Initial Public Offerings

Jay R. Ritter

Warrington College of Business Administration

University of Florida

December 2015

Number of Offerings (bars) and First-day Returns on Turkish IPOs, 1990-2015

-5%

0%

5%

10%

15%

20%

25%

30%

35%

40%

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10190001900r1l

15190001900r1l

20190001900r1l

25190001900r1l

30190001900r1l

4190001900r2l

9190001900r2l

Ave

rage

Fir

st-d

ay R

etu

rns

Nu

mb

er o

f IP

Os

Sources: Halil Kitmaz, Banu Durukan, Guray Kucukkocaoglu, Orhan Emre Elma, Dealogic, and the Borsa

Istanbul. 2015 numbers are for the first six months only.

Number of Offerings and Average First-day Returns on Chinese IPOs, 1990-2014 (There were no IPOs in 2013, due to a CSRC moratorium starting in October 2012)

Source: Jia, Xie, and Zhang (2014)

Number of Offerings and Average First-day Returns on Japanese IPOs, 1980-2014

Source: Takashi Kaneko and others

Number of Offerings and Average First-Day Returns on German IPOs, 1980-2015

For 2015, the numbers are for January-November

IPO volume has been very low in the U.S. since 2000

6

In 1980-2000, an average of 310 firms went public every year

In 2001-2014, an average of 110 firms went public every year

Number of Offerings (bars) and Average First-day Returns (yellow) on US IPOs, 1980-2014

U.S. 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)

7

Number of U.S. IPOs with pre-IPO Annual Sales less than or greater than $50m/Year ($2009)

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29190001900r5l

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26190001900r10l

15190001900r12l

3190101901r2l

small

big

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26190201902r9l

22190501905r6l

18190801908r3l

13191001910r12l

8191301913r9l

4191601916r6l

1191901919r3l

25192101921r11l

29

28

1

29

64

6

30

01

1

30

37

6

30

74

2

31

10

7

31

47

2

31

83

7

32

20

3

32

56

8

32

93

3

33

29

8

33

66

4

34

02

9

34

39

4

34

75

9

35

12

5

35

49

0

35

85

5

36

22

0

36

58

6

36

95

1

37

31

6

37

68

1

38

04

7

38

41

2

38

77

7

39

14

2

39

50

8

39

87

3

40

23

8

40

60

3

40

96

9

41

33

4

41

69

9

Nu

mb

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of

Do

me

stic

Co

mp

anie

s Li

ste

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n C

RSP

Date Note: Operating companies only (i.e., no limited partnerships, closed-end funds, REITs, ETFs) listed on Nasdaq, NYSE, and Amex (now NYSE MKT) Source: University of Chicago Center for Research in Security Prices

Number of U.S. Domestic Companies Listed on Nasdaq, the NYSE, and NYSE MKT

Why Has IPO Volume Been So Low?

Figure 2: The Shiller P/E ratio is taken from Robert Shiller’s website and is computed as the ratio of the S&P 500 index divided by the inflation-

adjusted ten-year moving average of S&P 500 earnings. Scaled IPO volume is quarterly IPO volume divided by annual real GDP, in trillions of

2009 dollars.

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5190001900r1l

10190001900r1l

15190001900r1l

20190001900r1l

25190001900r1l

0190001900r1l

10190001900r1l

20190001900r1l

30190001900r1l

9190001900r2l

19190001900r2l

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Shiller P/E Scaled IPO Volume

11

IPO Exits for VC-backed Firms Have Been Limited

Source: NVCA 2015 Yearbook Figures 9 and 10

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

13

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

14

Changes in the Product Market

Evidence from the U.S. The percentage of small firms that are unprofitable has increased

15

Percentage of seasoned public companies with negative EPS, 1980-2009

0%

10%

20%

30%

40%

50%

60%

70%

Large firms

Without SOX costs

Small firms

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Small firm IPOs Large firm IPOs

Small firm IPOs have become less profitable

16

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

Large firm IPOs

Small firm IPOs

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.

Are recent IPOs going private more frequently?

18

Source: Table 3 (both LBOs and acquisitions by private firms)

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 1990s

Family businesses are more likely to sell out,

possibly in a cross-border transaction, than remain

independent and go public

Technology has resulted in greater economies

of scope and scale

Cheaper transportation costs and lower tariffs

have resulted in more globalization

Is going public too costly?

Fees paid to investment bankers

Regulatory costs including auditing costs

Money left on the table due to underpricing

IPOs are underpriced in every country

In the U.S. from 1980-2014, the average

first-day return is 18%

-10%

0%

10%

20%

30%

40%

50%

60%

Ave

rag

e f

irst-

day r

etu

rns

Average first-day returns on (mostly) European IPOs

0%

20%

40%

60%

80%

100%

120%

Avera

ge f

irst-

day r

etu

rns

Average first-day returns on non-European IPOs

Should there be a separate market for

small companies?

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.

IPOs

Style Matched0190001900r1l

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First YearSecond Year

Third YearFourth Year

Fifth Year

An

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al

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Re

turn

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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.

Annual Sales, $millions (2005 purchasing power)

3-year Buy-and-hold Style-adjusted Returns 7,700 U.S. IPOs from 1980-2012. Style-adjusted returns exclude the opening day return

Style controls for market capitalization and book-to-market

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)

30

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

Small firm IPOs Large firm IPOs

Mean 3-year buy-and-hold returns on IPOs (blue) and style-matched seasoned firms (red)

1980–2000 2001–2012 1980–2000 2001–2012

31

Small firm (<€30m in sales) IPO 3-year buy-and-hold returns are lower than for large

firm IPOs (returns are measured from the 22nd trading day closing market price)

European small firm IPOs returns have also been low

-5%

0%

5%

10%

15%

20%

25%

1995-2000 2001-2008 1995-2000 2001-2008

Small firms Large firms

BHR Benchmark (FTSE EuroMID)

Source: Vismara, Paleari, and Ritter, June 2012, European Financial Management

0%

10%

20%

30%

40%

50%

IPOs FTSE Euromid IPOs FTSE Euromid

AIM Official List

3-year buy-and-hold returns of London IPOs, 1995-2006

Markets for Small and Medium Enterprises

(SMEs)

Small company IPOs rarely achieve

success with large expansions of

profits, disappointing investors

Efficient Allocation of Capital Benefits

an Economy

Investors in publicly traded firms must have the

power to remove managers that are not acting in

the best interest of shareholders

U.S. firms in the S&P 500 paid $375 billion

in dividends in 2014, and about twice

that in share repurchases ($1 trillion total)

Russian firms paid out almost nothing

The market cap of Russia is less than

that of Apple