Just in case you were planning to take your company public.
IPO heyday is over, for good
DAVID BERMAN
15:37 EST Monday, Oct 17, 2011
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The number of U.S. initial public offerings isn’t what it used to be, which has academics and policy makers scratching their heads over why many companies prefer to sell out rather than go public.
According to research by Jay Ritter, a finance professor at the University of Florida, companies went public at an average annual rate of 311 between 1980 and 2000 – a pace that has since dwindled to an average of just 102 IPOs since 2000. (Hat tip: Paul Kedrosky)
Despite some high-profile IPOs this year, including one from LinkedIn Corp. and an upcoming offering from social gaming company Zynga, there have been just 97 deals in 2011. That number is unlikely to pick up in the fourth quarter – and no, activity isn’t picking up overseas.
Indeed, headlines now relate to the number of deals getting yanked, with 2011 shaping up to be a banner year for cancellations.
The rocky state of the stock market, highlighted by the S&P 500 falling into bear market territory earlier this month before its rebound, can be blamed for some of the IPO-shyness in the nearer term. This recent volatility follows big dips during the bursting of the technology bubble in 2000 and the market crash that followed the 2008 financial crisis.
Other popular explanations for the nosediving number of IPOs involve the rise in regulatory costs, due to the introduction of the Sarbanes-Oxley Act of 2002, a decline in the number of analysts covering smaller companies and the disappearance of boutique investment banks.
However, Mr. Ritter has another theory, and it points to a future where the IPO slump isn’t going to bounce back, even with regulatory reforms. It’s a dark view, given that IPO activity is often linked to economic and employment growth.
He believes that structural shifts in the U.S. economy have given large companies the advantage of economies of scale and an ability to get products to market faster. These advantages have reduced the profitability of small companies, making them much more inclined to sell themselves.
Take the speed with which Apple Inc. can launch or update versions of their iPhones, iPods and iPads as an example.
“No small independent company could implement new technology so rapidly and sell tens of millions of units to consumers in a matter of months,” Mr. Ritter said in his research paper.
“Instead, we posit that a small private company that develops valuable new technology for consumer electronics would find that its value-maximizing strategy would be to sell out to Apple rather than go public and start hiring more workers.”
The numbers support this view. The decline in the number of IPOs is concentrated among small firms, where the average has plunged to just 30 a year between 2000 and 2009, from an average of 165 a year between 1980 and 2000.
What’s more, Mr. Ritter points out that among small firms, the percentage that are profitable within three years of going public declined to just 27 per cent last decade from 42 per cent over the previous two decades. As well, returns earned by investors on small-company IPOs turned particularly disappointing after 2000.
Rather than go public, then, more companies prefer to sell themselves. A recent report from the National Venture Capital Association and Thomson Reuters found that just five venture-capital backed companies have gone public through IPOs this year, while 101 venture-backed companies were sold.
Mr. Ritter believes that another era of irrational exuberance, along the lines of the technology bubble of the 1990s, or the introduction of an exciting new technology, could lift the number of IPOs.
“But our analysis suggests that this would be just a temporary phenomenon,” he said.
In other words, IPO, RIP.