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Would WeWork in your portfolio?

By Tom Wickers, Hottinger Investment Management

WeWork announced yesterday evening that it has shelved its initial public offering (IPO) after the reduced price-tag failed to turn investors’ heads. While the firm has not yet announced how long the delay will be, financial pressures would suggest it cannot postpone for long unless its current major financier, SoftBank, forks out more cash. The WeWork shelving leaves the IPO market in an awkward position, not dissimilar to the global economic environment, where analysts will wonder whether there is much more petrol left in the tank.

IPO investors have enjoyed a successful 2019 so far. Whilst the performances of ride-hailing firms Uber -24.28% and Lyft -34.74%* have been stuck in reverse, many IPO companies have rocketed up on the voracious appetites of investors. The year-to-date performance of the Renaissance IPO Index, which invests in recent US IPO stocks, is at +32.79%. This is a result of strong growth in 2018 IPO holdings as well as monstrous growth from recent IPOs such as Beyond Meat +511.72% and Zoom Video +126.47%. 

Figure 1: IPO Index YTD growth**

Now, while the global economy stumbles and contemplates its position and a WeWork offering looks precarious, there are still several listings that continue to plough forward. Peloton has kicked off its roadshow, Airbnb is expected to list this year, AB InBev has renewed its pledge to go public and Aramco may yet push forward with its IPO plans when it has repaired its infrastructure and tightened security. This may be seen as surprising given the cyclical nature of IPO deal flow and the current uncertainty embedded in the markets.

Figure 2: IPO cyclicality

Assessing historical IPO returns can shed some light on whether this market should be attractive at all. First Trust US Equity Opportunities ETF (FPX US Equity) trades in stocks which have recently undergone an IPO. Since inception their performance has outstripped the US equity market. Even when accounting for different risk exposures through a Carhart four-factor model regression, the fund still averaged 1.44% higher return per year than we would expect.

Figure 3: IPO performance

These findings concur with a recent study conducted by Goldman Sachs which evaluated the performance of 4,481 IPOs since 1995, and found that an IPO portfolio outperforms the market. It is, however, worth noting that the median IPO actually underperforms, meaning that the portfolio relies on the high returns of a minority of companies.

Figure 4: Goldman Sachs analysis^

Perhaps more pertinently, Goldman Sachs also found that IPOs appear overpriced compared to the market before a recession^^, which would suggest investors may want to steer clear of new IPO stocks if they are forecasting a looming downturn.

The performance of the top 5 largest IPOs in each year between 2011 – 2017 also bears bad news. Analysing the returns of these stocks for a year post-launch reveals that they have underperformed the market by 0.25% per year on average and underperformed an asset with similar risk exposures by 0.21% per year (using a Carhart model). A potential explanation for this is that big IPOs are subject to “market hype” and so suffer more from a post-offer waterfall. Large IPOs have also tended to be mature companies this decade, which have less room for growth. This, however, does little to explain the poor risk-adjusted returns. The volatility and downside risk of the returns on these stocks are also particularly unattractive and would dissuade the majority of investors from holding a sizeable position in an IPO stock.

Figure 5: Weekly returns showing volatility and downside risk

IPO activity has been piping hot so far this year, but the numbers suggest a cooler outlook on performance in the near future might be wise. With big companies still pushing to go public and high levels of market uncertainty, there is a risk of the general listing being overvalued.

When assessing a specific case, it is also worth evaluating the motives for listing at this time – is it an action born of confidence or desperation?

* Percentage change on stock price since inception. Statistics were as of 13/09/2019.

** Data taken from the Renaissance Capital website

^ Data from Goldman Sachs Global Investment Research, as of 28/08/2019.

^^Source: https://markets.businessinsider.com/news/stocks/5-most-important-factors-for-successful-ipo-performance-goldman-sachs-2019-9-1028507003#valuation3


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