Is it worth investing in UK IPOs?

At the same time, there has been a cyclical decline in the quantity of new companies IPO’ing globally and, in the UK, a structural issue as domestically focused businesses choose to list in the US, as they anticipate being able to achieve a higher valuation in that market at a time when data shows consistent and persistent outflows from UK equity funds. 

Tom Slater jointly runs the £10.9bn Scottish Mortgage investment trust, of which around 30 per cent is deployed in companies not yet quoted on any stock market.

He says there are two reasons why IPOs globally have been scarce in recent times. 

Slater says many company owners are in no hurry to list their businesses as they believe being publicly listed comes with pressure to pursue a strategy that is more short termist in nature. 

He adds that several companies in which he is invested may be inclined to pursue an IPO in the near term, but feel that “market conditions” have not been conducive to this, as equity markets generally have declined.

The issue is that the seller is often from private equity, and there is an asymmetry of information. Jonathan Brown, Invesco

The types of companies in which Slater invests tend to be in areas such as technology and healthcare – businesses that are likely to earn the bulk of their returns in future. 

Slater says that in a higher interest rate environment, investors are sympathetic to businesses that expect to earn their profits further into the future, because investors can lock in guaranteed returns on cash right now. 

But he feels that with “mounting evidence” that interest rates have peaked in the developed world, investor sentiment may therefore shift back towards those types of growth companies. 

Getting the home fires burning 

But aside from global market conditions, there are uniquely UK reasons why there has been a dearth of companies listing on the FTSE, according to Jonathan Brown, who runs about £600mn of smaller company money at Invesco, including within the Invesco Perpetual UK Smaller Companies investment trust. 

He says that UK investors “like to see a company that is making a profit and paying a dividend, or at least having the capacity to pay a dividend, rather than a company that may be pre-profit. The latter get a better reception in the US”.

But he notes there is a societal issue in the UK that may be deterring UK entrepreneurs from listing in the UK.

He says that in the UK “there is something of a social stigma around wealth”.

Gervais Williams, small-cap fund manager at Premier Miton, notes that many of the larger IPOs that have come to the market in the UK in recent years have been poor investments.

He says: “UK small-cap fund managers might be forgiven for feeling a little queasy over including IPOs in their clients’ portfolios.

"In 2023 the largest UK IPO was CAB Payments, down 75 per cent by the year end. Numerous others have savagely disappointed before: The Hut Group, Dr Martens, Revolution Beauty… all down 74 per cent or more since issue."

Oliver Brown, who runs the RC Brown Primary Opportunities fund, says one of the issues with IPOs that have come to the market in the UK in recent years has been that "many are in areas such as online commerce, which had a big boost during the pandemic, but as pre-pandemic shopping habits have returned, so the performance of many of those companies has declined."

Seller's market

Invesco’s Brown says he tends to invest in "only about one in 20" of the IPOs that come to the London market.

He says: “The issue is that the seller is often from private equity, and there is an asymmetry of information, ie the company has been owned privately for years so they know more about it than me, and they are choosing to sell now, which makes me wonder why sell now?

"And more fundamentally, it is often the case that private equity owned companies have been under-invested in, and that a lot of financial engineering has been deployed, so what you are being sold at the IPO stage is a business that will need more cash to rebuild it.

"One of the things we look for is the ability of a company to convert the turnover it generates into profit.” 

Laurence Hulse, manager of the Onward Opportunities investment trust, says he does not like to invest in IPOs as it is difficult to find investments that are attractively priced because “typically the seller of the company at the IPO stage knows more than you do as the buyer”. 

It is remarkable that two companies that came to market in 2021 should be completely bankrupt now.Neil Hermon, Janus Henderson

Neil Hermon, who runs a smaller companies investment trust at Janus Henderson, says one should view IPOs brought to the market by private equity owners with "extra caution".

"And it is probably valid to apply a lower valuation to most of those, compared to an IPO that comes to the market from, say, a family business. But in general we are open to IPOs and they have provided us with a rich seam of opportunities throughout my investment career."

One of the elements he considers when evaluating an IPO is the “investment banker that is working on it from the seller's side. Is it someone we have worked with in the past, are they someone who does proper due diligence prior to bringing a company to market?”  

Hermon says he is one of the fund managers that tends not to invest in loss-making 'blue sky idea' companies, but does not regard this as something for which he should be criticised.

He says: “In 2021 there were a lot of those companies that came to the market via an IPO in the UK. Two of those that did have gone bust already, and really it is remarkable that two companies that came to market in 2021 should be completely bankrupt now.

"We don’t see ourselves as running a quasi private equity fund, and really a lot of the companies that came to market in 2021 were not ready to be listed companies. I think some investors have scars from that period, which is shaping their attitude to IPOs now.

"I think the approach of wanting profits from companies has been vindicated since 2021.

"But I don’t think there is a structural problem with the UK market, I think it has just been cyclical, that companies haven’t listed here, and that will change."

David Thorpe is investment editor of FT Adviser