 Bear Market Biting Unicorns and Other IPOs

April 8, 2020, 12:41 PM

The first quarter of 2020 began somewhat slowly for initial public offerings. January saw a modest number of companies go public, then many more in February. The pace slowed in late February but continued until March 11, the day the World Health Organization declared that the spread of the novel coronavirus had officially become a world pandemic. The IPO market stalled completely. After Boston-based clinical-stage biopharmaceutical company IMARA Inc. began trading on March 11, not a single company went public on U.S. exchanges for the remainder of the month.

Crystal Balls Shattered; IPO Market in Pieces

So much for everyone’s 2020 economic forecasts. Covid-19 illnesses and stay-at-home orders upended a Wall Street bull market that had lasted 11 years and 2 days. It disrupted the plans of many startups hoping to go public before the anticipated volatility of a November presidential election. And it threw workers out of jobs faster than at any other time in the nation’s history.

The Renaissance IPO ETF, which tracks the performance of the most significant U.S. IPOs during their first two years as public companies, fell 15.3% by the end of the quarter—but the quarterly results could have been much, much worse. The fund closed out 2019 at $31.11, had a peak closing price on Feb. 19 of $35.14, and tumbled to an intra-day 52-week low of $20.37 on March 18, representing a 42% decline in four weeks before climbing back to $26.34 to finish the quarter.

Fear and uncertainty have created wrenching, whipsaw volatility for companies and investors alike. Companies, public and private, are scrambling to improve their cash positions. They are tapping their credit lines, and many public companies are looking to follow-on and debt offerings to shore up their positions. Private companies that had anticipated going public this year are analyzing their capital requirements and reassessing their plans in the face of this new, grim reality.

On April 6, Bloomberg reported that Airbnb had arranged a massive capital raise of $1 billion in debt and equity securities from investors Silver Lake and Sixth Street Partners. Banks have seen many companies tapping down on their credit lines to build up their cash on hand. Consequently, banks have seen their cash swiftly vanish, negatively affecting their liquidity ratios, and leading the Federal Reserve to intervene to support the banking industry.

The intense scramble for cash has directly affected the price of equities as stocks get sold, sometimes at prices sharply reduced from mere weeks before, to increase cash positions. The strong downward draft on equity prices beginning in late February has created a tremendously unpredictable—and, hence, challenging—pricing environment for would-be public companies to navigate.

A Passing Pandemic Pause?

Although the WHO’s pandemic announcement paused IPOs for the rest of March, the IPO taps have not turned off completely. Two IPOs, New York-based biotech Zentalis Pharmaceuticals and Chinese cloud software solutions company WiMi Hologram Cloud, priced over the first two trading days of April.

Nevertheless, numerous companies are delaying their IPOs until a date uncertain, including Cole Haan, Madewell, and Warner Music Group. Highly anticipated 2020 debuts from Airbnb, DoorDash, and Robinhood are in serious doubt.

Covid-19 Measures Drive Q1 Results Off Cliff

The market started 2020 with 15 IPOs ($5.5 billion) in January, rose to 24 ($6.6 billion) in February, and then saw 5 IPOs ($2.5 billion) price and begin trading in March before the WHO’s pandemic proclamation sent the market into a freeze. Stock indexes such as the Dow Jones Industrial Average and the S&P 500, representing the health of established, larger cap equities, had been trending sharply downward since peaking on Feb. 19.

The five IPOs completed in March represent the smallest monthly haul since only two companies went public in January 2016, raising only a combined $83 million. The IPO market in 2016 had also paused, with investors seriously concerned about sluggish global economic growth. Over the last 30 years, the only other time periods with similarly paltry monthly results coincided with actual recessions: the early 1990s, the early 2000s, and the Great Recession of 2008-2009.

A comparison of first quarter 2020 totals against first quarters since 2014 paints a less dispiriting picture. Over the last seven first quarters, the average deal count is 45, with a median of 43 IPOs. The first quarter of 2020 saw 44 IPOs completed, raising $14.61 billion. The average total first quarter deal value since 2014 is $11.4 billion, with a median deal value of $13.2 billion. Those figures put Q1 2020 slightly above recent IPO market performance. It should be noted that first quarter 2019 results were negatively impacted by the partial federal government shutdown during most of January 2019.

Deal Size Increases Dramatically in Q1

The well-established current trend toward larger offerings accelerated in dramatic fashion this year. Last year saw the $100M-$500M offering size become predominant by percentage of overall capital raised, firmly eclipsing the $1M-$100M offering size. That trend was supercharged in the most recent quarter despite a lack of super-unicorns to tilt the scales, such as Facebook, Alibaba, and Uber.

Five offerings did succeed in breaking the $1 billion barrier (the unicorn valuation threshold): Blackrock Health Sciences Trust ($2.2 billion), PPD Inc. ($1.8 billion), GFL Environmental Inc. ($1.4 billion), Reynolds Consumer Products Inc. ($1.4 billion), and Churchill Capital Corp III ($1.1 billion).

The smaller offering sizes completed more deals, however. The $1M-$100M offering size completed 17 IPOs ($742 million), the $100M-$500M size saw 20 deals completed ($4.2 billion), only two deals were completed in the $500M-$1B offering range ($1.6 billion), and the $1B-$10B offering size completed 5 IPOs in the first quarter, raising $8 billion. No mega-unicorn IPOs ($10 billion or larger) were completed during the quarter.

Life Sciences and SPACs Dominate Q1 IPOs

Two categories of IPOs, Life Sciences and Special Purpose Acquisition Companies (SPACs), combined in the first quarter to account for 59% of the 44 completed initial public of offerings, with 13 apiece. Life science companies are a subset of consumer, non-cyclicals and are comprised of biotechnology, pharmaceutical, and health care companies. In first quarter 2020, 100% of consumer, non-cyclical IPOs were life sciences companies. SPACs are blank shell companies that raise money in an IPO, then hunt for merger or acquisition targets. SPACs fall into the diversified industry sector.

Results from other sectors were tepid. Financials completed six IPOs to earn third place. Technology startups each posted four IPOs in the quarter, while communications and industrial companies each had two IPOs. Consumer, cyclicals recorded four IPOs in the quarter but are not included in the above chart, owing to their low count in preceding years. No energy companies went public during the period.

Life Sciences raised $4.7 billion in the recently completed quarter, leading consumer, non-cyclicals to raise the most money from IPOs compared to any other sector. SPACs raised $3.8 billion for diversified, while financials were close behind with $3.5 billion on less than half as many deals (six) as the top two sectors. Combined, the consumer, non-cyclical; diversified; and financial categories raised over $12 billion, representing nearly 83% of all monies raised by IPOs in the first quarter.

A year ago, the top sectors for the first quarter were financials ($4.9 billion), consumer, non-cyclical ($4.2 billion), diversified ($3.2 billion) and communications ($2.9 billion – boosted by the $2.3 billion Lyft IPO).

The top-raising IPOs for each sector in first quarter 2020 are listed in the table below.

Private Equity May Increasingly Fill Funding Needs of Startups

Taking more private investment and remaining a private company longer have become hallmarks of startups over the past decade. Now, the volatility of the equities markets and the caution of public market investors in the face of substantially increased risk are threatening to drive startups more firmly into the arms of private equity. Diminished outlooks for most industries near term will put tremendous pressure on public offerings, forcing companies to discount their offer price as volatility continues to make new offerings difficult, if not impossible, to price.

Enter private equity. Private equity firms began 2020 sitting on nearly $1.5 trillion in dry powder—unspent cash ready to be invested—according to a Bloomberg report citing Preqin data. Poor hedge fund performance and a better track record than major stock indices continue to attract investors to private equity, despite the long capital commitment—perhaps as long as a 10-year lockup. Private equity funds returned more than 13% a year on average over the 25 years ending March 2019. The S&P 500 posted returns of about 9% over the same period.

That $1.5 trillion in private equity dry power grew to about $2 trillion over the first quarter, but firms are reportedly waiting for the pandemic’s economic damage to be sorted out before putting it at risk. At a time when so many companies are feeling cash-poor and the price of equities has declined so far, so fast, private equity firms are surely looking closely for investment opportunities. Valuations have been high in recent years, and competition for deals remains fierce. A short-term drop in the value of private and public companies, combined with an increase in investor confidence, will likely lead to greater private equity activity before the year is out.

If there is one exception to the trend of staying private longer, it is likely to be life sciences startups. Biotechnology and other life sciences companies have very high cash burn rates, owing to the cost of research and development, and they tend to need to raise money in the public markets sooner than other businesses do. If the IPO route is temporarily unavailable, these startups will probably approach their existing investors for more funding. Pre-IPO biotech firms typically have a close relationship with their investors that continues after going public. Unlike most startups, when biotech and other life science startups conduct an IPO, insiders generally stay in and buy more shares rather than take the opportunity to exit their investment.

Other startups may find staying private longer than they had planned buys them time to wait for market conditions to improve without taking on the substantial extra expenses of going public and being a public reporting company at a time when they need every penny. Regardless of the business model, startups will need to reduce their expenses and solidify their capital positions if they are to weather what Goldman Sachs predicts will be a deep and painful recession.

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