Contributing to the extent of these declines is the fact that 2021 was a record year for IPOs, with almost 2,400 deals raising more than US$450 billion globally. Some hangover was always inevitable, notwithstanding economic and geopolitical developments.
Speakers agreed that surviving current macroeconomic uncertainties was the key to improving investor sentiment for IPOs. This is particularly important as central banks in advanced economies from Australia to the US aggressively raise interest rates to combat inflation.
As Rothschild & Co’s Stuart Dettman observed, the resultant market volatility “isn’t the friend of capital markets” and directly correlates with a reduction in IPO activity. Investors were waiting to see how these central bank interventions might impact economic growth, corporate profitability and market valuations. And, as the window narrows for IPOs to be completed in 2022, fund managers would likely continue to maintain their current positions rather than consider new opportunities. “It’s going to be a tricky period to navigate,” Dettman said. “On the capital markets side, I think investors will be cautious. What develops over the course of the next few months on the economic front is going to be a real driver for what the final quarter of the year looks like for IPO activity.”
Greg West of IDP Education noted that he had just returned from New York on (non-IDP) listed company business. This involved preparing companies for future fundraising, as well as introducing them to investment banks and other market participants. In many sectors, including fintech and biotech, the sentiment is that US capital markets have effectively “shut up shop” until the outlook is more certain.
Andrew Lockhart of Metrics noted that the Australian Government’s recent changes to benchmark the investment performance of superannuation funds had prompted re-allocations across a range of investment strategies. “Volatility is always a concern to us because it flows into nervousness around investments. People start switching,” he said. Calvin Kwok of Pinnacle added: “This is the time to invest with active managers. We’ve seen the shift from growth to value. Obviously, everyone is trying to navigate around the volatility quite carefully.”
Meeting urgent capital needs
Australian companies currently have limited options to raise capital, particularly as the major banks reduce liquidity. Yet in some situations the need to raise capital has increased.
Amelia Hill of MA Moelis noted that businesses may have invested heavily in inventory, potentially at high freight rates, as supply chain disruptions hit. Unable to pass the costs onto customers given the weaker macro environment, they now face increased margin pressure. Bing Jiang of Next Capital added that many companies are also having to deal with wage pressures and workforce shortages. These factors could reduce earnings, placing pressure on their ability to comply with debt covenants. These are all reasons companies may need to come to market to raise fresh funds.
Some private businesses have raised shorter-term capital in the pre-IPO market in recent years, typically issuing investors with debt that only converts to equity once public listing occurs. However, if an IPO cannot be executed before the near-term maturity of this debt, capital must be raised relatively urgently to repay it, or other arrangements negotiated.
On the plus side, publicly listed businesses are generally significantly less leveraged today than during the Global Financial Crisis (GFC). In addition, debt markets remain open, also unlike the GFC (although they are tighter). This has reduced the likelihood of a significant increase in emergency raisings to shore up over-extended balance sheets, according to Will Lawrence of Wilsons.
Where emergency raisings are required, roundtable participants did expect affected companies would be more likely to find support from existing shareholders looking to protect their existing investment. Garnering demand from new investors would likely prove difficult for companies in or near distress.
When the tourism industry experienced extreme difficulties during the pandemic, it was noted that Flight Centre and Webjet both issued convertible bonds to aid their post-pandemic recovery. While such structures can be complicated (and therefore, not appropriate in all instances), they represent an option where investors perceive value but are not tempted by the current share price.
The roundtable agreed it seemed highly unlikely current conditions would spur interest in vanilla bonds. Despite federal government reforms in 2014, a meaningful market has not eventuated, with raisings arguably still more costly for issuers relative to traditional bank finance.
Strategic capital raises
A key theme in equity capital markets is the switch in market power, from companies raising money to those providing it. Many institutional investors are flexing their muscles, seeking discounted share prices and greater liquidity in stocks.
Lockhart recounted how Metrics pursued an entitlement offer in early 2022. The initial plan to keep the offer open for several weeks was paused due to market volatility in January. An eventual two-week capital raising in February was completed with a separate wholesale investor placement subsequently arranged over a couple of days in May. Sometimes, he added, the decision to launch is purely driven by the market: “If investors are coming to us saying that they’d like to have the opportunity to participate in a capital raising – we’re responsive.”
Successful capital raises are also occurring where funds are needed to pursue accretive mergers or acquisitions. Dettman described a recent transaction in which insurer AUB Group undertook a $350 million equity raising to purchase a business in the United Kingdom (UK). AUB Group had a market capitalisation of $1.7 billion and the acquisition cost of the UK business was about $1 billion. The process was structured to minimise market risk, with the bulk of equity proceeds raised quickly. “This transaction illustrates that despite current market volatility, investors will support companies doing sizeable strategic acquisitions,” Dettman said. In subsequent weeks, this has further proven to be the case, with Carsales executing a very large capital raising to fund a well-received acquisition.
Prospects for growth stocks
The roundtable heard how even promising companies looking to raise capital suddenly face renewed challenges to demonstrate viability – particularly in once ‘hot’ sectors such as healthcare, fintech and biotech.
Even promising companies looking to raise capital suddenly face renewed challenges to demonstrate viability.”
Until the markets recently cooled, sectors such as technology and biotechnology relied on capital markets to pursue growth objectives in areas such as research and development, capital expenditure and market share. Loss-making companies within these sectors will likely need additional capital to fund operating cash requirements. “The question will be whether existing shareholders and new investors see long-term opportunity in these companies,” said Lawrence.
Investors in growth stocks are now looking for financial discipline and positive cashflows. Anthony Brown of NobleOak Life, a growth-oriented life insurance company which listed on the ASX in July 2021, said that managing cost inflation was now the company’s biggest challenge. The war for talent and other labour supply shortages had made it difficult to find call centre and claims staff. “Investors want to know that we can still generate the right profit and manage inflation going forward.” Less profitable companies, which were gearing up for expansion, may find it challenging to adjust to the new circumstances and could struggle to access capital.
West added that international education occupies a unique position as a growth stock with some defensive properties. This is because international student mobility tends to maintain a steady rate of increase, despite economic shocks. Parents often save money for their children to get into overseas universities well in advance. Even when student demand drops, as previously seen during the GFC, it can catch up. Far from being deterred by the pandemic, some young people are eager to move forward, he added. As a result, even growth companies in this sector (and other growth sectors with defensive properties) should retain a level of capital market access, despite difficult conditions.