The London Stock Exchange (LSE) is running dry on new companies coming to market and it is very unlikely that the post-Covid boom will continue into 2022, particularly at the small-cap end, according to Scott McKenzie, manager of the TB Amati UK Smaller Companies fund.
Last year was a bumper 12 months for initial public offerings (IPO) on the UK market, with 120 companies listing, breaking the previous record set in 2014.
The Alternative Investment Market (AIM) also enjoyed a particularly bountiful period, surpassing the number of new IPOs in 2020 as early as June.
This year is a very different story, according to McKenzie, who said that there are fewer names joining the market in 2022, with the small-cap space particularly lacking. So far just 27 new IPOs have joined the LSE, with nine on AIM.
McKenzie said the “thin diary” was completely different to this time last year, when “we were literally deluged with IPOs”.
“I think that we've gone from feast to famine in the current year,” he added, noting that his TB Amati UK Smaller Companies had invested in zero IPOs so far this year.
She said that although there was some buzz about things picking up after the summer, “I suspect even in the second half of the year the IPO markets will be quiet”.
New listings are vital for fund managers as it increases the number of stocks they can invest in and allows for more diversified portfolios, as well as the ability to differentiate from benchmarks indices.
McKenzie explained that 2021 was such a strong year for UK IPOs that it was a tough act to follow, but said that was not the only reason for this dip.
The bigger explanations are that the inflation and other macro and geopolitical events, as well dwindling investor sentiment, had put businesses off coming to market.
One of the main issues facing small-cap IPOs this year is that they have tended to be tech, consumer and internet businesses – sectors that are experiencing a downturn.
Indeed the former was the main theme for IPOs in 2021, with tech and consumer internet businesses leading the primary market issuance. They made up 39% of total IPO capital raised and some of the most successful listings were on AIM.
But these types of stocks are facing a much tougher time now that inflation has hit 7% and is projected to go even higher in the second half of 2022.
McKenzie said that “the bubble has kind of burst to a degree for that type of stock, and I think it really started when the Nasdaq started to come off the boil around June last year”.
He said that the Nasdaq was the “leading indicator for UK tech fundraisings” and its near 12% decline since the start of 2022 was not a good omen.
“That whole sector theme has dissipated among IPOs at the start of this year,” he said.
At the same time, the market has been digesting the impacts of ongoing supply chain problems and the breakout of war in Europe, as Russia invaded Ukraine back in late February.
This intense geopolitical event has sent markets into extremes, with only the FTSE 100 enjoying any real benefits, mainly because it is densely populated by oil, commodity and energy stocks.
“Recently, the kind of businesses that have done well are not the type of companies raising money in the markets in recent years,” McKenzie said.
Indeed, around 15% of AIM is made up of oil and mining stocks, “and obviously that was much lower at the start of the year, closer to 10-11% but because of Ukraine most of these companies are going up in value”.
“When's the last time an oil company raised money as an IPO? I can't remember. There's not many in recent years, and there's been a lack of capital in those parts of the market,” he said.
Inflation has also fed into a more subdued investor sentiment, with companies seemingly unsure that they would raise enough capital in the current climate.
“I think it is a lot more difficult for them now than it was a year ago,” McKenzie said, as the cost of capital increases.
“Interest rates are rising and inflation is going up substantially, that makes it a more challenging environment for early stage companies in general, many of which rely on equity fundraising to execute their growth, and the environment for that is just much more hostile now than it was a year ago,” McKenzie said.
Glennie had identified a similar theme, adding that in uncertain market environments investors’ appetite for IPOs dwindles. She said that there was “more focus on the companies already owned, how are they operating, reporting etc” as setting forecasts when there so much disruption and volatility made “the outlook less certain for many businesses”.
Even if companies overcame these hurdles and saw a path through the macro and political headwinds they may struggle to price themselves appropriately, Glennie said.
This has always been a tricky part of public offerings, but “setting valuations is tougher in this environment as share prices and valuations are moving about,” she abrdn manager said.
“Also a lot of sellers, especially private equity, are tied to valuations they thought their business deserved six months ago, and don’t want to list and lock in a lower price initially.”