Bulls beware

Given skyrocketing US IPO volumes, this might seem like a good time for sponsors to be plotting a public offering for their portfolio companies. But the picture may not be as rosy as these numbers suggest.

Initial public offerings dominated headlines this week, as at least ten companies debuted on US exchanges as of Thursday. Among these were travel technology company Sabre, backed by Silver Lake, and medical device company TriVascular Technologies, backed by an investor group including venture capital firm NEA.

The buzz in the US IPO market goes back farther than just this week, however. The first quarter of 2014 was one of the most active for US IPOs in years, with 71 public company debuts, a 109 percent year-over-year increase, according to research from PwC. And that's largely down to private equity: sponsor-backed companies accounted for 75 percent of US activity last quarter, up from 50 percent in Q1 2013.

This hot market has continued to simmer through April, with another 27 companies listing so far this month.

This level of IPO activity might just look on paper like a continuation of 2013's robust activity levels. But in practice, it is rare for so many public market debuts to take place during the first quarter. As Neil Dhar, PwC’s US capital markets leader told us recently, the first quarter is usually much slower because companies typically wait until year-end numbers are ready – which often leads to a dip in new issuances.

Still, despite these uncharacteristically high volumes, private equity firms should be wary of reading too much into this about the prospects for the rest of the year.

The first point to note is that despite the rise in volumes, IPO proceeds are actually down year-over-year: the $11 billion raised during the first quarter came in under the quarterly average of $12.5 billion during 2012 and 2013. Healthcare-related IPOs accounted for nearly half of all IPO volume for the period, but in total these offerings together yielded just $2.2 billion in proceeds (about 20 percent of the total). 

Equally, this week there have been some early warning signs of shifting sentiment. Most of the companies that debuted priced below their proposed offering range. Sabre, for example, priced at $16 per share, below its $18 to $20 range, and sold about 39 million shares, less than the anticipated 44 million. Meanwhile, Weibo, the Chinese equivalent of Twitter, priced at the lower end of its range and raised only $286 million, having targeted $340 million.

On top of this, Hellman & Friedman-backed Associated Materials pulled its IPO on Wednesday, the first cancelled listing in some time. (This was followed on Thursday by Silver Lake-backed high-frequency trading firm Virtu indefinitely postponing its IPO, though that may have more to do with Michael Lewis' book than market conditions.) 

At the same time, it goes without saying that the IPO market remains extremely sensitive to wider macroeconomic conditions. Geopolitical upheaval – like the escalating crisis in the Ukraine – tends to cause market volatility, and that is bound to have a damaging effect on investor sentiment toward IPOs. As PwC’s Dhar points out, this is a market that “does not like volatility”. 

So investors should think twice before they start pushing every other company in their portfolio towards the IPO window (as per some of the more excitable predictions). Because this is a market that has a tendency to turn on a dime.