Financial Update 9-10

The big news on the stock market right now is the upcoming Alibaba Group IPO. Seeming to come out of nowhere with its quirky business model – putting western businesses and consumers directly in touch with China’s thousands of small manufacturers – it’s now become an e-commerce sensation; the company is expecting to raise up to $21 billion when it floats later this month. It’s a huge and complex offering; Alibaba does more business than Amazon and ebay combined. Markets are definitely buzzing with anticipation.

Not every company is Alibaba Group though, and there are signs that when more normal numbers are involved IPO fatigue is starting to set in. This is becoming obvious in the European markets, which are picking up steam again after the summer. So far this year there’s been a flood of IPOs, raising more than $55 billion in nine months – nowhere near the $160 billion Alibaba could be valued at, but still a significant pile of money. In fact it’s four times the corresponding figure for last year. All this has happened on a wave of enthusiasm for new stocks, a sign of recovering confidence as Europe continues to emerge from the recession.

That enthusiasm looks like it’s wearing off though. A new IPO means a lot of work for investors who take due diligence seriously, and the sheer volume is starting to draw groans instead of excitement. With a big name or exciting business model to play on an IPO can still generate enthusiasm but for more marginal businesses it’s getting a lot harder to attract buyers. The market is basically suffering from indigestion – it’s swallowed too many IPOs this year and its appetite for more is shrinking.

From a company’s point of view there are still good reasons to push ahead with an IPO. Valuations remain strong, and especially for a firm backed by private equity that wants to start feeding some money back to its founders that makes a flotation look tempting. The bar for entry is getting higher though. A few months ago investors would be all over just about any IPO, but now they’re getting selective. Without a unique selling point to attract their interest they won’t do the legwork to investigate the company, and unless that’s done they won’t risk their funds there either.

Another deterrent to investors is the strategy that’s been pursued by a lot of advisers. US hedge funds have been prepared to pay very high prices over the last few months, and that’s forced up valuations. The problem is that a high valuation at flotation doesn’t always translate into continued high share prices later, and several recent high-profile IPOs are now trading well below what they were issued at. That’s making potential buyers increasingly wary, and many are skeptical about how realistic valuations really are.

It looks as if right now the market’s jumped too quickly between extremes – from a shortage of IPOs during the recession to a glut of them now. Market Darwinism should restore equilibrium soon enough, forcing valuations down until the volume of new offerings coming along is at a level the market can comfortably absorb. That should make everyone happier except the bargain hunters.