Analyst view: The pre-IPO pipeline is evidence of a shift underway in Australian capital markets
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Global stock markets have rolled into 2020 at an interesting juncture.
It follows a strong 2019 when major central banks (including the RBA) began cutting interest rates.
With rates at record lows, the ASX200 recently hit a record high — a theme in and of itself which is worth keeping an eye on.
The Small Ords index didn’t reach those heights but it’s still historically elevated. And when stocks are this buoyant, it can also make it harder to find a bargain for small-cap investors.
To discuss the current state of play, Stockhead recently caught up with Gregg Taylor — chief investment officer at Bombora Group.
As a crossover investment fund, Bombora has been a leading player among domestic institutional investors looking to deploy more capital in pre-IPO companies.
And Taylor offered some interesting insights into some of the forces that are driving that trend.
“For a lot of investors, it’s much harder to find yield. So we’ve seen money flooding into equity markets looking for stocks with a proven growth model — but a lot of those companies already on the ASX are fully valued,” he said.
“So when an interesting story comes to the ASX via an IPO with positive growth attributes, it tends to attract a lot of money. And that’s why there’s been strong demand in the space.”
As market-watchers would know, last year was a pretty strong year for IPOs, with a number of companies posting triple-digit returns based off their listing price.
Looking back at the year that was, Taylor said out-performers were usually “priced appropriately, and benefited from factors post-listing that resulted in their revaluation”. But along with the gains, there were also 24 stocks that lost ground from their IPO price.
“What that all means is there’s this big divide in the market for ASX stocks that fit in the growth category. The ones that have proven their model have run to record valuations — but as an investor it’s sort of hard to chase those valuations,” Taylor said.
“On the flip-side there’s companies with an interesting growth story which have had a slip-up, and they’ve been put in the ‘sin-bin’ until they reprove their growth credentials.”
From the investor side, Taylor said the increased focus on pre-IPO investment opportunities was a trend that was probably here to stay.
“What we’re seeing increasingly is a lot of these companies are trying to do a smaller pre-IPO round of funding to prove up their growth model,” he said.
“Ideally, that will drive another round of growth and they’ll get a step-change in the valuation before listing, which helps to offset the larger dilution event of the IPO.”
It’s still a long way from the US market, where increased depth and liquidity allows investment funds to keep companies private for longer.
But in effect, the trend has added another layer into the fabric of how Australian capital markets function.
Along with Bombora, other local funds participating in the shift include Regal Funds Management, Alium Capital, Perennial Value Management and Acorn Capital.
“You’ve got to be careful because in effect the US market has taken it to an extreme, where companies are getting very high valuations before listing and then underperforming,” Taylor said.
“Our markets are different because the capital pool isn’t as deep, but increasingly companies are trying to extend their time until listing with some extra pre-IPO funding.”
Often, companies will structure that funding via the issuance of convertible notes, which allow investors to convert their debt to equity at a discount to the IPO price.
Taylor said an example of that was telecommunications company Uniti Wireless (ASX:UWL), which was the best-performing IPO on the ASX last year.
Bombora initially invested in Uniti with a convertible note, then tipped in more capital at the IPO and followed through on post-listing rounds.
“When we invested in that 12-18 months ago with the convertible note, there weren’t as many funds that could invest at the pre-IPO stage. Now there’s a lot more companies wanting exposure to that growth story a bit earlier,” Taylor said.
While 2019 was a good year, Taylor said he didn’t expect the well to have dried up for investors scoping similar opportunities in 2020.
“I don’t think company fundamentals or the broader environment have changed too much from 2019,” Taylor said.
“There’s still a high appetite, and companies that can prove out their growth story will have the opportunity to perform like the class of 2019.”
Looking ahead though, Taylor said it would be worth keeping an eye out for a pickup in IPO activity during the June quarter.
“We’re seeing a very strong pipeline, in terms of both straight IPOs and pre-IPO rounds. And in that market there’s a window between March and June they’re all trying to squeeze in, so I think you’ll find it’ll be a very busy period,” he said.
The expected flurry is because companies want to seize the opportunity to get to market based on their audited year-end numbers to December.
“You kind of need your prospectus out to market by March/April, because by June 30 you’ve got school holidays then it’s reporting season, so the next window isn’t until September/October,” Taylor said.
By sector, there’s still plenty of expected activity in fintech and payments, following the roaring success of last year when a number of buy now, pay later (BNPL) stocks stole the show.
Other predominant sectors in the pre-IPO space include artificial intelligence and health-tech, Taylor said.