Markets & Finance

IPOs: Still in a Deep Freeze


The tough stock market is slowing the pace of initial public offerings to a crawl, even as many companies crave capital

Despite the hunger for capital by startup firms, the dicey stock market is scaring them away. The market for initial public offerings, or IPOs, is nearly frozen, experts say, and won't thaw again until the stock market stops its downward spiral. "Folks are scared because there is so much uncertainty in the broader economic scene," says Tim Walker, an IPO watcher at Hoover's.

So far in 2008, there have been 37 IPOs, off 72.4% from this point last year, according to IPOHome.com.

Unfortunately, experts don't see the IPO market picking up any time soon. "I don't see much activity at all taking place in the third quarter," says Mark Hantho, head of equity capital markets at Deutsche Bank (DB). Walker says maybe early 2009 could see an uptick in IPO activity. In late June, the National Venture Capital Assn. polled its members, asking when they saw the IPO window reopening. Only 17% said IPOs should revive by the end of 2008, while 43% are prepared to wait a year, and 32% said one to two years.

VCs Feeling the Strain

The only IPOs that were successful this year were Visa (V), Intrepid Potash (IPI), and Colfax (CFX), says Scott Sweet of IPO Boutique. All three went public during a brief time of investor optimism in March, April, and May—before major stock indexes again dipped back into bear market territory.

The scarcity of IPOs is putting a strain on venture capital firms, which back startups but often rely on stock market IPOs to exit their investments. "Many management teams and their investors are faced with tricky conditions," David DiPietro, president of specialty investment bank Signal Hill, says of private companies that would like to go public. "Do you wait this out? Do you raise more from [existing, private] investors? Or do you sell?"

A few companies, notably in the still-healthy energy or alternative energy industry, are sticking to their IPO plans. But many outfits that already filed paperwork for IPOs have postponed their actual public offerings indefinitely. The bleak IPO market has been toughest on the riskiest names, such as biotechnology and biomedical firms, Sweet says. IPOs that "blew up" in 2008 included a couple of financial firms that planned to buy up troubled mortgage-backed debt, he says.

Low Valuations a Turnoff

With the broad Standard & Poor's 500-stock index down 21% from its October peak, many firms are dissuaded from considering an IPO simply by the modest valuations the companies will get in a market like this. "IPOs rely on generally favorable sentiment," Walker says. In this environment, when a company makes its pitch to equity investors, "now people are much more likely to give it a skeptical hearing."

Many small companies aren't pursuing IPOs because they wouldn't hit a market capitalization large enough to make being a public company worthwhile, DiPietro says. Citing the costs of regulations and compliance, companies need a market value of at least $250 million to $300 million, he says. Plus, many companies are somewhat uncertain about what the current economic and financial environment will do to their businesses. No company wants to go public and then see its stock price plunge when its first earnings report is a disappointment, he notes.

Whenever the IPO market improves, those companies could move quickly to seize on the opportunity. "There are a lot of companies lined up waiting to tap the market," says Kathy Smith, principal of Renaissance Capital in Greenwich, Conn. And there's a lot of capital sitting on the sidelines, which creates alternatives for firms that postpone IPOs. "The good news is that the world is truly full of liquidity," Hantho says. Plus, tough conditions place great pressure on IPO issuers to price their stocks fairly, Sweet says.

Good Things Come to Those Who Wait

Only the bravest and best companies are likely to consider IPOs in the next few months, DiPietro says. That creates opportunities for investors. "Any company that has the confidence to venture into this IPO market is probably worth looking at," he says. And when the market starts to recover, IPOs can offer nice returns, even though they carry more risk. Says Smith: "They know that out of the downturn can come fantastic returns."

But until then, investors will have to wait for the IPO market to thaw.

Steverman is a reporter for BusinessWeek's Investing channel.

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