What is an IPO cycle
The IPO bubble - when will it burst?
Company valuations in the disruptive technologies segment are in some cases clearly strained, particularly in the case of new issues (initial public offerings, IPOs). Mark Hawtin of GAM Investments believes that the time has come to apply an intrinsic value approach to avoid dangers and risks.
December 21, 2020
The wave of new issues did not ebb at the beginning of December either. Doordash and Airbnb are the last big names to defy gravity for the time being: Not only did their issue prices have been set higher than expected - they also recorded price gains of more than 100% on the first day of trading. Movements like this evoke memories of the “dot-com bubble” from 2000 in numerous commentators. Although we are of the opinion that there are currently clear signs of an irrational exuberance in the market for new issues, in contrast to the year 2000, when all (actual or perceived) disruptive companies climbed to dizzying heights, IPOs and stocks are out of the range « Work at Home »(Work from Home, WFH) has far more appropriate assessments.
The current environment could well prove to be favorable for generating alpha over the next twelve months. Although we have been investing in this part of the market for our customers for more than 25 years, we have never seen such a discrepancy between ratings and expectations. A hysteria fueled by the digitization of all areas, including online securities trading, makes buying and owning stocks even easier. The result: According to data from The Ascent (part of The Motley Fool), more than USD 18.4 trillion in client assets are currently held with the leading online brokerage firms. A large part of this fortune is driving the prices of these “hot” growth stocks - largely or entirely regardless of their valuations - higher and higher. IPOs represent a large part of this, and in our opinion Doordash and Airbnb clearly show how extremely excessive the levels that have now been reached are.
The Renaissance IPO ETF illustrates the hype cycle in the IPO area. Although the performance of IPOs over time has traditionally been pretty much the same as that of the S&P 500 Index, they have recently decoupled from it. The effect is even more noticeable if you look at the price movements of the stocks contained on the first day of their stock market debut. According to the investment conditions, the ETF can buy the securities on the first official trading day at the earliest and in the first five days after the IPO. This means that the enormous subscription profits on the first day of trading are not included in Chart 1 below. The graphic illustrates the potentially irrational activity of private investors, who go away empty-handed when subscribing to a new issue, but then drive up prices in an undifferentiated manner after the IPO.
Figure 1: IPO bubble (change over the five-year period: Renaissance IPO ETF and S&P 500 in comparison).
According to Bloomberg information, the sum of the funds raised from IPOs so far in 2020 exceeds the mark of USD 160 billion - that is a new record! On the day of Doordash's IPO alone, there were six more new issues, including C3.ai, a provider of artificial intelligence (AI) for companies (160% plus at the issue price), the Internet advertising platform PubMatic (60% plus) and four new shell companies (Special Purpose Acquisition Companies, SPACs) that have a lot of liquidity but no investments yet. We are convinced that a worrying bubble is currently also forming on the SPAC market, which we will deal with shortly in a separate article.
In the current environment, courses in many areas are developing in worrying ways. On the other hand, since numerous companies are valued appropriately or even cheaply, the possibility of generating alpha seems very good. As a result, the current situation differs significantly from the environment in which the Internet bubble burst at the time. In our opinion, the application of an intrinsic value approach is now urgently recommended in order to avoid dangers and risks. In phases when a wild herd of investors drives stock prices, a sensible approach that focuses on the substance and value of companies should pay off. Popularity is not synonymous with fiduciary responsibility.
Tesla's market capitalization (around USD 600 billion as of December 11, 2020) corresponds to the cumulative market value of all established automakers. In conclusion, this assessment would mean that Tesla will either replace the entire previous automotive industry or that Tesla's electric vehicles / battery technology will create an entirely new, disruptive and huge segment of the transportation and energy sector. In our opinion, both scenarios can hardly be substantiated with sufficient arguments. Many of the large, highly regarded new issues that recently took place also have breathtaking ratings. Doordash closed its first day of trading with a market capitalization of around USD 60 billion - 21 times its total sales in 2020. Grubhub, the number one in the U.S. grocery delivery market, was promoted for a price in the first half of the year of 4 times its sales and its buyer, Just Eat Takeaway, is valued at 5.7 times its total sales in 2020. Uber, also a major player in the market with its Eats division, is valued at 9 times its sales, which are undoubtedly suffering from the decline in ridesharing as a result of the Covid-19 pandemic. In the software sector, the impression could arise that Snowflake was on the verge of world domination, since the valuation of the share after the IPO was an astronomical 175 times its sales in 2020.
Finally, we would like to note that in parts of the disruptive technology universe, especially new issues, we believe valuations are now extremely high as retail investors seem willing to pay any price to buy stocks. Nevertheless, we believe that the next wave of disruptive topics offers great value potential, including in the areas of automation of information processing, healthcare, industry, transport and fintech. We are convinced that we will be able to generate alpha for our customers in these segments in particular.
The information in this document is provided for informational purposes only and is not to be understood as investment advice. The opinions and assessments contained in this document are subject to change and reflect the views of GAM in the current economic environment. No liability is assumed for the correctness and completeness of the information. Past performance is not an indicator of current or future performance. The financial instruments mentioned are provided for illustrative purposes only and are not to be understood as a direct offer, investment recommendation, or investment advice.
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