These numbers are reason for optimism in the new year. But there are still deep, embedded issues with the market for initial offerings. Here are three of them:
First, the total of 54 offerings on the New York Stock Exchange and the Nasdaq composite index in 2009 pales next to the 500-plus a year of a decade ago, as well as the annual rate of about 200 that prevailed from 2004 to 2007. Still, this higher number provides reason for hope of continued recovery in 2010. In this recovery, private equity initial offerings are likely to be prominent.
In 2009, offerings backed by private equity grabbed more than 40 percent of the market, with 22. These companies tend to be large and mature and to produce very large offerings, like those of Dollar General and Hyatt Hotels. But private equity initial offerings are repeat trips. Much more worrisome, with venture capital as the crucial driver, is that this market is still rather quiescent. There were only 15 venture-capital-backed offerings. Most of these companies were in technology or life sciences. As Claire Cain Miller wrote on The New York Times’s Bits blog earlier this month, these initial offerings are in a drought. The reason may be the next point.
Second, and what is more ominous, small-issuer offerings remain in a retreat that has lasted more than a decade. The consulting firm Grant Thornton has issued a series of quite perceptive reports on this trend. The most recent one was in 2009. Its analysts point to the death of the small-issuer offering.
During the period from 1991 to 1997, approximately 80 percent of initial offerings were for less than $50 million. This began to fall precipitously in 1997, and has remained at about 20 percent of the market since then.
The authors of the Grant Thornton study contend that this change is not a result of the oft-cited regulatory burden of the Sarbanes-Oxley Act. Instead, the change began to occur before Sarbanes-Oxley, due to changes in the regulatory structure of the markets, including the rise of online brokerages. These changes have collectively and individually taken away the ability of investment banks to profit from small-issuer offerings. The consequence has been that the venture capital market, which had its own bubble during the 1990s technology boom, now looks to acquisitions that offer early exits, as it cannot access the American market until the company is of a substantial size.
The third issue is that the foreign private-issuer market remains an important part of the equation, but it is shifting in character. Foreign issuers accounted for about one-fourth of the American initial offering market in 2009. The year’s largest American exchange-listed offering, at just over $7 billion, was by the Brazilian bank Banco Santander.
But the real story is Chinese issuers. Of the 14 foreign initial offerings in the American stock market in 2009, 11 were from mainland China, one from Hong Kong, one from Singapore and one from Brazil. None were from Europe. At first blush, this data provides affirmation for the “no one is coming here” argument, as these numbers are far reduced from the high numbers at the turn of the millennium. But the London Stock Exchange had only three initial offerings in 2009.
In other words, no one at all was going to London, domestic or foreign. Worldwide, the flow had shifted to China primarily and the United States secondarily. According to preliminary year-end numbers from Thomson Reuters, the Hong Kong stock exchange had 21 initial offerings and the Shenzen Exchange had 40. Meanwhile, the New York Stock Exchange had 27 and the Nasdaq had 27.
China may be dominating initial public offerings, but those offerings are a result of the rise of its domestic market. Given the penchant of issuers to raise capital in their domestic markets, this is to be expected. The United States is the only competitor right now for foreign listings. To the extent that there is a global listing market, the United States still dominates it, however small that market has become. The United States, however, is likely to draw these listings outside Europe as that is now a mature market and European issuers now have fewer reasons to list here.
I note two things of interest about these Chinese listings. First, many of these Chinese issuers are undertaking American offerings using prepared financial statements that following American generally accepted accounting principles, or GAAP. This is despite the fact that China has publicly announced its endorsement of international financial reporting standards, or I.F.R.S., and the Securities and Exchange Commission has very publicly acted to allow foreign issuers to use I.F.R.S.
In other words, the global capital market still values American GAAP over international GAAP. In some instances, Chinese issuers are even filing for American initial offerings using the much more stringent domestic form of S-1 rather than F-1, presumably for extra credibility. This is grist for the value that American regulation and supervision has historically provided to foreign private issuers. Nonetheless, the numbers are too few to draw any definitive conclusions.
Second, this is hot money flowing. Chinese accounting principles are an open joke. One can believe that once they have to list in the United States and comply with American regulations they get religion, but I am skeptical. A 2008 article in Barrons concerning Chinese listings in the United States raised similar alarms at their accounting practices. This is particularly true since the financials are prepared locally by Chinese branches of American firms with similar cultural norms. Thus, the question is whether the foreign-issuer market is turning to its natural course of drawing in issuers from less-established companies or is simply a conduit for hot money that will likely have a decently short half-life and possible regulatory consequences. In either case, these issuers are the future of the foreign market for initial offerings. It only remains to be seen whether it will end badly.
Ultimately, while there are reasons for optimism, the numbers appear to show that the market for initial offerings is in transition. It would behoove market participants and regulators to take a hard look at market structure again, including these important issues, through a lens other than Sarbanes-Oxley.
Note: Some of the data and ideas in this piece will be presented by me in a paper on the S.E.C.’s international securities regulation at the University of Cincinnati College of Law Corporate Law Center Symposium on the Globalization of Securities Regulation on March 5. (http://www.law.uc.edu/institutes/corporate_law/events.shtml). For those who would like more information on the market structure issues facing initial offerings, there is a valuable new treatise, “Initial Public Offerings: A Practical Guide to Going Public,” that is quickly becoming the bible of the market. (More information about it can be found at IPOguidebook.com.) David Westenberg, the author, has put together a comprehensive guide to these issues in the treatise and was a source for this column