Sir Winston Churchill famously said to never let a good crisis go to waste. Early in the pandemic, extreme uncertainty caused investors to rush into cash instruments, intensifying the pre-pandemic phenomenon of cash building in investment portfolios. Accommodative fiscal policy also allowed savings rates to rise materially. With a buildup of excess cash in investors’ pockets and a swift recovery in valuations, the health-turned-economic crisis became an opportunity for many companies to raise capital via initial public offerings (IPOs). Ernst & Young (EY) reports there were 1,070 IPOs raising a total of $222 billion USD globally in the first half of 2021, the most active first half for IPOs in 20 years. Over half of the capital raised (or one-third by deal count) was for companies known as Special Purpose Acquisition Corporations (SPACs) – companies with no existing underlying businesses raising money for the promise to find an operating company to buy. Offerings from this type of company are not dissimilar to the types of businesses that raised capital the last time global IPO activity was at this level, in the technology bubble of the late 1990’s.
IPOS IN THE CANADIAN CONTEXT
Research from Scotiabank shows that the level of IPO activity in Canada in 2021 thus far is the highest since the early 2000’s when income trusts were emerging in popularity. EY highlights that 23 IPOs were completed on the TSX in the first half of 2021, greater than the number of IPOs completed for the full year of any of the preceding four years.
Demand for initial public offerings provides some interesting real-time perspective on the general risk vs. reward appetite of investors. At the beginning of the IPO fervour, deals were often oversubscribed (demand for the offering outweighed supply) and companies were able to receive the valuation they had hoped for. But as the march of IPOs dragged on, we began to see more selectivity from investors. Companies increasingly had to revise terms such as valuation or offering size in order to complete a deal. For example, online learning software provider D2L Corp. was initially looking to raise $200 million (CAD) at a price range of $19-$21 per share but cut its offering to $150 million at $17 per share in order to get a deal done. In some instances, companies had to pull their offerings altogether.
As more and more capital is absorbed into investment opportunities, investors seem to be more choosy about where their incremental invested dollar will go. Of the 19 Canadian technology company IPOs raising $50 million or more since mid-2020, eight are now trading below issue price and the average tech sector IPO return over the last year is -2.4%. Not all IPOs have performed poorly, however, with some stocks more than doubling in a short time period, further reinforcing the view that the market has become more selective.
OUR APPROACH TO IPOS
Given the size of most IPOs, the QV Canadian small cap team sees a number of these opportunities come across our desks. Every opportunity is different, and financial track records are often limited, but our repeatable process emphasizing enduring franchises helps us identify which cases warrant further due diligence. Specialty pet retailer Pet Valu Holdings Ltd. (TSX:PET) is one of the IPOs in which the QV Canadian Small Cap Strategy participated this year. Although, as for most IPOs we only had access to a few years of historical company data, the fact that the business had operated in the growing Canadian pet care industry for 45 years helped support our assessment of a likely-enduring franchise. From the record we could see, Pet Valu had been delivering healthy organic growth in the high-single digit percent range, complemented by store growth. Importantly as well, the business is profitable and continues to deliver profitability growth aligned with revenue growth (in contrast to several other recent IPOs failing to demonstrate profitability.)
The QV Canadian Small Cap team will continue to monitor IPO activity through the same lens we would use to consider any investment. We think this consistency of process enables us to stay focused when a myriad of new businesses are testing the market.