The “wild ride” of IPOs issued between 2020 and 2021 has been nothing short of a train wreck, according to Michael Cembalest, chairman of market and investment strategy for J.P. Morgan Asset Management.
“For IPO investors, some of the substantial gains from the prior decade were wiped out by a flurry of poorly performing IPOs that were issued in those two years,” Cembalest said in a new report. And that’s before including “the generally disastrous returns” on special-purpose acquisition companies, he noted.
Still, SPACs were the worst offenders, with Cembalest calling them “an unmitigated mess for investors.”
Cembalest had warned investors about the SPAC bubble as early as February, 2021 — just as that bubble was about to burst. At that time, he concluded that “that SPACs were an adverse selection of companies brought public.” In the recent report, he noted that they nonetheless grew “from practically nothing to equal the entire size of the traditional IPO market by 2020 and 2021.”
The Covid-era monetary and fiscal stimulus boom created “a perfect environment for issuers and a perfect storm for investors,” Cembalest added. Nowhere was this more prevalent than with SPACS, he said.
“Even more than crypto, the metaverse, and unprofitable hydrogen [and electric vehicle] companies, SPACs may be the best example of the corrosive effects of too much stimulus on markets, investments, and risk appetite,” he said.
Of the 431 SPACs that were able to complete a merger during the time period, 90 percent of them had negative net returns — meaning they underperformed the equity benchmark (the S&P small cap growth index). And they did “much worse” than the other IPOs JPMorgan analyzed. SPACs that went public in 2020 had the worst performance, with a median loss to investors of more than 80 percent.
Yet returns for some investors were even worse that what JPMorgan’s research showed, because “many investors bought SPAC companies at the time they were merged rather than at the time that the ‘blank check’ SPAC company went public,” Cembalest said. By the time of the merger, the SPACs had already gained an average 5 percent to 15 percent.
Companies brought public via SPACs also generated worse business results than their IPO counterparts —at least in the tech sector, according to Cembalest. “Since most IPO/SPAC companies go public without any profits, they need rapid revenue growth to become profitable and grow into their projections,” he explained. “The much lower SPAC revenue growth may partly explain their poor performance.”
But even excluding SPACS, Cembalest found that eroding underwriting standards led to “painful” results for investors in the 2020 and 2021 IPOs, which “have generally done poorly vs the equity market, wiping out 0.5 to 3 years of prior IPO portfolio gains depending on the sector.”
The surge of companies that went public was led by software, biotech, and consumer discretionary firms, according to the J.P. Morgan research. “Since 40 to 60 percent of IPOs generate negative returns even in good times, their value proposition is whether a small subset of winners offsets all the losers,” he said. “Long term IPO survival odds are low and skewed to a small number of mega-winners.”
JPMorgan also found returns slumped after insider lockups ended and that “only 15 percent of repeat financial sponsors consistently brought IPOs to the public which have outperformed the equity market.”
Around 80 percent of the IPOs during that two-year period were associated with a financial sponsor, according to Pitchbook results provided to JPMorgan. The dataset included private equity, hedge fund, and venture capital sponsors and excluded banks, corporates, sovereign wealth funds, family offices, registered investment advisors, and traditional asset managers when they acted as sponsors.
“In our roles as money managers, we’re very interested in the track record of financial sponsors that consistent bring value to IPO investors, or not,” Cembalest said.
The top five financial sponsors were ICONIQ Growth, HBM Healthcare Investments, Bessemer Venture Partners, Alta Partners, and Aisling Capital.