IPO comeback:
What’s driving the uptick?
[MUSIC]
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 cuurrent
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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