Initial Public Offerings Jay R Ritter Warrington College

Initial Public Offerings Jay R. Ritter Warrington College of Business Administration University of Florida September 8, 2016

Number of Domestic Companies Listed on CRSP 8000 Number of Domestic Companies Listed on CRSP 7000 6000 5000 4000 3000 2000 1000 0 3/3 3/3 3/3 3/3 3/3 3/3 3/3 3/3 3/3 1/1 1/1 1/1 1/1 1/1 1/2 1/2 1/2 1/2 980981982983984985986987988989990991992993994995996997998999000001002003004005006007008009010011012013014015 Date Note: Operating companies only (i. e. , no limited partnerships, closed-end funds, REITs, ETFs) listed on Nasdaq, NYSE, and Amex (now NYSE MKT). CRSP is the University of Chicago’s Center for Research in Security Prices. Quarter-end numbers are plotted, 1980 -2015.

Number of Foreign and Domestic Companies listed on CRSP 9000 8000 n_foreign n_domestic Number of Companies 7000 6000 5000 4000 3000 2000 1000 0 3/3 3/3 3/3 3/3 3/3 3/3 3/3 3/3 3/3 1/1 1/1 1/1 1/1 1/1 1/2 1/2 1/2 1/2 980 981 982 983 984 985 986 987 988 989 990 991 992 993 994 995 996 997 998 999 000 001 002 003 004 005 006 007 008 009 010 011 012 013 014 015 Date Note: Operating companies only (i. e. , no limited partnerships, closed-end funds, REITs, ETFs) listed on Nasdaq, NYSE, and Amex (now NYSE MKT)

IPO volume has been very low in the U. S. since 2000 80 70 600 60 50 400 40 30 200 20 10 0 19 81 19 82 19 83 19 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 0 Average First-day Returns Number of IPOs In 1980 -2000, an average of 310 firms went public every year In 2001 -2015, an average of 111 firms went public every year Number of Offerings (bars) and Average First-day Returns (line) on US IPOs, 1980 -2015 4

US IPO Volume has been particularly low for small firms Small firm IPOs are defined as IPOs with less than $50 million in LTM sales ($2009) 400 350 300 small 250 200 150 big 100 50 84 19 85 19 86 19 87 19 88 19 89 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12 20 13 20 14 20 15 83 19 82 19 81 19 19 19 80 0 Number of U. S. IPOs with pre-IPO Annual Sales less than or greater than $50 m/Year ($2009) 5

IPO Exits for VC-backed Firms Have Been Limited 100 60 %IPO M&A 40 20 20 15 20 14 20 13 20 12 20 11 20 10 20 09 20 08 20 07 20 06 20 05 20 04 20 03 20 02 20 01 20 00 19 99 19 98 19 97 19 96 19 95 19 94 19 93 19 92 19 91 0 19 90 Number of VC Exits 80 Source: NVCA 2015 Yearbook Figures 9 and 10 and 2016 Yearbook Figures 4. 02 and 10. 0 6

19 75 19 76 19 77 19 78 19 80 19 81 19 82 19 83 19 85 19 86 19 87 19 88 19 90 19 91 19 92 19 93 19 95 19 96 19 97 19 98 20 00 20 01 20 02 20 03 20 05 20 06 20 07 20 08 20 10 20 11 20 12 50 25 Scaled Quarte 40 20 Shiller PE Scaled IPO Volume Shiller P/E 30 15 20 10 10 5 0 0

Why Has IPO Volume Been So Low?

Conventional Wisdom: The IPO Market Is Broken Sarbanes-Oxley Act of 2002 (SOX) has imposed costs on publicly traded firms, especially small firms Decimalization, Reg FD in 2000, and the Global Settlement in 2003 have led to a drop in analyst coverage for small firms, lowering their P/E ratios, and the collapse of the IPO ecosystem

The Economies of Scope Hypothesis Increased economies of scope Increased importance of speed to market Getting big fast is more important than in the past 10

Changes in the Product Market The profitability of small independent firms has declined relative to the value created as part of a larger organization that can quickly implement new technology and benefit from economies of scope 11

Evidence The percentage of small firms that are unprofitable has increased Percentage of seasoned public companies with negative EPS, 1980 -2009 12

Small firm IPOs have become less profitable 100% 90% 80% Small firm IPOs 70% 60% Large firm IPOs 50% 40% 30% 20% 10% 0% 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Small firm IPOs Large firm IPOs Percentage of IPOs from the prior 3 years with negative EPS in fiscal year t Source: Table 2, columns 2 and 4 of Gao, Ritter, and Zhu “Where Have All the IPOs Gone? ” December 2013 Journal of Financial and Quantitative Analysis 13

Are recent IPOs going private more frequently? Source: Table 3 (both LBOs and acquisitions by private firms) 14

Young growth firms are more likely to be involved in an M&A transaction Either as an acquirer or being acquired Uptrend started in early 1990 s

Evidence on post-IPO analyst coverage There is near universal analyst coverage on IPOs in 1994 to 2009 The percentage of small (grey) and large (red) firm IPOs with analyst coverage from at least one lead underwriter within one year of the IPO 100% 95% 90% 85% 80% 1994 -2001 2002 -2009 Source: Table 5, column 3 of Gao, Ritter, Zhu (2013 JFQA) 16

Figure 2. Price-earnings ratio of small company (annual sales less than $1 billion, 2011 purchasing power) and big company stocks with positive EPS (Before extraordinary items) traded on the Amex, Nasdaq, or NYSE with Compustat EPS data available. The price-earnings ratios are computed as the sum of the market values divided by the sum of the earnings for, respectively, small and big companies with positive EPS.

IPOs are underpriced in every country In the U. S. from 1980 -2014, the average first-day return is 18%

50% 40% 30% 20% 10% Average first-day returns on (mostly) European IPOs 60% 0% Greece Switzerland Sweden Germany Ireland Cyprus United States Finland United Kingdom Italy Israel Belgium Poland Portugal France Spain Netherlands Turkey Norway Denmark Austria Russia

80% 60% 40% 20% Average first-day returns on non-European IPOs 120% 100% 0% China (A shares) India Korea Malaysia Japan Taiwan Thailand Sri Lanka Brazil Singapore Indonesia Iran Australia New Zealand Philippines South Africa United States Hong Kong Israel Nigeria Mexico Egypt Turkey Chile Canada Argentina

Does Underpricing Harm the Shareholders of an Issuing Firm?

The Effect of Underpricing on the Wealth and Ownership of Pre-issue Shareholders Assumptions: Pre-issue shares outstanding: 15. 6 million shares Gross proceeds of IPO: $78 million Post-issue market cap: $280. 8 million # of shares sold by pre-issue shareholders: zero Offer price and number of shares offered: Post-issue shares outstanding: Market price per share: Money left on the table: Post-issue wealth of pre-issue shareholders: Post-issue % of firm owned by pre-issue shareholders: Strategy 1 7. 8 m at $10. 00 23. 4 million $12. 00 $15. 6 million $187. 2 million 66. 7% Strategy 2 6. 0 m at $13. 00 21. 6 million $13. 00 zero $202. 8 million 72. 2%

Long-run Performance of IPOs

While IPOs tend to go up on the first day of trading, in the long run, on average they have tended to underperform. But there is a strong cross-sectional pattern in the U. S. : IPOs that had annual sales of less than $50 million severely underperform, whereas those that had achieved annual sales of $50 million don’t underperform. Buy-and-hold stock returns are skewed: there are some big winners, but most stocks underperform. This is especially true with young companies, where there is even greater right skewness.

20 Annual Percentage Returns 18 16 14 12 10 8 6 4 2 Style Matched 0 First Year Second Year Third Year Fourth Year Fifth Year IPOs Annual returns in the five years after going public for U. S. 8, 278 IPOs from 1970 -2011. Style-matched firms match on market cap and book-to-market.

3 -year Buy-and-hold Style-adjusted Returns 7, 855 U. S. IPOs from 1980 -2013. Style-adjusted returns exclude the opening day return Style controls for market capitalization and book-to-market 30% 25% 20% 15% 10% 5% 0% -5% 0 -9 10 -19 20 -49 50 -99 100 -499 - -10% -15% -20% -25% -30% Annual Sales, $millions (2014 purchasing power) 500 -up

US small firm IPO returns have been disappointing $60 million in pre-IPO annual sales cutoff, returns not including first-day return and ending in Dec. 2014 Mean 3 -year buy-and-hold returns on IPOs (blue) and style-matched seasoned 45% 40% Small firm Large firm 35% 30% 25% 20% 15% 10% 5% 0% 1980– 2000 2001– 2012 1980– 2000 2001– 2012 27

European small firm IPOs returns have also been low 25% 20% 15% 10% 5% 0% -5% 1995 -2000 2001 -2008 Small firms BHR 1995 -2000 2001 -2008 Large firms Benchmark (FTSE Euro. MID) Small firm (<€ 30 m in sales) IPO 3 -year buy-and-hold returns are lower than for large firm IPOs (returns are measured from the 22 nd trading day closing market price) 28

3 -year buy-and-hold returns of London IPOs, 1995 -2006 AIM Official List 50% 40% 30% 20% 10% 0% FTSE Euromid IPOs FTSE Euromid Source: Vismara, Paleari, and Ritter, June 2012, European Financial Management