The number of IPOs on Japan’s three small-company stock markets in 2008 was the smallest since 2000. Furthermore, the last time annual IPOs on these markets were in the double digits was in 1992 when there were only 27 IPOs. Stock prices fell sharply in 1992 following the end of Japan’s asset bubble. Equity financing activity was impossible in this environment, bringing the IPO market to a halt. But this was only a temporary downturn. The number of IPOs recovered to 90 in 1993 as the stock market became less volatile.
To determine the outlook for the number of IPOs in 2009 and afterward, we must first examine the reasons for the decline in 2008 IPOs. No one would deny that companies use IPOs to procure funds using the stock market. Naturally, stock valuations fall along with stock prices. That means companies may not be able to procure sufficient funds through an IPO when stock prices are low. For the 49 IPOs in 2008, there were total proceeds of ¥136.8 billion from the sale of newly issued stock and secondary offerings. However, the IPOs of only 16 companies procured more than ¥500 million from the sale of new stock. Significantly, the largest IPO of the year did not include the sale of any newly issued shares. Seven Bank used its offering to generate proceeds of ¥52.3 billion by selling only stock that was already issued.
Public ownership requires annual expenses of about ¥50 million. Companies need to pay fees to a stock exchange, independent accountant, transfer agent and printing company (for disclosure materials). Expenses are needed for an investor relations program, Web site and other activities, too. In addition to this ¥50 million, companies must spend large amounts on the personnel required for compliance with Japan’s corporate ethics law, production of quarterly earnings reports and other activities as a publicly owned company.
For the 36 companies that procured less than ¥500 million from their 2008 IPOs, the cost of these funds relative to the benefit was obviously much higher than for an ordinary bank loan. In general, companies can receive better terms for bank loans once they become publicly owned. But with today’s low interest rates, the small decline in the cost of a loan due to an IPO would probably not have a meaningful impact on a company’s operations.
An IPO offers a significant advantage for companies that are essentially owned and operated by the CEO. In this case, going public eliminates the need for the CEO to personally serve as guarantor for the company’s loans. Terminating these guarantees frees the CEO of a major risk. On the other hand, accepting even one yen of equity from a third party increases the obligation to disclose information about the company’s operations. Unfortunately, some companies complete an IPO without making the necessary alterations in their disclosure policies.
What is the reasons for the downturn in the number of IPOs? The primary cause is simply a matter of cost. Companies can no longer justify the expense of an IPO unless they can procure a sufficient amount of capital relative to that expense.
Next topic is an examination of stock prices of the 2008 IPO companies.
On average for the 49 IPOs in 2008, the opening price was 18% higher than the offering price. This is far below the 49% average in 2007. Furthermore, the opening price exceeded the offering price for only 20 of the 2008 IPOs. That means there was roughly a 60% probability of losing money by purchasing stock at the offering or secondary offering price and selling it when trading began.
On December 30, the closing prices of the 48 remaining 2008 IPO stocks were an average of 12% below their offering prices and 30% below their opening prices. For the 2007 IPO stocks, closing prices on December 30 were an average of 48% below the offering prices. The conclusion is obvious. Buying IPO stocks at offering prices as a long-term investment is suicide. But there is a positive side. Prices of the 2007 and 2008 IPO stocks hit bottom at the end of October and have since rebounded even more quickly than the corresponding stock indexes.
Investors must remember that less capital is flowing into stock markets. Furthermore, it is virtually impossible to determine why and when money will start returning to the small-stock markets where most of the IPO stocks are traded. One key indictor is changes in trading value. JASDAQ is Japan’s largest small-company stock market in terms of the number of stocks listed. Trading value declined steadily throughout 2008. In 2008, trading value was only \208.8 billion. This is about the same as between the fall of 2002, which was the bottom of the stock market following the collapse of the Internet stock bubble, and March 2003.
For the TSE Mothers market, where prices have rebounded sharply, December trading value was 38% higher than in November. This is an encouraging sign for the outlook for inflows of capital to small-company stock markets. On the TSE 1st section, though, monthly trading value has dropped to almost ¥30 trillion because of the global economic downturn. This is the lowest level in three years and a half years. When the Nikkei Average reached a new low in April 2003 following the end of the Internet stock bubble, trading value was ¥14 trillion, less than half the December 2008 level. Therefore, the current level of trading value indicates that the downward correction in big-company stocks has not yet reached its end. But we are very likely near the end of the decline in the small-company stock markets in terms of both the length and depth of this bear market.
Outlook for 2009
There will be fewer IPOs in 2009 than in 2008. The main reason is that IPOs are not an effective way to procure funds in many cases. Expenses are too high relative to the benefits. Therefore, companies that are preparing for an IPO will continue to face challenges for some time.
But this is good news in one respect from the perspective of investors. The small number of IPOs means that the level of fund procurement is lower. IPO stocks with low valuations are thus likely to attract buyers because of favorable supply and demand dynamics. There hasn’t been a single bear market for IPO stocks over the past three years. Stocks of all companies that went public since 2006 have been consistently weak to this day. Nevertheless, more than a few of these companies have business models that can survive this recession. Investors should watch the third quarter earnings announcements as one way to identify these companies.
Companies now preparing for an IPO are encountering an economic downturn that many say occurs only once in a century. Despite today’s challenges, I hope these companies move ahead with their plans and continue growing. In addition, I want to remind investors that they are very likely to find jewels among the stocks that other investors have abandoned. Another important point to keep in mind is that successful businesses are often created during recessions. There is good reason to hope for the emergence this year of companies that will help revitalize the stock market in the coming years.
