For small cap investors, initial public offerings (IPOs) often make for an interesting addition to the portfolio.

In part, that’s because valuing what a private company is worth on public markets is an inexact science. Other factors also play a role, such as broader market sentiment and hype around a given stock or sector.

And in hindsight, 2019 proved to be a good year for paying close attention to who was hitting the ASX boards.

Data compiled by Stockhead just before Christmas showed that of 61 listings, 37 (61 per cent) had returned a gain, with nine companies posting returns of 100 per cent or more.

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In view of that, last week’s 2019 IPO Report from equity-raising platform OnMarket provided some more useful insights into the key factors driving activity in Australia’s IPO market.

The data showed that by year-end, 63 companies had joined the ASX, raising a total of $5.4bn, posting an average post-IPO return of 35.2 per cent.

As a measure of IPO volatility, that comfortably outpaced the 2018 year which recorded an average loss of 14.9 per cent from 95 listings. But 2019 marked the fourth year out of five that IPO returns exceeded that of the broader Small Ords index.

Importantly, IPO returns are measured off investments made during the book-building process before the IPO.

For example, fintech company Splitit (ASX:SPT) joined the market 12 months ago and promptly jumped to 38c on day one of trade. But it’s overall return was measured from the pre-IPO price of 20c.

Speaking with Stockhead about the report, OnMarket CEO Ben Bucknall said the positive activity was representative of the fact that the ASX played in important role in Australia’s capital markets, in terms of the funding requirements for small-to-medium enterprises (SMEs).

“Typically, the majority of companies that IPO on ASX are raising growth capital, rather than selling down,” Bucknell said.

“Australia has a very well-established market for SMEs to raise capital for growth. The governance associated with listing gives investors comfort about the veracity of information and also a market to trade.”


Analysing the gains

While companies that are in the growth-phase of their maturity cycle offer investors the potential for increased reward, by their nature they also come with increased risk.

And to be sure, not every stock that listed in 2019 posted a positive return. But we asked Bucknell what other factors he observed that helped drive 2019’s broader gains.

“I think one of the reasons we’ve seen this systemic outperformance against the issue price is because the investors who are providing the bulk of pre-IPO capital need to be incentivised to buy into an IPO issue, as opposed to the secondary trading price post-listing,” he said.

“That doesn’t mean they always get it right, but it would provide an explanation for average outperformance.”

“Typically in valuing an unlisted company versus listed stock, you’d discount for a liquidity premium. So by getting to market, you allow people to realise that premium.”

“And the fact that we had a lower number of IPOs in 2019 compared to 2018 suggests valuations had to be even more compelling to attract investors into the IPOs, and this translated to better returns.”

Year-end returns provide one measure of performance, although Bucknell said it was a metric that could be skewed based on the date the company listed.

The OnMarket report included a standardised approach based on a simple annualised return measured one day, one month and three months post-listing.

On those calculations, OnMarket said a theoretical investor that participated in all 63 pre-IPO rounds and sold one month after listing would realised an average pre-tax gain of 161.7 per cent.

And Bucknell said those numbers lent weight to the merits of a portfolio approach to IPO investment.

“If you look at the numbers in the report, a key thing I draw out of it is the thesis that there’s large returns to be made from taking a systemic approach to IPO investment,” he said.

“Those returns — you didn’t actually need to be particularly skilful to do that. A lot of people think ‘I need to be a lucky stock picker to do this’. But you didn’t need that much luck to make returns that were far in excess of the industry standard.”


Looking ahead

After a strong 2019, Bucknell reckons the outlook for 2020 is strong — at least in the first half of the year.

He cited the introduction of some more established tech companies — to accompany the high-growth plays — as a good thing that would help underpin the market.

“One exciting IPO for us to work on was Limeade (ASX:LME), which was an established US software company floated by Macquarie Bank,” Bucknell said.

“So I think while there’s still plenty of activity among local SMEs looking at IPOs for growth. We’re also seeing a positive shift towards more established businesses backed by investment banks.”

But further down the track, Bucknell cited some potential headwinds stemming from the pending launch of the Small Business Growth Fund (SBGF) — a $500m+ initiative with support from the federal government in partnership with the major banks.

“In the second half of the year, I think there’s a real risk that the SBGF could compete with, and crowd-out businesses that would have otherwise raised capital from the private sector via an IPO,” Bucknell said.

Stockhead has contacted the ASX for any comment on whether the local index has a view on how the introduction of the SBGF could affect listing activity.

For now, investors are likely to be staying on the lookout for new IPO opportunities in the wake of last year’s strong returns.

By sector, the OnMarket data showed IPO activity was dominated by financials and IT stocks, which collectively raised $3.5bn — or 77.4 per cent of total IPO funds raised.

So far in 2020 three companies have joined the ASX boards, led by asset management company Cosol (ASX:COS), which jumped from 20c to 38c when it listed on Friday.

A further 12 companies plan to list in the weeks and months ahead – six of which operate in the fields of mining, minerals and precious metals exploration.