IPOs Expected to Exceed $7B in June as Volatility Index Falls

Positive signs are happening on Wall Street, but the Fed could easily derail any momentum in IPOs.

By Vincent Ryan

The stock market shows early signs of a more welcoming climate for initial public offerings.

The CBOE Volatility Index has been below 20 for most of April, May, and June, closing at a low of 12.91 on June 22. The S&P 500, meanwhile, is up 14% in the last six months.

Falling Volatility

The Cboe Volatility Index dropping below 20 is usually a good sign for companies waiting to IPO.

With three days left in the month, 23 U.S. IPOs have thus far raised $6.7 billion, the largest amount in six quarters. Six deals are scheduled for this week, including two deals seeking to raise more than $325 million.

And some large deals have managed to pull off successful debuts. Mediterranean restaurant chain Cava Group, which is not profitable, raised $318 million. It was priced at $22 per share, above its stated range, and it almost doubled its price by close on trading’s opening day.

The Cava deal was more of an outlier, though.

In June, “several of the names demonstrated qualities that we expect to see in a challenging market, like profitability and mature business models,” according to a report by IPO ETF provider Renaissance Capital.

Investor Preferences

When comparing the IPO perspective between 2020 and 2021 versus 2023, there has been a shift in investors’ preferences, Isaac Freites, a managing director at Accordion, told CFO.

In 2020 and 2021, investors rewarded IPO companies that demonstrated high growth rates, even at the expense of lower profit margins, he said. However, “today there is an increased emphasis on healthy profit margins with reasonable growth rates for viable IPO candidates.”

Renaissance Capital’s review of the second quarter IPO market pointed to the pause in the Federal Reserve’s interest rate hikes as one possible spark for IPOs. Improving returns for IPOs in the secondary market could be another momentum builder.

But it’s a little early to declare IPOs out of the doldrums, say experts.

“It’s premature to say the IPO market is definitely back,” said Adam Birnbaum, executive director at GP Bullhound, a technology advisory and investment firm.

For the IPO market to be fully back, he said, “you would ultimately want to see some of the higher quality tech unicorns … such as Stripe, Reddit, Instacart, Databricks, and Chime Financial going public.”

Other Indicators

Signs that would show the IPO market is healthy enough to absorb larger and more IPO offerings would include a favorable valuation environment. That would require an ability to forecast business and macroeconomic indicators more accurately, said Accordion’s Freites.

Other positive signs would be a “stable and growing market backdrop” evident from the S&P 500 and Stoxx 60 performance and continuing strong aftermarket performance from previous IPOs.

According to Freites, private equity-backed, established companies with tangible business models demonstrating consistent value creation and solid forecasts may be some of the first to act upon this market environment.

Accordion is working with financial sponsors to prepare their portfolio companies for an exit, as “[for] any IPO candidate it remains most critical to be capital-market-ready coupled with a strong equity story as the market window opens to unlock value,” Freites said.

Rate Sensitivity

One development that could dampen IPO buyers’ enthusiasm would be the Fed resuming the cycle of raising interest rates. Fed funds futures pricing reflects a 76% probability of a 25-basis-point rate hike at the July 26 FOMC meeting.

“IPO institutional buyers use pricing models that are very sensitive to interest rates as a discount factor to arrive at valuations for IPOs,” explained Birnbaum.

“Increased interest rates could make these buyers less bullish in future deals and bring down the price of comparable stocks relative to those being IPO’d. It could reduce interest levels in buying into a newly minted stock in an IPO versus the ones already trading.”

Still, the current activity is surely a positive sign, said Frietes, and “from talking to market participants including our clients, in line with an increasingly bullish expectation for 2024.”