Institutional investors are increasingly positive about the IPO market, a new Ernst & Young survey shows.
According to the more than 300 institutional investors surveyed in December, a vast majority - 82% - have invested in pre-IPO and IPO stocks in 2012 compared to only 18% in either 2010 or 2011.
Going forward investors cite the prospect of a brighter corporate earnings outlook, an improving macro-economic environment and more stable equity markets as the key drivers of sustained positive market sentiment through 2013.
“These results dispel the myth that institutional investors do not support the IPO market," says Maria Pinelli, Global Vice Chair Strategic Growth Markets, Ernst & Young. "Not only was there a significant pick up in interest in 2012 but the sentiment for 2013 is equally positive if not more so.”
Majority of investors are focused on domestic markets
So where are investors intending to place their bets? Mainly domestically – investors expect to favor investment in their home or regional markets for the next three years.
This sentiment was particularly true of investors in North America where 89% are focusing investment in domestic listings. By contrast, European investors are most inclined to support listings outside their home region. At 41%, the percentage stating a preference to invest overseas is more than double that of those in the next most adventurous region – Africa and the Middle East.
Very few (13%) of Asian investors are actively looking at opportunities overseas, while only 9% of Central and South American investors look outside their home region.
Investors perceive rapid growth markets as both more risky and more expensive with 72% of investors saying the risk is higher and 41% believing valuations are higher. Risk perceptions are strongest among North American investors.
“With deep and liquid capital markets at home, US investors may feel less need to take on this additional risk,” explains Pinelli.
The popular perception that PE and VC-backed IPOs leave less value on the table for future investors appears to be a myth, according to the survey results. Investors have varied perceptions on the price of financial sponsor-backed IPOs versus other IPOs.
Just over 40% of institutional investors believe they are more expensive, leaving around 60% who say that such IPOs are the same or cheaper, implying higher returns for new investors.
Financial services have universal appeal
The survey highlights that financial services is the industry with the highest appeal in every region. Overall, 51% of investors currently have it as one of the top three sectors in their portfolio.
The next highest ranking sectors are consumer retail (35%), consumer products (27%), oil and gas (26%) and technology (21%).
“Investors are attracted to financial services due to high demand for financial services globally and a rise of innovative service,” says Pinelli. “Consumer industries are particularly strong in fast growth markets where populations are young and expanding and where incomes are rising.”
IPOs need right team, right story and right price
Right price featured in 91% of investors’ top three critical factors influencing IPO success across all geographic regions and investor types. This was followed by the right story which was cited in the top three by 65% of investors and right team by 57%.
“For an equity story to be compelling, companies need to provide the evidence that the business model has performed well in recent years and that there is a solid track record of growth and an actionable plan to sustain it,” explains Pinelli.
“The findings underline the fact that good quality companies led by the right team, offered at the right price and with a good story to tell will always command the attention of the market. Companies that are well prepared will be able to launch when the window opens up.”
Overpricing: The biggest threat
Reflecting the importance of launching at the right price with the right management team, over-pricing ranks as the top challenge to IPO success, cited by 85% of investors, followed by having the wrong team (56%). Going public too early in the life cycle of the business is seen as the third most significant challenge (43%), often triggered by the need for capital or concerns to capitalize on what’s seen as a limited window of opportunity.
“The good news is that the top challenges to IPO success can be managed – these are all factors that companies can address,” says Pinelli. “Those that do can expect their investors to hold onto their stock for longer – our findings show that 73% of investors hold IPO stocks as long as they are performing.”
How investors view success as a public company?
Overwhelmingly, investors view success as a public company as dependent on three factors that outweigh all others by some margin: strong operational excellence (66%), fulfilling investors’ expectations (66%) and using IPO proceeds as planned (47%).
“As ever success is all about delivering on your promises so that you meet or beat market expectations. Investors want to hear every quarter about how you’re performing against what you promised. It’s impossible to predict every event, but if a company delivers bad news or surprises investors, it can suffer up to a 50% drop in market value and it can take up to three years to regain credibility in the public market,” says Pinelli.
Sustained positive outlook
Through this year and 2014, the positive outlook for IPO investment highlighted by the findings should be sustained.
“Notwithstanding the possibility of equity market volatility, we expect continued Institutional investment in IPOs. Given investors’ positive sentiment towards public listings, the key question of timing will depend on when pre-IPO companies are ready to meet investors’ terms and expectations,” says Pinelli.
“The US will continue to lead the way, followed by rapid growth markets in Asia – particularly China – and Brazil. The sector mix is unlikely to change significantly in the next five years although investments in mining and metals and oil and gas will likely increase on the expectation that rapid growth economies continue to build their infrastructure and manufacturing capabilities.”