Q1 2016 Middle Market Equity Capital Report Is the IPO Window Closed?
A CohnReznick LLP Report
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Middle Market Equity Capital Report ― Q1 2016
“This quarter is different. This quarter, we break the mold.” Since the inception of our Quarterly Middle Market Equity Capital Reports, the basis of our analysis, observations, and insights has been grounded in middle market equity capital transaction activity. This quarter is different. This quarter, we break the mold. With so few IPOs making their way to market in Q1, a statistical analysis of middle market transaction activity seems futile—there are just too few numbers. And that’s the story. With economic fundamentals in the United States strengthening, IPO transaction activity through Q1 2016 was at its lowest point since 2009. After a record number of IPOs in 2014, it didn’t take long for the IPO market to collapse under the pressure of market volatility and a continued lack of investor confidence. Even a growing U.S. economy can’t seem to create enough confidence to jump start IPO transaction activity. As a point of reference, when Q1 2014 ended, 81 companies had gone public. At the end of Q1 2015, only 40 companies had gone public. In Q1 2016, there were no IPOs at all in January and just a trickle through February and March. In fact, at the close of Q1 2016 the IPO window has practically closed with only 9 companies having gone public. Uncertainty throughout the capital markets ecosystem has placed a road block in the middle of the IPO on-ramp. Most companies with plans to become public have either postponed or withdrawn them. These companies are now rethinking their
timelines and considering alternative sources for raising capital. We expect that strategic plans that had included a near-term IPO will be revisited and revised. Growth-oriented private companies still need access to capital to fund research and development, retire existing debt, finance acquisitions, and expand operations. But it seems they may have to do these activities without accessing public equity capital. Options like debt or accessing private capital certainly deserve consideration. And, for those companies in a financial position to hold off until the IPO window opens again, a smart strategy may be to look inward with a goal of improving operational efficiencies, decreasing burn rates, and accelerating growth. For middle market companies and their management teams, today’s capital markets ecosystem offers its share of opportunities and risks. I hope our Q1 2016 report offers observations, insights, and analysis for your thought and consideration.
IPO activity may not fully recover until
2021
IPO transaction activity typically peaks about 2 years before a low
dr
op
CPA, Partner, CohnReznick’s National Liquidity and Capital Formation Advisory Group
Once every 6 or 7 years, IPO transaction activity experiences a severe drop
IPO transaction activity is off to its slowest start start since 2009 slowest
Alex Castelli
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Current Environment for IPO Activity Although not formally closed, when will the IPO window open again? No one knows for sure. However, in analyzing Q1 IPOs since 2000, and assuming typical patterns of recovery, IPO activity is likely to make progress over the next few years and recover completely by 2021. It is interesting to note how quickly IPO activity deflates (1-2 years) and how long it takes to recover (4-5 years). Confidence seems to be quickly lost and slow to return. The “confidential filing” provision of the JOBS Act has made the IPO pipeline less transparent. Therefore, no one really knows how many companies may be preparing for an IPO in the event that market stability and investor confidence returns to the markets. Most companies that have publicly announced their intentions to go public have either postponed or canceled those plans. Private companies are showing that they are less motivated to accept the risks of going public today. Pricing pressure and additional scrutiny from public investors make the decision to go public a difficult one. Private capital remains plentiful as both financial and strategic investors are searching for opportunities to put their money to work. Even though valuations in the private market have been moderating, companies will likely not experience the current levels of pricing pressure and scrutiny concerning valuations that exist in the public markets if they
“IPOs aren’t the end all strategy for companies. Public and private clients continue to seek out other means of capital successfully amid today’s market volatility. We expect strategic plans that included a near-term IPO will be revisited and revised, not only in the near term, but quite possibly for the next several years.” Alex Castelli CohnReznick Partner, National Liquidity and Capital Formation Advisory Group
strike a deal for private capital.
200
190
Q1 IPO ACTIVITY
150
(2000-2016)
100
81
78 62 50
39
57
60
59
34
26
11 0
2
2000
2001
2002
2003
55
54
40
36
9
4 2004
2005
2006
Middle Market Equity Capital Report ― Q1 2016
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2021
A Dip in IPO Activity May Translate to More Opportunities for Strategic and Financial Investors
Today’s reduced level of IPO transaction activity may
capital at lower valuations, we may see private equity
present some interesting opportunities for financial
and venture capital firms shift their emphasis from
and strategic investors. Moderating valuations in
selling assets to buying them. However, even private
the public market are helping to rein in sky-high
investors are proceeding more cautiously as a result of
valuations in the private market. Those companies
current market conditions. For the last 18 months, the
once destined for life as a public company have
public market has been characterized as a buyers’
now become acquisition targets for private investors.
market with investors putting pressure on pricing and
Cash hungry companies have become more
scrutinizing valuations. Conversely, the private market
reasonably priced acquisition targets for strategic
has been characterized as a sellers’ market featuring
and financial investors. Together, lower valuations
investors with plenty of cash and few investment
and a challenged IPO environment may signal
opportunities. As a result of the decreased level of
opportunities for financial investors who have been
transaction activity and decreasing valuations, the
struggling to win deals.
private market is transitioning to more of a buyers’
The good news for companies interested in accessing private capital is that there is plenty of it available.
market—an important change for those negotiating the sale or partial sale of their business.
With an increased supply of companies seeking
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Shifting Mindset from “Position for an IPO” to “Strategies for Sustainable Growth” The current IPO environment may be motivating more companies to stay private longer. Without an immediate need for growth capital, more middle market companies may choose to sit tight and focus on increasing operational efficiencies and exercising growth strategies. Companies that don’t need immediate access to capital, but will need it in the near term, may tend to focus their attention on cash management. Strategies to reduce burn rate and make cash last longer may grow in importance.
Reducing cash burn rates may involve cost cutting measures such as delaying or canceling new product development, or reducing research and development budgets. If companies stay private longer, they may place greater emphasis on growing through operational efficiencies and mergers and acquisitions. In the long term, this may strengthen the foundation of the company and make them a better public company candidate when the IPO window opens.
“Growth-oriented companies continue to need access to capital to fund research and development, retire existing debt, finance acquisitions, and expand operations, but must do so without accessing public equity capital. Companies can overcome this challenge by seeking non-public options to access capital.” Stephen Wyss, CohnReznick Partner, Retail and Consumer Products Industry Practice
Follow-On Transactions: ATM Offerings and PIPEs May Substitute for Traditional Follow-Ons One of the advantages of becoming a public company is the ability to access additional capital after the IPO in the form of follow-on transactions. Current market conditions have put a damper on follow-on transaction activity. Some public companies have turned to ATM—or at-the-market—offerings, which are follow-on offerings used to raise capital over time. ATM offerings provide greater control of the timing and the proceeds raised. In a volatile market, the issuer can always refrain from selling stock when prices are lower
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Middle Market Equity Capital Report ― Q1 2016
and begin selling stock when pricing is improved. As proceeds from an ATM offering typically flow back to the issuer sporadically, it may not be a suitable way to raise capital for a company with immediate needs. Private investments in public equity (PIPEs) offer another option for companies unable to generate demand for a follow-on offering. Even though the pricing of the PIPE includes a discount to buyers, sellers in need of capital may attract more interest from private investors than their public counterparts.
Thinking of Raising Capital? IPO Activity Market volatility is taking a toll on IPO activity.
-83% 7
2016
2015
2016
2015 Proceeds ($ billions)
Follow Ons % CHANGE
% CHANGE
-55%
-52%
130 290
35 73
2016
2016
2015
2015 Proceeds ($ billions)
PIPEs % CHANGE
% CHANGE
+22%
+42%
78 64
7.4 5.2
2016
2016
2015
2015
Transactions
Mergers and Acquisitions
% CHANGE
-34% 1566 2361 2016
Our capital raising indicators reflect Q1’s choppy waters. When market stability and investor confidence increase, conditions should improve.
2015 Capital Invested ($ billions)
Deals
Private Equity Transactions
% CHANGE
% CHANGE
-28%
-27%
720 996
53.3 72.7
2016
2016
2015
2015
Capital Invested ($ billions)
Deals
Venture Capital Transactions VCs, active technology sector investors, may be proceeding with more caution as a result of shifting valuations.
-78% 1.2
PIPEs, an alternative to traditional follow-ons, are a bright spot in the capital raising landscape.
Private equity investors continue to be challenged originating and closing deals, but the transcation activity is impressive when compared to public options.
% CHANGE
40
PIPEs
M&A activity has decreased year over year, but has been buoyed by continued emphasis on growth.
% CHANGE
9
Follow-On Transactions Pricing concerns and a lack of investor confidence are pressuring follow-on transaction activity.
Proceeds ($ billions)
IPOs
% CHANGE
% CHANGE
-37%
-8%
2220 3551
18 19.6
2016
2016
2015
2015
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Life Sciences and Technology Sector Companies Are Most Affected
“Given decreased IPO transaction activity, life sciences companies in need of capital will focus on alternative methods such as collaboration agreements and private capital raising opportunities, often with existing investors in order to sustain and grow. If possible, coordinating the achievement of important milestones with capital raising activities may yield positive results. In today’s environment, management teams are likely to redouble their cash management efforts to decrease burn rates.” Craig Golding CohnReznick Partner, Technology and Life Sciences Industry Practice
Growth-oriented biotechnology and pharmaceutical companies will be significantly impacted by the slow-down in IPO activity. Healthcare and life sciences companies, including biotech and pharma, had been the major beneficiaries of the vibrant IPO market of 2014 and early 2015. In fact, they accounted for nearly 40% of middle market IPO activity. Life sciences companies, faced with long development and approval processes, viewed the IPO as the form of capital that best met their near-term needs and offered a platform for additional access to capital in the form of follow-on transactions. Of the nine IPOs making it to market in Q1 2016, six were issued by life sciences companies. The general decrease in access to equity capital may force many early-stage life science companies to delay research and preserve cash due to the lack of opportunities for raising capital. Without the option of an IPO, we may see even more life sciences companies place greater emphasis on finding the right strategic or financial partner. The acquisition arms of large pharma companies may be in a position to acquire smaller life sciences companies that can’t support their operations or access additional capital. The reduction in access to capital may spur an increase in collaboration and licensing deals in an effort to
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Middle Market Equity Capital Report ― Q1 2016
maximize resources. Debt capital is less of an option for these companies as many are “asset light” and may be without revenue. Biotechnology and pharmaceutical companies with promising drugs—those in the later stages of approval and monetization—will be in the best position to attract public equity capital in the form of IPOs or follow-on transactions. By timing the achievement of important milestones with capital raising activities, these companies may be able to lift pricing and attract investors. For technology companies, IPO transaction activity has been in decline for some time. Strategic and private investors have rewarded technology companies with chunky valuations. Technology companies and their venture capital investors may now have to adjust to an environment of moderating valuations coupled with a severely limited opportunity to go public. Some technology companies can’t make the jump to public company status without adjustments to their stock prices and their high valuations. Those that are developing interesting intellectual property will continue to receive investment interest from corporate VCs and larger partners. IPO and follow-on activity, however, are likely to remain slow.
Conclusion
It’s clear that investors have developed a stronger
rewards. Instead, IPO activity has been replaced
aversion to risk amid volatile market conditions. Even
with mergers and acquisitions (also decreased in
a strengthening U.S. economy, and what appears to
Q1 2016 when compared to 2015). Private capital
be a resilient stock market, seem unable to create
has filled part of the void left by fewer IPOs and is likely
enough confidence to stimulate an increased level
to continue its important role in the near term. Looking
of IPO activity. Typically, as goes the stock market, so
forward, we believe that IPO activity will improve, but
goes IPO activity. But there seems to be a disconnect.
the time horizon is questionable. Private companies
The stock market is making progress, but IPO transaction
with good stories to tell investors, a solid track record,
activity is stied. IPOs, a riskier investment proposition
experienced management team, strong financials,
to begin with, require a greater sense of calm to
and within specific industry sectors will be in the best
create any traction. IPOs would certainly benefit from
position to go public. We anxiously await the return
longer periods of market stability. Right now, the risks
of a robust IPO market.
associated with IPOs are perceived to outweigh the
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About CohnReznick’s Public Companies Group Utilizing comprehensive resources and deep industry expertise, the professionals of CohnReznick’s Public Companies Group understand the goals of both middle market companies and investors to deliver timely and appropriate solutions and services. We understand the challenges and opportunities of the capital markets and possess the forward thinking technical skills and experience necessary to address the needs of clients, investment bankers, investment advisors, attorneys, lenders, investors, managements, audit committees, and the U.S. Securities and Exchange Commission and other regulatory authorities. • • • • • • • • • • • • •
Alex Castelli, CPA, Partner, National Liquidity and Capital Formation Advisory Group Anton Cohen, CPA, Partner, Renewable Energy Industry Practice Co-National Director George Gallinger, Principal, CohnReznick Advisory − Governance, Risk, and Compliance National Director Craig Golding, CPA, Partner, Technology and Life Sciences Industry Practice David Kessler, CPA, Partner, Commercial Real Estate Industry Practice National Director Adam Kleeman, CPA, Partner, Commercial Real Estate Industry Practice Gary Levy, CPA, Partner, Hospitality Industry Practice Leader Cindy McLoughlin, CPA, Partner, Hospitality Industry Practice Steven Schenkel, CPA, Partner, Chief Risk Officer Richard Schurig, CPA, Partner, Retail and Consumer Products Industry Practice Leader Mark Spelker, CPA, Partner, National Director of SEC Services Jeremy Swan, Principal, National Director, Private Equity and Venture Capital Industry Practice Stephen Wyss, CPA, Partner, Retail and Consumer Products Industry Practices
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Source: Thomson Reuters
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Middle Market Equity Capital Report ― Q1 2016
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