(Illustration by Iker Ayestaran)
Hootsuite. Vision Critical. Real Matters. These are just some of the Canadian technology names many people expected to go public this year. A few months into 2016, though, it became apparent that none of these buzz-worthy businesses was going to list and, for that matter, neither was anyone else. Just one corporate initial public offering tested the Toronto Stock Exchange big board—women’s clothing chain Aritzia Inc. (TSX: ATZ)—and it waited until October. Unless something surprising happens over the next few weeks, 2016 will go down as one of the worst-ever years for Canadian IPOs.
For portfolio managers, pension fund members and retail stock pickers, the dearth of new companies coming to market is troubling. Fresh listings provide them with more choice. Without new issues, the investable universe shrinks, as listed companies get taken over, taken private or delisted. The current IPO drought isn’t going to last forever. But whether it recovers to the level needed to maintain the Canadian market’s depth and breadth remains to be seen.
The trend is partly driven by the fact that going public is no longer the only—or even the primary—means for a company to grow. Years ago, listing on a stock exchange was the obvious way for an expanding enterprise to generate cash. Debt was expensive, and the private investment community wasn’t nearly as developed as it is today. A public listing brought an air of legitimacy to a business too. Now, ultra-low interest rates have made debt financing cheap; robust venture capital and private equity networks are willing to keep pumping money into a business until it’s mature; and companies themselves are increasingly deterred by the heavy administrative and regulatory burden that comes with being publicly traded.
Private companies are staying private for longer, says John Christofilos, vice-president and head trader at AGF Management. In 1999, American companies would list after an average of four years in existence. After the corrective of the dot-com bust, Christofilos says, businesses now typically wait 11 years to go public. “A lot of companies today are started by two guys in a garage somewhere,” he says. “They don’t have the ability or the aptitude to deal with regulations and compliance, so they remain private.”
While these are some of the big reasons IPOs are down worldwide—the U.S. has seen 48% fewer IPOs through the third quarter compared with 2015—for Canada, additional factors are at play. It’s no coincidence that Canadian IPOs peaked in 2010, when commodity prices were soaring. Even with our growing tech sector, the majority of domestic IPOs over the past decade have been in energy. With oil now hovering at US$45 a barrel and mining still struggling, there’s little appetite for investing in new resource operations. “The demand isn’t there for smaller IPOs, so they sit in the pipeline and wait for the market to turn,” says Dean Braunsteiner, PricewaterhouseCoopers Canada’s national IPO services leader.
Investor tastes have changed, too, Braunsteiner says. With so much uncertainty in the market this year, thanks to Brexit, the U.S. election and worries about China, people want to own tried-and-true operations, not risky technology and energy firms. Aritzia, a demonstrably profitable 32-year-old company with 75 stores, is the kind of IPO Canadians will get behind right now, says Braunsteiner. Its stock promptly rose about 15% from the offering price and stayed there.
Still, the lack of such new listings is a problem for fund companies like AGF, says Christofilos. Managers are looking for new places to invest, he says, and “these opportunities are very important to us.” As well, when a company comes to market, a certain percentage of shares goes toward retail funds, while another portion is allocated to institutional investors. If a hot issue is in high demand, institutions will get a larger chunk of that split. A slowdown in IPOs could, therefore, affect pension and retirement accounts.
Many investors avoid newly listed companies, however. They wait until the stock has a track record before buying. That’s the case with Paul Harris, a partner and portfolio manager with Avenue Investment Management. For that reason, he’s not overly concerned with what he sees as a cyclical phenomenon. The IPO market will rebound once the broader equity market stabilizes, he says. Venture capital and private equity firms still need to cash out of their investments. If oil rises to US$60 a barrel, Harris expects to see more energy-related IPOs. He also thinks that once American tech companies start listing again, their Canadian counterparts will follow suit. One positive sign was the Nov. 15 announcement that Snap Inc., the developer of the Snapchat app, valued at US$25 billion, plans to go public in 2017.
For all their problems, public markets remain reasonably efficient. It’s therefore reasonable to believe the supply of public equities will respond to the demand. Should listings become scarce, their valuations would climb, lowering the cost of capital raised on equity markets and attracting more companies back into the public sphere.
Christofilos is optimistic that the market will bounce back next year. His broker-dealer partners are telling him the IPO pipeline is filled with opportunities. American president-elect Donald Trump’s pro-growth policies, if they come to fruition, could buoy the market and encourage more companies to list. “I believe there’s a lot of pent-up demand, and it’s about getting those companies comfortable enough to say, ‘OK, let’s pull the trigger,’” Christofilos says. “Maybe 2017 will be a good year.”
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