Trader’s Narrative

At the beginning of the year we looked at the long term trend of IPOs and how they track the speculative impulses that run through the stock market. If you missed it, check out the historical chart of IPOs.

Last year’s bear market completely shut down the initial public offerings and took the number of companies going public to lows that we hadn’t seen since 1978. Depending on what criteria you use, we had about last year we had between 20 and 43 IPOs. Although the year isn’t over, it looks like we are set for a quiet recovery. So far, about 67 companies have amended their existing filings or registered to go public. More than half of them coming after the March low in the stock market.

Here is a chart of the IPO market for the past 20 years:

Source: Bloomberg

There is no sign that we are about to revisit the speculative frenzy that we saw accompany IPOs in the last bull market. That kind of speculative sentiment takes time to generate and the current IPO market is merely returning to ‘normal’ after the shock of the financial crisis. If anything, the IPO landscape going forward will be more selective and opportunistic.

Secondary Market
While the primary market is returning to normal, the secondary issues market has roared to life as companies rush to recapitalize and heal their damaged balance sheets. Just this week more than 15 US companies announced plans to issue more shares for a total of $7 billion. The largest chunk of that comes from Barrick (ABX) who is removing their infamous short position against gold. The same is true around the world. Lenovo and Alibaba both will place shares in Hong Kong. As well Cemex, the Mexican cement giant, will issue $1.8 billion worth of shares.

IPO Pipeline
Here is a chart of the quarterly IPO pipeline for issues filed, priced, and withdrawn:

There is a limited history shown but you can see that the activity in the IPO market in the past few quarters has mirrored closely what we saw in the bear market that followed the tech bubble. Around the same time that the stock market stabilized in late 2002 and early 2003 and again in early 2009, the number of IPO withdrawals increased, filings and pricings dropped to a trickle.

Here you can read the recently released report on the third quarter IPO outlook from Renaissance Capital. If the link doesn’t work, you can also find it at the Free Trading Resource section of the blog (in the Reports folder).

Look, I know we’ve been starved for IPOs… but this is ridiculous! Today was the debut of Changyou.com (CYOU) a Chinese website portal spun-off Sohu.com (SOHU). Changyou is a recently launched MMORPG (massive multi-player online role playing game) much like “World of Warcraft“.

You’d think we’re back to the Tech Bubble era where companies would slap a dot com after their name, have one product or service related to the internet and float shares… and watch them soar into the stratosphere.

CYOU shares received healthy demand and priced in the upper range ($14 to $16) and popped at the open. Unless you were able to get your hands on an allocation, you missed the +25% one day gain. The difference between this IPO and the Tech Bubble IPOs is that Changyou actually makes money and is a “growth” story. It was priced at around 6.5 times earnings to make it palatable because keep in mind, it is based on only one product - within the very fickle entertainment/gaming sector.

Personally, I wouldn’t touch CYOU with a barge pole (as an investment) but after the regulatory IPO period is over, it might be a great short (akin to other one product wonders like Crocs).

The last real IPO in the US was Mead Johnson (MJN), another spin-off - from Bristol-Myers Squibb (BMY). It didn’t open the flood gates of initial public offerings, as many thought, and has traded sideways. The lack of IPOs is not only indicative of a very sick stock market, it is no fun. The only silver lining around this cloud is that, in the long term, the kind of IPO drought that we’re seeing now, characterizes generational lows. Take a look at the long term historical chart of IPOs going back to the 1970’s.

On a grand scale, you could argue that the level of the stock market is set by two forces: the supply of ‘paper’, which comes from initial public offerings (IPOs), secondaries and other corporate actions, and on the other side, the demand of stocks which is not only influenced by the sentiment of investors but also by valuation and perhaps most importantly, by the supply of money in the economy.

The amount of money sloshing around the economy matters because eventually it has to find a home. In the past decade we’ve seen it rush into two markets, causing sequential bubbles in tech stocks and real estate.

One way to look at the relationship is to chart the change in change of money supply and see how it corresponds to the market and the economy. The chart below shows 35+ years of monthly data but before you can make sense of it, some explanation is needed:

Data: St. Louis Fed (FRED database)

M2 is a widely used measure of the money supply but since inflationary and deflationary periods can warp it, we look at inflation adjusted M2 (using CPI numbers). This gives us ‘real’ M2 which is more useful to compare across time. But we also have to account for the number of people in the economy because everything else being equal, on average, the more people we have the more money is used by them. So we divide the real M2 by the estimated monthly US population to get per capita, ‘real’ M2.

Then finally, we are interested in the annual rate of change that occurs in the real per capita M2 money supply, which gives us the chart you see.

The middle line represents zero, so anything above that means that the rate of change in money supply is positive and the Fed is pumping money into the economy (and vice versa). Obviously, the more extreme the move and the more the line stays above the 7 year moving average, the more significant it is.

From the latest data available (January 2009), the annual rate of change is higher than it has ever been - even higher than the early 1980’s. This means that eventually, as it works its way through the economy, there will be more and more money chasing fewer shares, driving up the level of the stock market.

Credit for this measure comes from an article by Norman P. Poiré, published in Barron’s on August 28th, 2000. If you aren’t a subscriber, you can read the article on Poiré’s website.

I know that the IPO market activity is a contrarian indicator for the stock market but this is ridiculous! The present public issuance market is the worst we’ve seen since the vicious bear market of the 1970’s.

The last IPO to grace us was Grand Canyon Education (LOPE) back in November 20th, 2008. Before that, we had Rackspace Hosting (RAX) on August 8th, 2008 and China Mass Media (CMM) on August 4th, 2008. Can you believe for the whole year, we only had 20 IPOs?

According to the National Venture Capital Association (NVCA), venture capitalists are bracing themselves for a very tough year in 2009. Please join me in a moment of silence for the poor Patek-Philippe wearing, Veuve-Clicquot sipping VC who won’t be able to flip his holdings to Mom’n'Pop for the usual 10 bagger. Most of them expect the IPO market to thaw sometime next year; but 92% of VC’s surveyed said they expect a slowdown in investments with 61% believing that the slow down would be more than 10% compared to last year, and cause funding to fall to $27 billion for the year.

The Obama adiministration’s stimulus package may become the main theme of IPOs for the remainder of the year as investment banks try to ride the wave of infrastructure plays. But right now, there are a couple of IPOs coming down the pipeline already, hinting that we may be starting to see some action soon:

• O’Gara (OGAR) - a homeland security play
• Mead Johnson (MJN) - infant nutrition [spin-off from Bristol-Myers Squibb (BMS)]
• Medidata Solutions (MDSO) - biotech consulting firm

Believe it or not, I can still remember a time when traders had the luxury of predominantly trading IPOs and spin-offs!

Here’s an interactive chart (use the slider to zoom in) showing historical annual data for the number of IPOs :
Continue reading ‘Will The IPO Drought End In February 2009?’

No, really. When was the last time you saw an IPO in the wild? or in captivity?

According to the Standard & Poor’s it has been almost 3 months since we had an IPO. Unless I’m mistaken, that would be Rackspace (RAX) a internet hosting company which has seen its share fall almost 60% (from the offer price of $12.50).

This is nearly as bad as things got in early 2003. You remember that dark hour in market history, don’t you?

But the IPO freeze isn’t limited to the US. Over in Europe the same thing has taken hold. Not only are IPOs completely on hold, but any financial dealing, including mergers, acquisitions, buybacks, etc. are similarly shelved. This can’t be good news for financial firms who are grappling with the most intense crisis we’ve ever seen. It is as if all the taps were turned off instantly.

Or for their employees. Time to brush up on the resume or gasp, consider grad school

Usually a dry period in IPOs is bullish because it indicates that prices are too cheap. But right now we are not seeing a normal cyclical turn of the markets. This is very unusual because if it were a matter of stocks being cheap, so many firms would not be canceling buybacks as well. Obviously things are so bad everyone is getting in a fetal position and hoarding cash.

Either this is extremely bullish or the momentary suspension in the air before we plunge to zero. Your pick.