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(No) Wild Canaries

Last February, an investor sentiment assessment framework was introduced, relying on a dozen variables (see ‘Market Sentiment & IPOs’). A pickup in IPO activity was expected in Q2 that year. That was before the 10-year risk-free yield decided to behave like a drunken dragon, frantically moving from just above 3% in May to 5% in November, thereby killing any hope for a constructive IPO market.

Below is an updated analysis. It shows significant improvement across parameters. A technical analysis complements this positive assessment (see Arbitraging Emotions’).

Two variables continue to suggest caution: the expected volatility in treasury rates (MOVE index) as investors look for more evidence that the dragon has sobered up; and a lingering bad taste from the IPOs of the last three years (check the Renaissance IPO Index). Investors want issuers to know, as per a French saying, that ‘one shall not take the children of the good Lord for wild canaries.’

It is not unreasonable to expect an alignment of stars supporting a broadening of the IPO market around the middle of the year. This assumes that the Fed implements a first cut by its June meeting, a critical event for the market psyche. By then, there will conveniently be some visibility on the 2025 outlook. Whether the uncertainty caused by the U.S. election campaigns and China’s economic woes is digestible remains to be seen.

Whenever the IPO window opens in earnest, investors’ due diligence is expected to be particularly thorough. Hyped lotteries for FOMO-fuelled wild canaries are unlikely – at least for a while. Instead, the focus will be on coherence considering a company’s:

  • Equity story (leadership, business model, tech, end-markets, China), avoiding mumbo-jumbo;

  • Business fundamentals (Porter’s five forces – no need to reinvent the wheel);

  • Financial profile, with emphasis on profitable growth;

  • Capital structure, noting an ongoing aversion to leverage, including in the US;

  • Non-financial performance, considering enhanced disclosure requirements across regions; and

  • Public profile vis-a-vis the broader stakeholder base.

Aligning the stars internally to market an investment opportunity with coherence, conciseness, and conviction will require a potent mix of leadership, corporate finance expertise, seamless interdisciplinary collaboration (incl. with advisors), and a severe dose of brain power.

Three takeaways: first, an alignment of stars internally (company) is as important, if not more important than the alignment of stars externally (market sentiment); second, since the alignment of stars externally has proven difficult to anticipate, there is a premium to IPO readiness and agility; third, issuers must resist the urge to push prices beyond reason. An IPO’s performance is judged after a few quarters, not a few days.

Finally, here is an overarching due diligence question for firms across sectors: ‘What will the investee company look like in 2040?’ The more certainty in the answer, the lower the discount to future cash flows.

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