Capital markets reset brings a return to fundamentals
Capital raising activity in Q3 2022 continued to decline toward historically low levels amidst a long list of uncertainties, most notably the inflationary environment and corresponding rate hikes. Markets also are trying to determine if a tightened money supply will cause a recession and, if so, what that recession will look like in terms of length and depth. Global geopolitical uncertainties — including the war in Ukraine, US-China tensions and economic concerns in the UK — also continue to impact markets.
All of these factors have contributed to 2022 tracking towards the quietest year for US-based IPOs this century. US debt markets will likely remain challenged in the near term as economic headwinds keep issuers on the sidelines and investors demand greater return for riskier assets. Volatility should be expected while the Fed fights its battle against inflation.
Still, we do see some encouraging trends:
- Seasoned professionals across the capital markets are applauding valuation resets that better reflect reality. This allows issuers to focus on long-term growth and success, and provides less incentive to make decisions that deliver only short-term stock pops at the expense of a company’s outlook, health and fundamentals.
- The labor market remains in a strong position, helping keep the economy on relatively stable footing, although labor supply remains a key issue as staff shortages persist.
PwC capital market analysts expect that Q3 economic activity will likely show a soft rebound in real GDP growth with inventory growth and net trade driving positive growth. While higher inflation continues to erode consumer purchasing power, consumer demand should remain a positive driver of growth over the next few quarters. However, with the Federal Reserve expected to continue hiking interest rates at a relatively aggressive pace, we expect economic growth to slow further in the near term. Our baseline projection is for real GDP growth to slow to roughly 1.5% in 2022, a sharp deceleration from 5.7% in 2021.
“The IPO market is not closed, but the current investor focus on scale, profitability and an attractive valuation is challenging for most companies in the pipeline.”
Q4 economic outlook
Looking forward, attention remains on Federal Reserve Chairman Jerome Powell, who has reemphasized the Fed’s role in maintaining price stability to support consumer and business confidence. In the September Federal Open Market Committee (FOMC) meeting, the Fed signaled plans to continue raising rates until inflation returns to its target rate of about 2%. The market will closely watch key indicators such as the Consumer Price Index (CPI) and Personal Consumption Expenditure (PCE) in order to help forecast the magnitude of the rate increases and what that would mean for a potential recession.
Upcoming IPOs likely delayed until late 2022 or early 2023
- High inflation, rising interest rates, and uncertainty around a recession have caused IPO activity to slow to a crawl, with just five traditional IPOs raising over $2 billion in Q3, and six SPAC IPOs raising just shy of $500 million.
- More than 60% of IPOs year-to-date have been withdrawn, clearly illustrating the challenges of going public in this environment.
- Since 2017, about 30% of IPOs have been Private Equity (PE) backed. With PE exit activity particularly slow, these firms are likely preparing their more mature companies for an exit — whether via M&A or IPO once the market reopens.
- We remain broadly optimistic about the US IPO market in the coming quarters, with a number of companies kicking off public company readiness and getting in the queue. Investor preferences have pivoted from a focus on high-growth IPO candidates toward companies with sustained profitability, strong cash flow and competitive differentiation. We would also look for a return to commodity price stability, positive earnings reports and reductions in volatility for the IPO market to reopen.
Venture capital exit window is closed… for now
- Venture capital invested $40 billion in Q3 with most of the proceeds earmarked to later stage companies. With the exit window essentially closed, VC firms have shifted focus toward their late stage companies for an exit once the markets reopen.
- Although unicorn formation has slowed dramatically in 2022, more than 650 unicorns may be looking for an IPO, M&A or alternative exit.
- VC investment should see strong upcoming quarters. Near record levels of dry powder coupled with a healthy valuation pullback can provide investors ample opportunities to invest at more attractive valuation multiples.
Debt capital markets slow down in Q3
- Issuance continued its decline in Q3 with just $356 billion across the investment grade, high yield and leveraged loan markets as negative sentiment dominated market headlines.
- M&A and LBO volume in the leveraged finance market plummeted in Q3 with $50 billion raised, down from an already weak $65 billion in Q2.
- There continues to be a number of issuers waiting on the sidelines with about $43 billion in the pipeline for M&A and LBO activity, including a few high profile deals that will likely help reopen the market.
- Looking further ahead, we expect volatility to persist as the Fed continues its quantitative tightening program. Issuers should be tactical and opportunistic when open window periods arise.
Note: IPOs with deal values of less than $25 million, best efforts offerings, oil and gas royalty trusts, business development companies, pricing on OTC Bulletin Board and OTC Pink Sheets are excluded from this narrative. Data from SEC filings and third-party databases as of 9/26/22.
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