New IPOs: turnaround in IPO activity
Deutsche Börse IPO indicator for Q2/2012
7 May 2012. FRANKFURT (Börse Frankfurt). Since August, IPO activity has come to a halt. The past fourth quarter saw a single IPO at Frankfurter Wertpapierbörse (FWB®, the Frankfurt Stock Exchange). The uncertainty on the capital markets continues to influence the primary markets. At the same time, there have been encouraging signals which indicate that IPO activity might be recovering. Despite all uncertainties, volatility in equity markets has remained on a relatively low level. Accordingly, we observed an upward trend of IPO climate. Within the period under report, Deutsche Börse’s IPO indicator has risen for the second time running to 29.78 points, albeit at a moderate pace gaining only half a point. According to our survey, market participants expect IPO activity to pace up considerably in the upcoming months.
Figure 1: IPO indicator light
Historical experience has shown us that the activities in the IPO market are exposed to cyclical movements. However, it is controversial which factors trigger these cycles, but there are certain patterns. One of these patterns is that a decline in market volatility is preceded by an increase in the primary market activity.
This pattern can often be identified in many markets, also in Germany, as figure 2 shows.
The toughening of the European debt crisis in July 2011 stopped the continuous trend towards a declining volatility of German shares that had dominated since 2009. Measured against the VDAX, the expected margin of fluctuation between late June and October 2011 almost exactly doubled from 18 to 34 points. Due to the aforementioned historic experiences, it has to be assumed that this decrease in volatility will have a positive effect on primary market activity.
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)
A second pattern is the correlation between price development and primary market activity. Here too, analyses have shown that an upswing in the primary market is basically preceded by an uptrend at the respective stock exchange. This correlation is also shown in figure 3. The market recovery expressed by the aforementioned lower volatility is also reflected in the valuation level.
Between the beginning of October 2011 and the end of January 2012, the DAX experienced an increase of almost 20 percent. Since then, we have been observing a sideway movement in the DAX. Altogether, this this development could lead to a revival of IPO activity.
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)
This forecast is calculated on the basis of the so called underpricing sentiment. It can be interpreted as the average underpricing of all new listings which took place in the past 18 months applying a time-based weighting method. However, as there were only a few IPOs, the figure should not be over-interpreted.
The underpricing sentiment was at 5 percent at the end of 2009, at the end of 2010 at 0 percent. In the meantime, it has fallen to 5 percent. It continued to decrease by another 5 percent in the third quarter and has since been stagnant at -5 percent, a level last undercut in the third quarter of 2004. In the light of the historical experience, this signal speaks against a revival of IPO activity in the upcoming months.
Figure 4: Underpricing sentiment and number of IPOs
Blue line: underpricing sentiment; grey bars: number of IPOs (moving three-month average)
The primary market sentiment is generated by the results of a survey among decision makers at banks, issuers and investors, the summary of which is represented by the IPO climate. The historical development of the IPO climate is represented in figure 5. As you can see, these subjective assumptions from decision makers reflect very well the actual development on the primary market.
Between March 2009 and December 2010, IPO activity saw a continuous upward trend, while a decrease marked the first nine months of 2011. At the moment, the IPO sentiment is at 29.38 points, levelling just slightly higher than in the second quarter of 2009. As it is, IPO climate has improved for the third time in a row, now levelling at 31.35 points. That indicates a turnaround also for the sentiment among market participants.
Figure 5: IPO climate and number of IPOs
Blue line: IPO climate in points; grey bars: number of IPOs (moving three-month average)
The valuation of companies, of course, plays an important part for the reception capacity of the primary market. Taking a closer look at the historical correlation, it becomes obvious that there is no clear relation in contrast to the two effects mentioned above. This may be due to the fact that issuers desire a high valuation, whereas investors prefer a low valuation at the time of issue.
It remains to be said, however, that the average price-to-earnings ratio in CDAX, levelling at around 12.44 percent at the end of April 2012, is significantly below the historical average of approximately 17 percent.
From the investors’ point of view, at least, IPOs might currently be thoroughly attractive. As a matter of fact, the survey amongst market participants has also shown that particularly investors still consider the valuation level at the markets attractive.
Figure 6: Average p/e ratio in CDAX
© 7 May 2012 / Christoph Kaserer, TU München