From blockbuster to bust: Behind the precipitous drop in IPOs

David Gura

July 06, 2022 / 4:00 am

Lynn Martin has been the 68th president of the New York Stock Exchange for six months, and so far, her tenure has coincided with a period of extreme volatility.

It started out on an auspicious note. On Jan. 3, her first day on the job, the S&P 500 and the Dow Jones Industrial Average closed at new highs. But since then, the two indexes have fallen about 20% and 15%, respectively.

With inflation rising at the fastest pace in four decades and the prospect of a recession looming, Wall Street worries are running at a fever pitch.

"You know, I view markets as a mirror to the way people are feeling," Martin says. "A lot of times, there's uncertainty, and that winds up getting expressed in markets."

The anxiety and fear have led to sharp sell-offs in stocks big and small. And it's freezing out IPOs, or initial public offerings, from private companies that are scared of selling their shares to the public at a time when investors are pulling away.

There have been about 80% fewer IPOs, or new stocks listed, on Martin's exchange so far this year, compared to the same period last year.

It was a record year for IPOs in 2021

The comparison might be a little unfair because the markets were running hot in 2021, when the U.S. economy emerged from the darkest days of the COVID-19 pandemic.

As the government pumped stimulus money into the economy and people didn't have too many places to spend, bank balances ballooned last year. Millions opened stock trading accounts with online brokerages.

The stock market responded with a record number of IPOs.

"It was a blockbuster year, by all accounts," says Rachel Gerring, the head of the Americas IPO practice at Ernst & Young, of 2021. "There was a lot of pent-up demand and appetite for high-growth companies, primarily in tech and healthcare."

Today, investors are less confident of the prospect of future growth at many companies.

As the Federal Reserve hikes interest rates to rein in inflation, borrowing costs will continue to rise, and that could force companies to preserve more cash, take fewer risks and invest less in their futures.

The calculus has shifted with an uncertain future for the economy

A huge part of Martin's job is to convince private companies to list on the New York Stock Exchange. Right now, she says, many of them are just waiting for the future of the economy to come into finer focus, and for the sharp sell-offs of the first few months of the year to subside.

"The pipeline is very strong," says Martin. "But it's on pause."

At the Nasdaq, the New York Stock Exchange's main rival, it's the same story. In 2021, 753 companies went public on the Nasdaq. In the first half of this year, there were only 108 new listings.

Jeff Thomas, Nasdaq's chief commercial officer, says investors' expectations are different, and they have a smaller appetite for risk. It's harder to predict how companies will perform, and also, what they will be worth in the future.

When he talks to the heads of private companies, they often ask him about how investors are likely to value their companies. According to Thomas, that calculus has changed.

"Part of the conversations with executives is getting them to wrap their heads around the fact that they likely aren't going to get the same valuations this year that the bankers promised them last year," he says.

Valuations were incredibly high last year, but since then, share prices have sunk. On average, shares of companies that went public in 2021 are 42% lower than when they started trading, according to Ernst & Young.

SPACs and new Chinese stock listings have also vaporized

A handful of other factors are conspiring to make 2022 a tough year for the stock exchanges.

Because of a regulatory standoff between China and the U.S., Chinese companies are not going public in the U.S. In June, Didi, a ride-sharing giant that went public a year ago, left the New York Stock Exchange.

On top of that, another fad that flourished is fading. In 2020 and 2021, hundreds of private companies went public via SPACs. Shorthand for special-purpose acquisition companies, the SPACS provided a shortcut way for companies to go public. They attract less regulatory scrutiny compared to traditional IPOs. The companies use a mechanism where they pair up with shell companies already listed on the exchanges to sell their shares.

"Investors were looking for places to put that money, and SPACs seemed like a relatively attractive place," says Thomas.

But, there is less money sloshing around now, and some 600 SPACs are sitting on the sidelines, with no one to pair with.