Listen: Season 2 | Ep. 1 - M&A on The Road to Recovery

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Joe Mantone

The IPO market has been close to dormant for much of 2023. However, Seth Rubin at Stifel Financial sees signs for optimism. Hear why on the next episode of The Pipeline.

Hello, and welcome to The Pipeline, an S&P Global Market Intelligence podcast. I'm Joe Mantone, an editor at Market Intelligence and the host of The Pipeline podcast. This episode will be focused on the current state of the IPO market. And for it, I reached out to Stifel Financial for the discussion because the company's investment bank focuses on a broad range of industries and company sizes.

Given the company's wide range of coverage, I thought Seth Rubin, Head of U.S. Equity Capital Markets at Stifel Financial, could provide some interesting perspective across the market as a whole. Up next is my discussion with Dr. Rubin, Head of U.S. Equity Capital Markets at Stifel.

Joe Mantone

Great. All right. Seth, well, thank you for joining us here today. To start off, I kind of wanted to ask you about the IPO market in general. I mean I know IPO activity slowed considerably in 2022 and it's remained muted in 2023. Did you expect to see more pickup in the activity by now?

Seth Rubin

Yes. Thanks, Joe, for the chat. Look, I think muted is probably a nice word for it. It's been pretty anemic as we've gotten through it. Look, I think we've been expecting to see market pickups for a long time now, but I'm not really sure why we're expecting it. I think this is actually a reasonably predictable trend just given where we are in the markets.

When you've got 5% interest rates out there and you've got companies who are kind of struggling to really quantify what their '23, '24, '25 plans are, it's going to cause a disruption in the IPO market. I think the good news is that we've started to see some successful deals. And I look back at different periods of time and sort of -- and we'll talk about that a little bit more, see how the market has opened up during those periods of times. This is not abnormal to see a couple of deals out of the gate.

The market wants to digest those, make sure they perform and then a couple of more and then a couple of more, and then we'll start to see the market open up. I'll tell you where I'm particularly bullish is the quality of companies that are in the backlog. We've got companies that are more mature. They've frankly been operating like public companies, even though they've been private for a long time. They've got real scale. And so I'm really looking forward to this next class of IPOs, but I don't necessarily think something snaps and it turns on overnight.

Joe Mantone

The quality of companies is that's just a matter of a pent-up demand.

Seth Rubin

I think pent-up demand, I think pent-up supply, frankly. Companies that have had access to a lot of private capital that have brought in great management teams that have operated public companies in the past. And then have been able to grow as private companies and do M&A and continue to succeed in that way. So I think there's a great group of companies that are waiting for the right time to time the market, and they're well-funded. So they don't have to come out before they're ready. They're not forced to go issue into either a tough tape or when they're not feeling 100% about their business.

Joe Mantone

Surely makes sense. And you mentioned interest rates. Is that the biggest headwind to IPO activity right now?

Seth Rubin

I think so. I think the interest rate environment and making sure that companies -- I mean, 2 things there. One, you've got to find companies that are going to perform in that higher interest rate environment and perform when money is not free. So it can't be companies that are just ready to spend in perpetuity for growth. You got to show positive unit economics.

But from an investor standpoint, I think there's 2 things. One is the risk-free rate obviously has gone way up. So you're comparing the new issue business to what you're seeing in terms of other returns. And two, just given the performance of the overall market, there's great opportunities for investors to continue to invest in their public companies that are out there.

So I think it's not a question of capital. There's plenty of capital out there. It's a question of conviction and resetting the return parameters, so that investors get confidence that they can get paid for the risk of buying a new issue, which by definition is illiquid, and it's going to have a little more risk to it.

Joe Mantone

So are we seeing any sort of change in that risk appetite from investors?

Seth Rubin

I think so. I think you're seeing it on both sides. I think you're seeing a little bit of a change in that risk appetite. And I also think you're seeing the sellers. The companies that are coming to market have a little bit more of a rational view in terms of valuation and size and what investors want. So it's going to have to come from both directions.

You have to have 2 sides to really make a marketplace. But my point before and what I was trying to say was, what I absolutely believe is it's not a matter of capital. There's plenty of capital there, and there's plenty of capital to support the leading companies and the leading growth companies from public investors, from big long-hauling mutual funds, from the big asset allocators, who play in the public market. It's just finding that equilibrium.

Joe Mantone

Given that activity has been so slow. I mean, have we seen any new types of structures or any sort of creative strategies out there to try to get deals done?

Seth Rubin

First of all, there's nothing that is particularly new or particularly novel. I think it's just going back to what we've seen in difficult markets before, which is that issuers are going to do all the things they need to do to derisk the transaction, issuers, banks, underwriters and whatnot. So there's a variety of things they can do there. Obviously, the easy ones are around valuation and size of transaction to really shrink that supply-demand imbalance.

What you've seen, and you've seen in the past and you've seen it in certain sectors for a long time, but what you've definitely started to see is companies spending a lot more time to shore up anchor orders in the IPO ahead of time. So you see it with strategic investors coming in, like on the cover of ARM right now, where you've seen strategic investors coming in. And you've seen it with financial investors, if you look at a couple of the recent transactions that have been successful like a Kava or an Oddity, where they've got some of the highest quality investors putting their name on the cover showing their support for the transaction with an indication of interest.

So what that's doing is it's number one, it's giving real comfort to the market that are quality investors that have done a lot of work, not just did work a year ago or 2 years ago, but did work recently and are willing to put their name on the cover and really help support that transaction. And number two, it's really helping to adjudicate the current valuation because it's saying, "Hey, look, we've got sign-off from some of the best mutual fund investors or otherwise, who are coming in to take big positions in the IPO". So I think you'll continue to see that. All companies want these deals to be successful, and they're spending the extra time upfront to make sure that there's that support in the market.

Joe Mantone

When you say on the cover, I'm familiar with investment banks being listed on the cover of the filings with the SEC for IPOs, but you're saying actual investors are being listed on the cover?

Seth Rubin

Yes, that's right. If you look at a number of the recent covers, you'll see, like I said, you'll see a variety of things. You'll see some of the strategic investors that are coming in. You'll see some of the existing investors that are putting on, frankly, the cover of the prospectus that they're going to -- that they've got an indication of interest of up to X. And you're seeing some new outside investors who look at it and say, look, we've done all this work. What's the best way for us to guarantee an outsized allocation.

Because if we think that this stock is going to continue to grind higher from here, and we think it's going to get more expensive over time. And it's going to be harder for us to buy a $50 million or $75 million or $100 million position in the open market without pushing the stock. This is our opportunity to take a big swing. And so you have seen that. I think you will continue to see it. And I think where it has the most value is when it's from either a very integrated strategic investor or it's from a long-hauling mutual fund who comes in and says, "This is my opportunity to build a position".

Joe Mantone

So in the past, we didn't see that at all or was it just on occasions?

Seth Rubin

That's not on occasion, like you've seen it in biotech for a long time. And I think in the past, you saw it when investors came in or there was more communication around it without necessarily being on the cover. But like I said, it's not new. It's just a cycle through. So the market likes it. I think the market says we understand that there's real value on both sides here. In an unbelievably frothy white hot, throw anything against the wall, everyone buys a market, it just -- it matters less.

And companies weren't pushed to or focused on negotiating around a price with a smaller group of investors. In the Q4 of 2021, peak valuations, free money for everyone, fear of missing out from investors, anything that you could say that provided for a frothy backdrop, companies weren't incented to say, you know what, I'm going to go negotiate my price with 2 or 3 big mutual funds, because they were able to say, I'll just -- I'll throw it out there, and I can sell this to the highest bidders. And that's what we all did for a period of time. So I think in this environment, it really pays off.

Joe Mantone

And you noted that we have seen a bit of momentum in the market, some successful deals. So do you expect that to continue?

Seth Rubin

You know, I hope it continues. I expect it to continue because I think there's high-quality companies that are continuing to come to market. Look, I think if you would have gone back through some of this, we would have maybe thought that there was going to be more transactions post Labor Day, in this sort of September window. We'll probably have 5 U.S. IPOs in September, the ones that are on file publicly now that have either launched or are preparing to launch, which is tied with the biggest month this year. But that's not a frothy post-Labor Day month. So I think we'll have those 5.

I think we'll have a handful in the fourth quarter. I think we'll have a handful in Q1. And then we're going to see, I think, if you've got to a point where you say, look, we've gotten used to a world of kind of higher, longer interest rates, but we start to see some relief. We've all at that point, in theory, said, hey, we might have a recessionary quarter or 2, but it's a pretty soft landing. And if we don't have panic around the election, which I think is completely unpredictable this year, then you've got companies looking and saying, "I'm going to get my 2023 audits on file. I'm really going to feel good about where my business is for the remainder of this year. I'm going to be able to get investors’ confidence that they're buying into a '25, '26 cycle". And I'm hopeful that we'll have a really active IPO market Q2, Q3 next year.

Joe Mantone

And it sounds like that with issuers getting more used to the current valuation, that seems like it's a good first.

Seth Rubin

Yes, I think it's the right first. Look, it's not realistic for issuers to say, I'll ignore the public comps that are out there. This is not realistic. So I think you have to say, hey, we've had this market. We've actually seen -- look, the underlying market, certainly on the growth side has been fine over the course of the last couple of quarters, we got to sell off recently. But we're going to price for the new environment.

And that new environment hopefully is a bit better than it's been for the last 6 to 18 months, but I don't see a scenario in the very near term where we're going back to peak valuations. And I certainly don't see a scenario where we're going back to an investor mentality that says just grow at all costs. Because you've got access to unlimited capital. It just doesn't exist. So you've got to be opportunistic, but you also have to be rational.

And you got to make it worth it. And that's going to mean that some companies are going to come out below the last valuation of the last round. And I can tell you one thing, the new investors, they don't care. That's sort of your problem. But what the IPO does that a lot of private rounds or private debt rounds or Bridge Capital doesn't do is it plans the capital structure. So you've got confidence in your business and you think that over the long term, you can create more value for all constituents by being a public company, then you can clean the capital structure, you wipe everyone down to common stock and you give yourself an opportunity to perform.

Joe Mantone

And then -- so it sounds like we're seeing more mature companies as opposed to high-growth companies with not much of a profit.

Seth Rubin

Yes. I'd be cautious. Look, I think we're seeing -- we're certainly seeing some more mature companies. My comment on maturity is a little bit more around sort of the corporate structure and the fact that they've been operating as public companies for a period of time and they know what to do and they know what's there, not necessarily that they've been mature in terms of slowing growth. I mean right now, if you talk to investors and you say, "Hey, what do you want? Do you want great growth companies? Or do you want profitability? Or do you want lots of scalability? Or do you want a huge TAM? Or do you want this?"

Their answer is, "Yes, I want all of it". I don't have to choose today. I want companies that have reasonable scale. I don't think they all have to be profitable, but I think they have to have profitable unit economics. So that the investors can say, "I know how this grows over time. I know you just don't have to flush money down the toilet to spark growth here. But I want you to outgrow your comps. I want you to be a market leader. I want you to have big upside potential. And if you can show me all those things and we can get it at a reasonable price, well, that makes it some sense".

I don't think that means they have to all be $5-plus billion market cap companies. Like where I focus, where we focus and where I think the real strength of the IPO market is and will come back, are those companies that are doing $150 million to $250 million IPOs at market caps of $750 million to $2 billion or $3 billion. That year in, year out, when you have a good market, that's the strength of the market. So you'll have some great companies out there that are significantly larger that, frankly, have already done the private equity trade 2 or 3 times.

They've already done the recap. They might even be too big for a consolidator to come in and say, "I'm going to buy it." So some of those will absolutely come to market. And I think there could be some great stories there. But I'm most excited about trying to return to the IPO market as a vehicle for the best growth companies, not just necessarily the biggest companies.

Joe Mantone

Got you. That makes sense. So if you're not profitable now, you need to have a good story on how you could get to that profitability.

Seth Rubin

Yes. I think that right now, you've got to get people very comfortable that within the couple of quarters that's following your analysis shows that you can get profitable. I mean I think if there are certain business units that you say, hey, we're going to still spend here, but our core business is profitable or trending in that direction. Then that kind of goes story by story. But like I said, I think right now investors have the opportunity to say, I want everything. Give me your best.

Joe Mantone

Okay. Any certain sectors that you'd say are more active now?

Seth Rubin

Look, I think if you look at what the year has been so far, it's been a little bit all over the place. It's been everything from biotech and healthcare, which I think will always be -- always might be the wrong word, but will likely still lead the market in terms of volume, because great companies need access to public capital. And because you've seen such an advancement in biotech technology that companies are creating value just quicker than they ever had before.

And so the benefit of that market is -- and when you look at it, the best biotech companies who are successful, need to raise more money. And biotech companies that have hiccups along the way need to raise more money. And the best access to that capital is in the public market and being public. So I think you'll continue to see it in healthcare. But this year, if you look back, there's been consumer, there's been energy, there's been fig. There's been some insurance deals. So it's been a little bit all over the place. I'm most excited about a return to the traditional growth sectors, technology, consumer, healthcare, as we've talked about, and some of the emerging energy and energy transition companies that I think are going to be great public stories.

Joe Mantone

Just thinking about that, though, I mean, I know those companies have raised a lot of money in the private sector and thinking about the lower valuations. Is that a challenge, thinking how they've raised capital previously at higher levels?

Seth Rubin

Yes. I think it's a challenge. And I think that's part of the reason why I don't think this market just turns on at the drop of the dime. I don't think you just going to -- it's not going to come back right away because I think you're going to have a period of calibration. Where those 2 sides have to meet. And I think -- look, it's the same thing in the private market. So if you don't need money and you're growing fine and you're able to keep all your employees and you're able to keep being an acquirer and you're able to stay on plan without any access to new capital and whatnot, then you don't necessarily have to do something that's going to adjust your valuation.

My point is, I think that you're going to recalibrate either way for the companies that are continuing to raise capital on the growth. And I think that over time, companies tend to come back to saying that the public market offers a really good alternative and in some cases, better market opportunity than doing another large private round.

Joe Mantone

Switching gears a bit. There were a couple of post-pandemic topics I wanted to ask you about. During the height of COVID, we saw IPO road shows practically halted. Have we returned to a more normal environment now with roadshows?

Seth Rubin

I mean I don't think we're ever going back to the 10 or 12-day global road show with every meeting in person having 6 or 7 meetings and a group lunch a day. It's just not efficient. You don't need it. I think that companies that do a tremendous amount of test-the-waters work and certainly in biotech, you're still seeing 3 or 4, really 4-day roadshows. And they've done enough work ahead of time, and the banks do enough work ahead of time that I still think that's super efficient and effective.

A few of the tech deals and a few of the other deals, I think you'll see back to 6-, 7-day type roadshows that go over a weekend, but they're going to be hybrid. All management teams, the biggest and best investors want to meet in person, they'll make time in their schedule to do it, but they've got to be efficient. And so we've gone from 6 or 7 meetings to being able to do 12, 13, 15 meetings today and touch a lot more people. So not sure that, that changes.

I think it's been actually a really good advancement in the market. The second thing is that the test-the-waters work, the upfront work is so much more pervasive now. It used to be just certain companies were doing real test-the-waters work or you were just doing one meeting here and one meeting there. And now we're launching IPOs after we've done 40, 50, 60 meetings with investors under the test-of-waters guidelines. And so people have a very good sense before the IPO kicks off in a lot of cases of where the business is, what the business is.

They've spent time with the management team. Ideally, you're coming in during the IPO and you get an update. How's business? How the partnership is going? How is the new VP of Finance that you hired? How is all that -- what are some of the things that you talked to us about in terms of some of the new growth engines that you have? How are those -- how should we track that?

And so if we're all doing our jobs, the IPO can become much more of a business update. And okay, hey, we haven't showed you all our numbers. Now they're in the prospectus, we can talk through that. But you probably have some pretty good knowledge prior to launch.

Joe Mantone

And in the test-the-waters, is that -- that was part of the prefiling IPO regulation?

Seth Rubin

Yes, that's right. So with the emerging growth companies, really expanded the ability to use test-the-waters and use it very, very effectively. And so we've gone from the, hey, we have a couple of discussions, a couple of meetings to, we have a very legal and compliant process that gets out to the leading investors. And every company sort of organizes it differently. But it's not a -- it's not a new thing right now, and I just -- I think this continues.

Joe Mantone

And then the other topic I wanted to ask about was SPACs. I mean, we saw the SPACs skyrocket during the COVID era and then it's really slowed considerably recently because of some regulatory scrutiny and some other issues. What do you see as a future for SPACs going forward?

Seth Rubin

In terms of like the SPAC IPOs, a new issue or in terms of the business combination?

Joe Mantone

The SPAC IPOs.

Seth Rubin

Look, I think the market obviously got way ahead of itself and is going to regulate. Every couple of years, we see new technology and new structures within SPACs that make them more attractive to the market, and you see a spike in activity. I think if you look during 2020, 2021, the number of SPAC deals that got done, I mean, that capital could not be deployed. And where it was deployed, obviously, there was a lot of reaching for transactions to do deals with companies that didn't make sense as public companies.

And so you've had a reversal in that market. So we will have a SPAC IPO market. It will be -- I think, it will circle back to repeat issuers that have made a lot of money for themselves and for investors and want to continue to use the vehicle. Frankly, I think what will drive more SPAC issuance is when the IPO market is better. Because if you've got a market where companies are coming public and investors are more interested in new companies becoming public and those deals get really attractive, well, then there's even more of a reason to use other vehicles to get new public companies.

So those things I think go more hand in hand than a lot of people give credit for. I don't believe we're going back anytime soon to anything remotely close to the types of levels that we had in 2020, let alone 2021, in terms of the SPAC new issue market. I just -- I don't think there's demand for it. I don't think there's really a need for it, but we will have deals for sure.

Joe Mantone

It should get pulled up the moment the IPO start getting pulled up?

Seth Rubin

I think so. I mean, look, we'll go back to -- I think if you look at 2017, 2018. There were 30 to 40 something SPACs, new SPACs that went public a year. I think we were closer to 60 in 2019. It was close to 250 in 2020 and over 600 in 2021. So if we get back to a market of somewhere between 30 and 50 SPACs, that's still a really interesting market that creates a lot of opportunities. And I think that would be very healthy.

Joe Mantone

Great. Okay. Seth, Well, I really appreciate you taking all this time with us here today. So thank you very much.

Seth Rubin

Absolutely. Good talking to you.

Joe Mantone

That will do it for this episode of The Pipeline. Thanks for listening.