New IPOs: lacklustre primary market
Deutsche Börse IPO indicator for Q3/2012
13 August 2012. FRANKFURT (Börse Frankfurt). The uncertainty which is still prevailing in equity markets as a result of the ongoing euro crisis has also direct impact on the primary market. Given the price increases in the stock market and the volatility which is developing sideways, the sentiment has indeed improved. However, the Deutsche Börse IPO indicator remains at the low level of the previous quarters. In particular, the IPO climate which reflects the sentiment of market participants is again quite gloomy. Since May, we have seen seven IPOs bringing movement to the primary market, but only two of the newly listed companies are currently levelling above their issue price. Accordingly, the perceived underpricing remains at historically low levels.
The Deutsche Börse IPO Indicator, which deals extensively with the conditions for IPOs, is the result of a survey among relevant primary market participants – investors, corporations and investment banks taking place every three months. The information they provide about their expectations is then combined with quantitative variables such as stock prices, first day trading profits and volatility.
Figure 1: IPO indicator light
Consistently high volatility
Triggered by the euro crisis, the high level of price volatility in stock markets strongly influences the sentiment in the primary market. In the period under report, i.e. from early May to late July, the expected volatility on a 30-day horizon, measured against the VDAX-New, remained nearly consistent at over 20 percent. Large fluctuations in the first two months might have produced a damaging effect particularly on business confidence. At its peak, the volatility of German blue chips has soared above 35 percent.
One possible explanation for the significance of the effects volatility has on emissions is uncertainty, stronger price movements for the first day trading profits and, consequently, the success of an IPO from the perspective of the company and the supervising banks. Figure 2 shows the correlation between price volatility and the cyclical activity in the primary market, using historical data.
Figure 2: Moving average of the number of IPOs and VDAX-New
Blue line: market trend of the VDAX-New (indexed); grey bars: number of IPOs (moving three-month average)
... at recently rising share prices
From early May to late July, the German stock market moved almost sideways up to 6,770 DAX points. Although prices for German blue chips had fallen sharply to less than 6,000 in the meantime, the prices have now recovered significantly. This was actually supposed to have a positive effect on IPO activity.
Prices in the secondary market
There is a strong correlation between prices in stock trading and the IPO market. Analyses have shown that an upturn in the primary market is typically preceded by gains.
Figure 3: Moving average of the number of IPOs and DAX
Blue line: market trend of the DAX (indexed); grey bars: number of IPOs (moving three-month average)
... and a dampening perceived underpricing
The Frankfurt Stock Exchange saw seven IPOs in the period under report. This revival is a positive signal, especially after the first quarter of this year with no IPOs, and the fourth quarter of 2011 with one single IPO.
However, since these companies are essentially small caps and only two of the seven companies have a current price which is ranging above their issue price, or else both, the issue price and the first price of most of them were levelling at the lower end of the price range, these IPOs could not really lighten up the sentiment.
The perceived underpricing, which measures the price signals provided by IPOs, remains at its historically low level of the previous quarters of minus 5.15 percent.
The price signals provided by the underpricing are an important element in the development of primary markets. In particular, first day trading profits, i.e. the difference between the issue price and initial share price, play a major role, as they indicate investor acceptance and simultaneously trigger a self-reinforcing feedback loop among investors. In fact, the underpricing can be used as an early indicator for the primary market activity.
Figure 4: Underpricing sentiment and number of IPOs
Blue line: underpricing sentiment; grey bars: number of IPOs (moving three-month average)
… while IPO climate is bad
The IPO climate remains gloomy at the level of the previous quarters and has even slightly deteriorated from 31.35 to 29.94 points. It is striking that the sentiment among issuers seems much worse than that of the investors or banks. This suggests that the lull in the primary market is driven mainly by issuers. The latter evidently believe that the prices they could achieve in an IPO, are too low.
The primary market sentiment is generated by the results of a survey conducted by Deutsche Börse among decision makers at banks, issuers and investors. The results of the survey are summarised in an index value, the so-called IPO climate. The historical development of this IPO climate is represented in figure 5. As clearly discernible, this subjective evaluation by decision makers provides a good representation of the actual development on the primary market. Between March 2009 and December 2010, the IPO climate continuously improved, while a decrease marked the first three quarters of 2011, a trend that is continuing after the slight recovery we saw at the turn of the year.
Figure 5: IPO climate and number of IPOs
Blue line: IPO climate in points; grey bars: number of IPOs (moving three-month average)
Conclusion: Cautious outlook
In a nutshell, we can say that the conditions for initial public offerings have not improved since spring, even if the markets’ valuation levels have recently increased in a significant way and volatility is moving sideways or has slightly decreased. Therefore, the Deutsche Börse IPO Indicator shows no further primary market stimulation. In any case, companies are rather reluctant when it comes to IPOs during the third quarter. The reason for this lies in the rhythm of publishing balance sheets, as companies prefer a stock exchange listing with fresh annual or half-year results.
© 13 August 2012/Christoph Kaserer, TU Munich, Edda Vogt