IPO Report Is Nostalgic for 1996

Grant Thornton put out a white paper today about why the IPO crisis is in fact structural, not cyclical.

Much of it is familiar territory for those who’ve followed the what’s-wrong-with-the-IPO-market debate over the past year. Key culprits: A lack of research and marketing of research for small-caps, momentum-trading hedge funds squeezing out long term investors, cumbersome regulation, and even technology, for pushing out the profitable retail broker model. (Full report here)

So what to do? I spoke to David Weild, co-author of the report, a senior advisor at Grant Thornton and former NASDAQ vice-chairman. He suggests turning the clock back, at least in some ways, to the idyllic IPO market days of the mid-1990s.

“I think the way the problem started is there were a series of rules that ripped the economics out of research,” Weild says. “What we’re simply arguing or proposing is that we should put some economics back into that part of the marketplace that attracts research.”

The problem right now, Weild says, is that small-cap stocks can’t maintain a reasonable valuation. It’s a little easier for companies that have some brand recognition. For example, IPOs this year of OpenTable and Rosetta Stone did well in part because they were familiar names to retail investors. But companies in sectors like biotech and semiconductor equipment manufacturing aren’t recognizable consumer brands, and so it’s imperative to have solid research – and also to make it visible to investors.

“Research in and of itself doesn’t improve stock price efficiency,” Weild says. “You can’t put it on the shelf because it has a tendency tocollect dust… You need people marketing the research.”

Some other snippets from the report include:

“The IPO Crisis was not induced by Sarbanes-Oxley (Congress), Regulation Fair Disclosure or NASD Rule 2711 (separation of banking and research). Each of these changes occurred well after the IPO Crisis was underway. While we believe these wellintentioned investor protections may have raised the costs of going public (and taking companies public), they did not cause the abandonment of the investment-centric Wall Street model that also supported small cap companies (and thus IPOs) in favor of a high-frequency trading model.”

“From 1991 to 1997 nearly 80% of IPOs were smaller than $50 million. By 2000 the number of sub-$50 million IPOs had declined to only 20% of the market.”

“The first six months of 2009 represents the worst IPO market in 40 years. Given that the size of the U.S. economy, in real GDP terms, is over 3x what it was 40 years ago, this is a remarkable and frightening state of affairs. Only 12 companies went public in the United States in the first half of 2009, and only eight of them were U.S. companies. The trend that disfavors small IPOs and small companies has continued. The median IPO in the first half of 2009 was $135 million in size. This contrasts to 20 years ago when it was common for Wall Street to do $10 million IPOs and have them succeed.”

“Simply stated, a U.S. economy with an abundance of venture capital should have produced over 500 IPOs every single year for each of the last four years — that, however, is not the reality.”