IPO comeback: What’s driving the uptick?

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David Rawlings: Hi. You're listening to What's The Deal?, our investment banking series here on J.P. Morgan's Making Sense podcast channel. I'm your host, David Rawlings, Country Head of J.P. Morgan in Canada. Today, we're exploring the current state of the IPO market. Joining me is my friend and colleague, Keith Canton, who leads Americas Equities Capital Markets. Keith, welcome.

Keith Canton: Thanks, David. Really appreciate you having me today.

David Rawlings: Listen, before we dive in, why don't you just spend a minute to tell our listeners a little more about you and your role here at J.P. Morgan?

Keith Canton: Yeah, absolutely. I've now been in banking for over 20 years, but I actually started my career in publishing at Sports Illustrated Magazine. Currently, I run the Americas Equity Capital Markets practice, so really responsible for all of our IPOs, public equity, but also our private equity placement business as well. When I joined J.P. Morgan nine years ago, I was hired to actually found and build out that private capital markets platform.

David Rawlings: So we get lots of questions from the 20-year-olds who say, "How do we get into banking?" How did you make that shift?

Keith Canton: Well, coming out of Sports Illustrated, I was not quite qualified to make the leaps specifically into banking, so for me my route was going into business school, and I ended up joining Lehman Brothers as a summer associate in 2001, and a full time associate in 2002.

David Rawlings: And where did you go to school?

Keith Canton: I went to Fuqua School of Business at Duke University.

David Rawlings: Go Blue Devils.

Keith Canton: Yes, sir.

David Rawlings: Awesome. Listen, I had Lorenzo Soler, who is our Global Head of Equity Syndicate and a very good partner of yours, and we talked about IPOs. Let's just play a clip from last year's discussion with Lorenzo.

Lorenzo Soler: In terms of what our investor's looking for, what types of quality businesses are they prepared to buy, I would say there's massive focus now on structural growth stories with profitability. The days of 30 to 40% top-line with less of a focus on bottom-line are behind us for now.

David: What he said was there was this shift away from high growth unprofitable to more disciplined and profitable. We'll get into this in a second, but when you think about your day, volume is about 15 billion up materially from last year. So I shift to you, is the current activity consistent with that approach?

Keith Canton: Yeah, I think Lorenzo was spot-on. When you take a step back, you know, on the face the market looks quite positive. The Nasdaq, S&P are both effectively at all-time highs and really equity capital markets are up across all products. Follow-ons and blocks are up a combined 65%, converts up about 65%. And I know we're gonna focus here on the IPO market, but the IPO market right now is running about 2X what it ran last year. And you're spot-on, $15 billion raised year to date. First is just under 20 billion for all of last year. So we feel quite good about where things are.

David Rawlings: Now, I would say 2023 that's not your bench-mark years because that was still a tougher year, '22 and '23, but 15 billion, if you put that into the context over a longer period of time, it feels pretty healthy?

Keith Canton: Yeah, I mean, the way we think about it is pre-COVID we were running in the mid-40s from an IPO volume standpoint. That clearly jumped up to a peak of well north of a hundred in 2021, then we dropped to seven. And so we're coming off of all-time lows, 7, 20. And based on what we're seeing, we would expect the IPO market to end up in the 30s from a volume standpoint.

David Rawlings: Good, so almost back to normal. But you know, it's been dominated by some big deals, and you might wanna highlight a couple of those particular transactions for our audience.

Keith Canton: You're absolutely right. I mean, when we think about where we are in the market, maybe just taking a step back, deals are getting done and they're getting done well. The deals are working, they're getting done across all sectors. And to your point, they're actually getting done in size. This year, the average deal, the median deal when you take out biotech is close to $700 million. We're seeing quite sizeable deals and this year we've already had four or five billion dollar plus transaction, which is really showing the investor sentiment to get transactions over the finish line.

David Rawlings: And when you say investor sentiment, take that one step further. Is it a different type of investor that's showing up today versus last year? Like what's the composition and how's that changing?

Keith Canton: You know, I think the biggest positive we've seen this year is really much broader participation across the landscape. So the mutual funds have actually started to come back in a very big way. And you're also starting to see generalist portfolio managers come back into the market. And what that does is it really allows for more larger IPOs, particularly those IPOs placed with really fundamental investors. So we're reducing the reliance on sector-focused portfolio managers who might be size-constrained and hedge funds who might be more likely to churn in the after-market. And so the marginal IPO dollar, we can actually place that now into stickier hands. So it's really good to see the mutual funds and the generalist PMs come back into the market in a really material way.

David Rawlings: And then what about across sectors, is it consistently strong across sectors?

Keith Canton: Historically, technology is the dominate sector within the IPO market. We're not really there. In this market we've seen five tech IPOs this year out of about 30. So we're seeing broad-spread participation, consumer, industrials, financial services. Insurance has been a big part of the market so far. And in healthcare. Healthcare services meets Lorenzo's threshold of big scale profitable businesses, but you're also seeing biotech as well. We are seeing deals get done across all sectors. But interestingly, deals are also working, which I think is also leading investors to wanna get back into the IPO class. This year, if you strip out biotech, 80% of the IPOs in 2024 are above issue price and the median IPO is up about 20%. So the deals are working and that's really leading people to view the IPO product as really a source of alpha once again.

David Rawlings: All right, so let's strip that down in a few different ways. So you mentioned scale and profitability. I've also heard you talk about durability. So just go a little deeper on kinda what that means.

Keith Canton: When we think about what is an attractive IPO candidate, we always come back to scalability, profitability, and durability. So, are the companies really sizeable? If not, can they become sizeable companies? Are they profitable today or are they on a very clear path to profitability in the near term with a high degree of visibility? And are these durable business models? Are they providing a service or a product or solving something that is really gonna be around if the company decides to remain independent for the next 5, 10, 15-plus years? Do the business model really have durability to them? And what you're seeing in the class of '23 as well as the class of '24 IPOs, companies are checking really all three of those boxes. And if you're doing that, you're gonna get rewarded with an appropriate valuation but also the right types of investors. And if you can only check two of those boxes, and we've seen a couple of examples of big companies real business models but not yet tipping into profitability, those companies are pricing and seeing much more muted after-market performance.

David Rawlings: And then when you talked about after-market performance, why is that important?

Keith Canton: I thnk it’s important for a couple of reasons. First and foremost, people tend to think of the IPO as the event, but it's really only the first step in a journey to being a public company. On average, most of the IPOs are selling anywhere from 10 to 20% of the company, which means you get 80, 90% plus that still needs to be potentially monetized over time. And so if you show some early gains to investors and you perform quarter after quarter, you're gonna have a far bit of investors who are gonna be there to help you monetize your stake over time and really get you the maximum value for that residual 80% stake versus trying to maximize out that first 10 or 20% stake.

David Rawlings: Okay. When you think about the potential headwinds, there's geopolitical tensions and other things going on, what are you hearing in terms of pushback from the investors? And can you put some numbers around that?

Keith Canton: I think investors want to deploy capital but they're mindful that we are still facing headwinds. Inflation and labor cost are still up. And that has a big impact in the consumer sector. We do have geopolitical risk, which is incredibly hard for an investor to handicap, and to price in the right amount of risk premium there. And so when you think about all that, investors wanna make sure that they're coming in at the right price. And so what we've experienced is the traditional IPO discount has widened out pretty materially. Historically, we would’ve thought about a traditional IPO discount of plus or minus 15% when measured against what the market perceives to be the closest comparables. In this market, we're seeing IPO discounts of 20, 25, in some cases just north of 30% on that same basis. So investors are incredibly disciplined to make sure that they're getting in at the right entry price. And part of this goes back to the lessons that they learned from the class of '21 IPOs, where 3/4 of those IPOs are still underwater today. So investors, I think, are showing a heightened degree of discipline in today's market.

David Rawlings: Well, to your point, it seems to be working, as long as the company has appropriate scale and that business model is durable, there's interest. It's just you have to figure out at what price, and I think finding that intersection is what we do really well.

Keith Canton: I think that's spot on. We're very fortunate. We get to see a lot of high quality companies, and we have the opportunity to tell those stories into the public markets. And so, for us, it's really making sure we get that balance of scaled business that's showing real growth but is also very focused on profitability. And when you take a step back and think about what the market is telling us about profitability, we've seen almost a 5X change in the relative importance of profitability to growth, when we measure those in an analytical way. So the market is very much focused on profitability, but I always come back to the fact that the IPO market is really predicated on growth. It is a growth market.

David Rawlings: You had mentioned your structured equity background. I know you spend a lot of time with private equity and structured investors, and private equity's become a much bigger part of our market over the course of the last several years, across credit and equity. But if you're in this environment where companies need to be more mature, how does that impact them, and what are you seeing as it relates to your market?

Keith Canton: I think the current setup of large or in profitable companies actually plays quite well to where sponsors historically have invested their capital. When I think about the IPOs we did this year for Viking and UL Solutions, those, I think, provided quite a good readthrough to how sponsors might think about their portfolio companies. Those were both billion dollar plus IPOs. Those were both very profitable businesses with fairly low leverage on a relative basis. But importantly, over 80% of the proceeds in both of those transactions was secondary, back to the existing shareholders. And so if you're a financial sponsor that is really focused on how do I return capital to my limited partners, those two deals in particular, and there's been a few others, really, I think, provide some positive signs of life. And so when we're having our conversations with the sponsor community, we've absolutely seen a pickup in the preparedness of financial sponsors to wanna get their portfolio companies out into the public markets.

David Rawlings: Is it uncommon to see that much secondary stock in an IPO?

Keith Canton: Historically, when you're in a growth market, that would be very uncommon, because the companies really needed to raise the capital to grow their businesses. But in a world where the companies that are going public are already profitable, you really only have a couple of use cases. You can repay debt, you can think about acquisition capital, or you can give the capital back to the selling shareholders. And so just with the shift in the size of the companies, the profitability of the companies that are accessing the public market today, we're actually not surprised to see secondary proceeds be a very accepted use of funds from the buy side community.

David Rawlings: Okay. So that covers more traditional private equity. And how does this impact the venture community?

Keith Canton: The venture community is clearly one of our important constituencies. And what they're experiencing is, they're waiting a little bit longer to access the IPO market because they want their companies to grow into a sufficient scale that they'll be attractive in the public markets. Historically, we would've thought about a company with $100 million of revenue being public company-ready. That was an IPO in '20 or '21. In the current environment, those same metrics are probably closer to $300 or $400 million dollars before you're of sufficient size and scale to really attract mutual fund or a public company investor.

David Rawlings: Got it.  So let's just shift for a minute, here we are, halfway through 2024, as we think about the back half of the year, obviously we got an election cycle which we won't spend a lot of time on, but what are you hearing from investors in terms of their appetite? Do you think this market will remain resilient as we get through the summer and the fall?

Keith Canton: I think the summer and the fall should be fine. When we look at the companies that we have in our backlog, and we take a look at what we believe is gonna come across the street, I think you'll see a pretty healthy issuing cycle for the balance of this quarter, Q2, which is really June. Then I think you'll see a pickup in July, the number of companies are shooting for that July window. And then ultimately, we're gonna get into the fall. And I think the bulk of the issuance will really come in September, October. Most of the clients that we're speaking to really wanna get ahead of the election to the extent possible. And once you get past the election, your windows with the year-end holidays tends to get fairly limited. So I think we'll see a fairly active next two months, and then I think we'll see a fairly active September, October, and then it might be a little quiet then we would historically think about for the balance of the year.

David Rawlings: And my guess is, just given the time it takes to be ready to go public, you've already got a pretty good lens on that.

Keith Canton: We do. I mean, we are having organizational calls and kickoff calls for companies that are looking to IPO in October. And, as we tell our clients, if you really haven't picked your banks, picked your law firm, and are well down the path of the IPO process, you're really looking at 25 at this point.

David Rawlings: Okay. So listen, we've covered a lot of topics. Let's just bring it back home. We're in the advice business. You spend a lot of time giving advice to issuers, you also understand deeply what the investor wants. Can you just talk about what advice you are giving to corporates today?

Keith Canton: Yeah, I think two things really jump out at me when I think about what companies oftentimes don't think about when they're ready to go public. One is, how do you want the public markets to view your company once you're public? What are the KPIs that you wanna be able to tell quarter after quarter, that you wanna be judged on by the market? So start thinking about what those KPIs are today, start thinking about how you're tracking those KPIs today. And that's critically important. A lot of times companies get to the public market, and they haven't really thought about what narrative they wanna tell one, two, three quarters down the road. So I think that's particularly important. The other thing that we always focus on with companies is, make sure you can predict your business. The public markets reward consistency and predictability, and so, as you think about putting the financial model together, you wanna balance being aggressive with what can you actually deliver? And there is nothing that destroys credibility for a newly public company than missing the market's expectation in the first couple of quarters. So those would be the two things that, as we think about advice to our potential IPO clients, that we really try to hammer home.

David Rawlings: Yep. And then I think the third one you touched on earlier, which investors recognizing that this is a market you can get sized on, but you have to be less sensitive on discounts. Let's get a successful deal done, let's set ourselves up for multi quarters of performance, and then we can continue to monetize into the future.

Keith Canton: Spot on. There is a lot of equity to sell once you become a public company. The IPO is incredible, but it's just one step on the journey to being a public company.

David Rawlings: Well said. Okay, good. Listen, to recap, today we explored the IPO market, we discussed the recent uptick in activity, the changing landscape, and some notable trends across sectors and regions. Big thanks to you, Keith Canton, for joining me. Valuable insights as always.

Keith Canton: Thanks for having me, David.

David Rawlings: And thank you to our listeners for tuning into another episode of, What's The Deal? I'm David Rawlings, until next time, thanks for listening.

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