In the first half of 2020, capital raises were largely focused on balance sheet strengthening as a result of Covid-19. In New Zealand, we saw 24 equity issuances by NZX listed companies raising over NZ$3 billion, 50 per cent more than 2019 and triple 2018. Towards the end of the year, we saw a shift towards companies raising proceeds for growth and that is the trend we see coming into this year, given the market is trading at all-time highs and investors are continually looking for somewhere to put capital.
We're only in the first quarter but this trajectory looks set to continue, with IPOs globally raising US$99 billion in the first two months of the year – more than three-and-a-half times that was raised via IPOs in the same period last year.
Here in New Zealand, we are seeing similar strength and interest in the capital markets. And the pipeline of IPOs for the NZX heading into 2021 is the strongest we've seen since 2014.
Why the shift back to public markets?
Private M&A for larger companies has become more challenging with the borders closed, since it is harder for potential global suitors to travel and conduct the necessary due diligence. It means the public market can be more appealing at the moment for vendors of companies when they get to a certain size, and that is driving the IPO pipeline.
In the current low interest rate environment, discount rates used in valuation models are lower as well as investor expectations on the required dividend returns. These all-time low interest rates are also making people move up the risk spectrum into both debt and equity products (shares) to maintain a level of income they require from their investment portfolio; previously they might have been earning around 3-5 per cent in a term deposit, but it's now around 1 per cent.
Equity markets have been strong, with increased in-flow from investors across the market who are looking for more options to deploy their capital.
These market conditions are making it a favourable time for the right companies looking to list and for already listed companies to raise the capital they need to grow. Institutional and retail investors were highly supportive of the 2020 equity raisings. In addition, Australian and global institutional investors are becoming increasingly engaged with (and important to) NZ listed companies, providing significant capital support and different thought processes around valuation.
Not all companies are right for capital markets. For companies thinking about listing, the most prudent first step is to seek advice about whether a listing makes sense for them, taking into account the age and stage of their business and the rationale for listing.
What it means for investors
For investors, it means there are more opportunities to invest in new companies and new sectors.
The New Zealand economy is not well represented on the NZX. For example, while food and agriculture are a large part of New Zealand's economy, investors couldn't access much exposure to this prior to the IPO of Fonterra; Synlait Milk, Scales and NZ King Salmon IPOs shortly followed and created a genuine sector in this space. The NZX listed tech sector was largely created through 2014-15 but we are still very overweight in electricity and property companies. Fresh listings will allow investors to access new sectors to diversify their portfolios and manage their views of risks.
Why retail participation is at an all-time high
Retail participation (by mum and dad, student and bedroom trading investors) is on the rise and this is particularly obvious in larger cap and household name stocks. Widespread use of online trading platforms has facilitated activity growth, and retail participated in Covid-19 raises in line with previous raises or stronger despite global economic concerns.
In 2020, the stocks that received strong retail interest were household names like Air New Zealand and Kathmandu. This comes down to the fact that retail investors like to invest in what they know or feel they understand.
There has been a theme of retail investors investing in momentum, not underlying valuation fundamentals. Having an understandable story is essential to attract mass market retail investors.
The increasing interest in capital markets is ultimately a positive thing, as long as retail investors are doing their research (which isn't just looking for tips on social media), understand the business and the fundamentals behind it, have a genuine reason for investing (which isn't gambling) and a diversified portfolio.
What we should expect beyond 2021
It's always impossible to crystal ball but it looks like there is no shortage of cash across both institutional and retail investors. This is reflected in the fact that equity and debt markets have remained largely unfazed by the deadly winter wave of Covid-19 in Europe and the United States.
What we do know is that equity markets are at an all-time high and currently priced as though Covid-19 and underlying economic conditions are irrelevant. With interest rates at all-time lows and price to earnings ratios at all-time highs, what could dampen market conditions would be the return of inflation. And New Zealand and Australia are probably at greater risk of inflation returning sooner given that the impact of Covid-19 has been comparably lighter, and we have been rebounding well.
Aside from the threat of potential inflation, it is challenging to see what else would disrupt the market at this time. At Jarden, we believe that while market valuations and conditions are strong, the window is open for companies looking to list.
In addition to IPOs, we should still expect to see a trend of placements and rights offers as well as secondary raisings to continue to fuel growth. Aside from the obvious candidates – Air New Zealand are saying they are looking at raising capital in the first half of 2021 – there are other balance sheets that may still need recapitalisation (although there is general balance sheet strength across the NZX) and a lot more companies that are seeing opportunities for acquisitions so need a way to fund them.
We should also expect to see more direct listings on the NZX, where money is not being raised. Radius Care, which went public through a direct listing in December last year, may look to raise funds at some point given its acquisition and development led growth strategy.
With a major IPO having just wrapped up (My Food Bag), it's a clear indication of the general confidence in the market and what is set to be one of the busiest years on the market we've seen in some time.
• Henry Chung is director of investment banking at Jarden. Note: Jarden is the arranger and joint lead manager on the IPO of My Food Bag