The IPO Market Is Getting Weird, and We've Been Here Before

A technology stock completes its initial public offering (IPO), and the founders are stunned watching the shares shoot up in value in trading far beyond the initial offering price. What year does the event described belong to? A year ago, many of us would have placed it somewhere in the late 1990s. However, it seems like the '90s are here again with a frothy IPO market, an updated version of the blank check company, and some seemingly insane tech valuations.

KEY TAKEAWAYS

• 2020 IPOs have seen massive pops on their first day of trading, with the effect on tech stocks being particularly powerful.
• Special purpose acquisition company (SPAC) IPOs have also increased and will result in these capital-flush companies reaching further into the private market for more pre-IPO companies at earlier and earlier stages.
• The market enthusiasm for tech IPOs is uncomfortably familiar for investors who were around for the dotcom bubble.

Fine Line Between Hot and Burning

The market for tech stocks is hot. Tesla, Inc. (TSLA) can attest to that as it continues to defy logic when it comes to the connection between fundamentals and market performance. But this heat is even more intense when it comes to new tech stocks hitting the market. Citing Dealogic data, The Wall Street Journal indicates that the percentage gain in terms of an IPO pop being enjoyed by stocks on their first day of trading is at its highest in the past 10 years.1

This type of market froth actually makes carrying out an IPO more difficult for investment bankers. In order to have a happy client following the offering, the syndicate wants to see the shares trading within a range of the offering price. When this happens, it suggests that they got the pricing just right. When a stock doubles on its first day of trading, as happened with Airbnb, Inc. (ABNB) and Snowflake Inc. (SNOW), it means that the company has left money on the table in a sense even though the shareholders within the company are still happy. The appetite for IPOs and tech stocks in particular has companies like Roblox delaying their offering to better understand where they should be pricing to bring in the most capital.

The Role of SPACs

Special purpose acquisition companies (SPACs) have played a large role in the IPO froth in 2020 and now 2021. According to PricewaterhouseCoopers, we haven't seen an IPO year like this since – you guessed it – the 1990s. 2020 saw 183 traditional IPOs and 242 SPAC deals worth $180 billion.2 These types of blank check companies used to be firmly in the realm of speculation, but they are gaining in popularity as returns elsewhere are depressed due to a flood of stimulus and a pandemic dampening activity. SPACs are still speculative as they are mostly launching to buy into private companies, but more investment capital is flowing into them than ever before. 

The number of quality private companies just waiting to go public through a reverse merger is an open question, but the odds are looking good that some SPACs will have to reach deeper into the barrel than their investors may want. There are other pros and cons around the growth in SPACs, including how the companies using them can market themselves prior to "going public," but that is a topic for another day. The important thing to realize for investors looking at the IPO market with confusion is that SPACs will be eating away at the IPO pipeline in their own way due to the capital they have to put to work.

Remembering What Happened to 1990s Surge

In the 1990s, of course, the craze was for companies who took a "www.something.com" approach to their business plans. There are many examples of how frothy the market was for internet stocks. Pets.com made an accelerated journey from IPO to insolvency within a year owing to the timing of the IPO at the busting of the dotcom bubble and a number of unresolved issues in the basic business model.

While we can tell ourselves that the market understands tech better now, there is no denying that the valuations on tech firms old and new are now extremely dependent on growth to catch up. The price-to-earnings (P/E) ratios on tech stocks are breaking barriers that were last pierced in the internet bubble, and even ones that were trending toward traditional value, like Microsoft Corporation (MSFT) and Alphabet Inc. (GOOGL), are climbing up in the 30s again. Although there is a first time for everything, we have historically seen markets ultimately face correction when a sector becomes unmoored from fundamental valuations.

The Bottom Line

The dotcom bubble and bust of the '90s and early 2000s burned a lot of investors and reduced the capital available for the tech companies developing in the following decade. Apparently those burns have largely healed in the 20 years since, as we are once again seeing incredible valuations on minimal revenue and a frenzy for IPO stocks and pre-IPO companies. Maybe this is that magical time when there are no consequences for valuations outrunning fundamentals, but there are concerning signs for investors who remember what it was like in the '90s.

Article Sources:

1. Farrell M. Record IPO surge set to roll on in 2021. Wall Street Journal. 
2. Bary E. IPOs in 2021: After a year of impressive pandemic offerings, these tech companies expect to keep it rolling. MarketWatch.