Equity investors may get their fingers burnt as IPOs hot up

America’s capital markets are as deep and liquid and IPOs are a standard feature of the financing landscape; week in, week out there will be a smattering of US listings regardless of the economic weather. In Europe, by contrast, it’s either feast or famine. At the moment we’re enjoying a fat period but the stop-start nature of the market can lead to over-heating when too many companies rush to list at the same time.

A more global (and more fundamental) problem concerns the purpose of IPOs. If they were, at least in the majority of cases, used to raise capital that was then invested in the long-term growth of the company, that would be one thing. But when a staggering proportion are used to realise the investments made by private equity firms, it is another thing altogether.

There is nothing wrong with this practice per se – after all, if buyout firms don’t have a ready means to exit their investments, they will be unable to make others. However, the sheer number of private equity-backed flotations – according to Dealogic 55% of all European IPOs by value this year were by financial sponsors – gives pause for thought: what do they know that we don't?

If legions of private equity firms are lining up to realise their investments by floating companies on the stock exchange, they can’t be particularly optimistic about future equity valuations. If they were, they’d hold on to their investments a little longer and, in so doing, make more money. Do these astute investors suspect the market is looking a little toppy?

Of course, private equity firms don’t have a crystal ball and they could very easily be wrong. But still, history suggests that equity investors get burnt soon after the IPO market gets too hot.

more