Ep 74 | Josef Schuster | What Does History Say About Post-IPO Performance Trends? | ROI Podcast

With the ongoing IPO market activity, Dr. Josef Schuster joins the podcast to discuss his research on the unique performance dynamics that often follow new listings.

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Transcript

Welcome And The IPO Revival

Ryan 0:08

Well, the IPO market has really begun to gather a lot of attention. There are several notable IPOs on the horizon, and that raises a lot of questions for investors. Oftentimes we see some volatility when a new uh IPO hits the market. Sometimes there's very strong performance followed by some other volatility. And so investors wonder how to incorporate some of these securities into their portfolios. They wonder what the dynamics are likely to be. Joining me today on the First Trust ROI podcast is Dr. Joseph Schuster from Ipox Schuster. We're going to discuss what his expertise is, and that is newly issued stocks. We're going to talk about some of the performance dynamics that investors should expect and how to think about investing in that space. Thanks for joining us on the First Trust ROI podcast. Joseph, thanks again for joining us. We just came off the floor of the New York Stock Exchange, had a great celebration, ringing the bell to celebrate the anniversary of a fund that you provide the intellectual capital for the underlying index. And that is our U.S. Opportunities Fund. We'll talk about that another time, but today I want to talk about the area of expertise that really is sort of the underlying driver for a lot of uh for that fund and some others that you provide the underlying indexes for. And that is the IPO market. There's a lot of interest in IPOs. We went through a period of time where there was maybe a bit less interest. And so I guess maybe that's my first question for you. Why is it now that we're beginning to see a pickup in interest in acquiring or tapping into public capital for these companies after a period of what seemed like a little bit lighter IPO activity?

Why Equity Strength Fuels IPOs

Josef 1:56

Well, first of all, thank you for having me, Ryan. It was a great uh pleasure to be uh opening the New York Stock Exchange Belt today. Um first of all, I think what it really comes down to is very strong equity markets in general. People are willing to take risk again. Even rates are high, stock markets are at all-time high, the average fundamentals of companies is quite strong. And that kind of risk appetite obviously uh leads to higher IPO activity, new listings, specs as well, and so forth. So that's kind of the macro story behind it. Um, in terms of the cross-section, obviously what we see is, and what the investors see, and what leads to more IPOs is that this IPO vintage of 2021, 2022, 2023, some of the firms have done extremely well. We talk Palantir, we talk apploving, we talk Robin Hood, we talk American Healthcare Read and so forth. Like across the board, companies in the cross-section have done well. There have been some losers, some really, really good winners. And I think that's really also the driver behind more IPO activity. People that know they can make money, they want to have more deals. Underpinning those performance is very strong earnings. 70 to 75% of our constituents in the IPO X100 have been beating on earnings and sales for 10 times in a row now. So a lot of positive underlying drivers there. Then we also have kind of a broader trend towards IPO MA. The post-IPO market nowadays is really a target market for corporate MA. So that's uh definitely driving IPO activity as well. So, really a lot of different kinds of uh forces uh driving it. And you know, we always say the golden age of IPOs this year.

Ryan 3:53

Okay,

Which Big Names May List

Ryan 3:54

so for those that maybe haven't uh been following closely the IPO market um as it's been in the news cycle a bit more, what are the um what are some of the major IPOs that are expected uh for 2026? Of course, there's SpaceX that has gathered a lot of attention. Are there some others that are on the horizon?

Josef 4:13

Yes, there's obviously SpaceX and Anthropic. That's expected. OpenAI filed confidentially, there's Strava, you know, there's uh Jimmy Jones, you know, there's uh um Sandwich Chain, uh Panera Bread, Databricks, small, large spin-offs all uh all across the board. Uh a lot of companies to be expected to go public.

Is The IPO Market Frothy

Ryan 4:39

So you mentioned the performance of some of the IPOs that have from that 2021, 2022, and and 2023 vintage has been quite strong. Of course, there was some volatility for the overall market in 2022. Um but you know sometimes uh we we certainly get questions about whether or not that means that the equity market is getting too frothy. Um how would you respond to that? Is is the all of a sudden companies wanting to go public? Is that an indication that the market's too frothy?

Josef 5:11

I would say in terms of the number of companies which go public, we are right on the average. We look at two 250 deals this year. We had similarly over the last probably 10 years, the average was just like that. What we're gonna see this year is obviously companies, you know, if we account for SpaceX and so forth, I mean the gross proceeds in terms of how much money is gonna be raised significantly higher than last year. But that doesn't mean we are really in a too frosty of an IPO market yet. That's what I think. So maybe some dangerous science on the horizon, but I don't think we are there yet.

Ryan 5:47

So

Why Firms Stay Private Longer

Ryan 5:48

that raises another interesting question because you mentioned the magnitude of the companies that are that are going public. Um, companies like SpaceX, Anthropic, OpenAI, they're all expected to be some of the largest companies in the world when they go public. Um and I think in the past, when we think about the IPO market, sometimes it's been smaller companies that are um in need of accessing public capital. That's why they go public. Um so I I one of the questions we hear time and time again with respect to IPOs is why is it that companies are now waiting for so long to go public? Is it just they they have plentiful capital, so they don't need to access public markets? Why are they waiting so long?

Josef 6:32

Uh I think it's a follow-through from just weak IPO markets from a few years ago. And there's also obviously the aspect of technology with technology, uh, the pre-IPO exchanges. I think uh obviously transactions, money can be raised easier. Uh sometimes the cost of capital a few years ago probably was uh uh was was better to do pre-IPO sometimes, you know, in the venture market and so forth. Um I think that's kind of the underlying forces kind of driving companies to be you know to wait longer to go public on average. Yeah.

Ryan 7:08

So you mentioned cost of capital. Is is um obviously interest rates play into that equation. Um there was a surge of interest rates uh in response to the inflation that we experienced a few years ago. Um am I right in that? Do do rates have an impact on the timing of IPOs?

Josef 7:30

Actually, right now what we believe is rates have a positive impact on IPO activity. The cost of capital, the alternative cost of capital for a company to to raise money is much higher on the debt market. Maybe cheaper to go public. Still cost five to seven percent of the gross proceeds to do that. However, and the margin must be maybe much cheaper, especially for older companies which uh want to go public anyway. So I think uh that's it's kind of a very interesting trend right now. There seems to be a really positive correlation between the level of interest rates on the debt and uh debt markets and the IPO activity.

Ryan 8:13

Yeah. So if you have to borrow and you're paying a spread over um, you know, uh the 10-year treasury that's four and a half percent and and uh it stays relatively high, that that does incentivize you to want to access cheaper equity capital. Absolutely. The other

The Hidden Danger Of Tiny Floats

Ryan 8:30

interesting part of these mega IPOs that are on the horizon is um trying to figure out what the what the public float is going to be. How much of those companies are actually being sold to investors? Um, do you have any sense of what these companies are are planning to do?

Josef 8:45

The public float of, for example, SpaceX is gonna be three to five percent, Android picks the same, open AI is the same. Um I think uh this is kind of tough to discuss given that the performance issues for very low and extremely low float IPOs is actually quite negative. According to our data, if you take the last 15 years of IPO activity, 2000 plus companies, there were around 90 companies which floated less than 7%. The average company was down 33% three years later, and the median company was down 66% three years later. We talk companies like Groupon, Venture Global, Mobile Eye, and so forth. So um these three companies will fall into the cohort where the data actually tells us there may be some danger zone we are entering right now by investing in those companies at this moment when they go public.

What Really Drives Post-IPO Returns

Ryan 9:48

Yeah, and you have a lot of data. Um I I haven't mentioned yet, but you um you have done your um your studies, your your graduate work and um in sort of the aftermarket performance of IPOs. Um before I ask you about that specifically, how did that become a uh a topic of interest for you?

Josef 10:08

Um again, like uh I did my undergraduate work uh in London, did my graduate work then at the London School of Economics on IPOs, and it leads me, led me into the PhD. And uh yeah, I made a business out of it about uh basically bringing to the market the Trombogel approach to IPO investing.

Ryan 10:30

Okay, so that that is uh a good segue to uh a lot of what I really want to focus on with uh with our discussion today, and that is some of these unique performance dynamics that surround companies that have recently gone public. And uh I suppose one of the initial questions that I have for you is what does that mean for the rest of the market? In other words, if you've got these big massive IPOs coming to the market, um, does that act as a sort of does it suck liquidity away from some of those other public uh companies, especially for these large IPOs? Is that a dynamic that you see?

Josef 11:06

Uh we haven't seen that yet right now in in this lost large IPOs like Medline or so forth. So like Venture Global, there was no impact on the market as a whole. There will likely be an impact when SpaceX, OpenAI, Amadropic go public, uh, given that they will be replacing certain other companies in the Nasdaq 100 SP and so forth in the indexes. So something needs to be sold when these companies are being bought, and that will create turnover liquidity um transactions and uh you know trading opportunities and and and especially again like turnover insults portfolios.

Ryan 11:46

Yeah. So when we think about the dynamics of what happens in the course of an IPO, I think most investors, their sense of what happens is this uh this company that was previously private, it goes public. Oftentimes, especially for these IPOs that have a lot of attention, a lot of PR surrounding them, you can have really strong surges in performance in the first day of trading as everyone's trying to scramble and get a piece of that company. Um, and then you know sometimes it settles down. Um based on your research, I'm sure we're not getting the whole picture. So could you explain what typically happens in that sort of life cycle after a company goes public?

Josef 12:30

So, first of all, obviously companies pop at the opening. In the US, it's probably the median is 9%. The average is probably higher, around 17%. Tech IPOs, they pop more than other ones. Uh so we have that dynamic. It's basically the academics, as they explain it, uh, is as kind of a real way to resolve some part of the risk of IPOs. What we see then is, and I think that's really the interesting part, and that's where my firm really comes in, is how those companies develop in the median and long run. In the median, you can show fundamentals don't drive IPO prices, but rather institutional friction they drive IPOs, like short selling constraints, underwriter price supports, there's limited analyst coverage, there's still a lot of beta uncertainty over the short run, and sometimes it shows up in an outperformance of a large sample of IPOs. What is then really interesting once you go to year two, three, four, once these companies are actually building an earnings track record, what we see in the data is a large divergence between basically the good ones and the bad ones. There are gonna be few Facebooks of the world, a few app lovings of the world, if you want, but many, many Krispy Kreme donuts of the world companies which will fall off and underperform. At the end of the day, I would say seven out of ten companies in the IPO, in IPO land will underperform. One or two will perform with the SP 500, and one company will do extremely well. And this one company can be the next Facebook. Cumulatively, there are still many companies which actually meet the criteria of outperformance. And it's really our goal at IPOX to model the performance of these well-performing IPOs via semi-passive index technology.

Ryan 14:25

So what you said is just really uh somewhat counterintuitive, I think, for many people that are thinking about the recently priced IPO. That chances are if you just bought an IPO on the day that it that it priced or the day after that it priced, you have a higher probability of underperforming or doing poorly. And that extends over the few year period, as, as, as you mentioned, some of that uncertainty around the underlying fundamentals becomes resolved. Um, and maybe some of the speculative juices get squeezed out. Um, but the other part of that that's fascinating to me is that the small group of companies that tend to perform better do so well that they can compensate for the underperformers. I think that's a that's a dynamic that is um very counterintuitive and very interesting. So that leads me to my next question. Why is it that those companies that do better tend to do better? And is there a way to identify them in advance? What are some of the characteristics that they've had in in terms of you know backward looking that you have tended to see better performance?

Josef 15:42

Yeah, those companies basically issue around 15% of the capital in the market. Those companies also the good performance probably pop between zero and fifty percent. They also again like they are decent in size. And um obviously looking back, uh those companies are always uh kind of ahead of the next theme. I mean, that's the next thematic investment idea. Um in a sector where they will be in and which becomes an economic driver then during the course of the next few years of being public. How we approach it at IPOX is we really don't look at that specifically, we just apply a process-driven approach to the largest of IPOs and at spin-offs in the sample. And by um real sad way, we are able to isolate the large stock-specific risk in IPOs and really take advantage of the opportunities of the sector.

Ryan 16:48

So that's a that's another really um good point, really interesting point. It sounds to me like there's um there's very little a way that you can specific to one of the, you know, SpaceX or Anthropic or OpenAI, you can't say in advance that one of these companies is going to be the best. And so um maybe it's better to have a more diversified approach for those that are um that are looking at that market. Um have I have I summarized some of your thoughts on that well?

Josef 17:17

I think you uh that's um exactly well explained.

Ryan 17:20

Yeah.

Josef 17:20

In our opinion, that a process kind of override um you know the whole portfolio. And um basically that's the way to go in post-IPO investing, process-driven approach.

Index-Like Process Beats Stock Picking

Ryan 17:33

Okay, so you've um we've touched on briefly um spin-offs, but we've mainly focused on IPO dynamics. Um can you maybe describe a little bit about what your research shows uh with respect to spin-offs in comparison to IPOs?

Josef 17:47

Aaron Powell So spin-offs are basically in its core form share distributions, large companies basically letting loose of a small unit.

Ryan 17:57

Uh those um So, like GE, for example, broke apart and they have several divisions that they made individual companies.

Josef 18:05

Exactly. Um usually the spin-off is is is not coming along a kind of capital raise. Typically, these companies don't need capital necessarily to expand or pursue growth objectives. What we see over the spin-offs are larger. They trade a lot, some pay interesting dividends, they are more from the old economy sectors. Um, however, what we find is that they display similar growth dynamics over time when compared to IPOs as well. It's basically a parent sending off uh the kid to college. The kid will still have the underlying trait of the parent in terms of religion, how to deal with money, and so forth. But obviously, the kid and the students then develop its own interest in school, and that's exactly what's going on, I think, in the spin-off market.

Ryan 18:59

Yeah. Um you you see these large conglomerates that it's almost like the overall valuation that those companies are given. And I I keep coming back to GE because this was a recent um, I think, success story when it comes to some spin-offs and breaking things apart, where GE was this amazing company under Jack Welch and everyone wanted to be GE. And then it went through a period of time where it just, you know, it seemed like the finance division was getting in in in the way of everything else, and that um it was being weighed down and then it's split apart. And some of these individual companies now have just done tremendously well. And, you know, some of that might be because they were in the right place at the right time. But I suspect if if if that conglomerate stayed together, maybe you wouldn't have some of the performance that you've seen um in the last few years.

Josef 19:50

Yeah, I totally agree. Luck is part of the story. However, it's also uh the separate, the separation of management, uh the focus on something where you're really good at. Um, and I think that's driving, has driven definitely the performance of of GEV, for sure. Gee, healthcare didn't do so well, but I mean that has all been made up by the tremendous performance of GEV.

Ryan 20:16

Yeah. Um, so what I'm hearing you say is um some of those uh spin-offs, one of the one of the differences is they tend to be higher quality. They're not as um dependent on uh they're not going public to get outside funding as maybe some of the IPOs are. Um and so they have they have a different um sort of quality characteristic typically. Um and so they they maybe help balance out the risk. If someone is thinking about investing in um new issued uh stocks that that maybe those play well together. Is that fair?

Josef 20:50

Aaron Powell Our experience is it it's that's a way to go to approach the new listings market. It's via the pooling of IPOs and spin-offs, and nowadays also D specs put set in a sample, measure the effect of this going public. And if you do it well, you can have a tremendously outperforming portfolio against USP.

SPACs Then And Now

Ryan 21:13

Um you mentioned SPACs um a few years ago. That was uh seemed like that was the meme, or you know, everyone is very excited about SPACs, this new way of accessing outside capital where you didn't have a traditional IPO. Um what happened to that market? Um because there was uh a lot of enthusiasm, a lot a lot of excitement, and then it seemed like it kind of went away. Uh what kind of happened with the SPAC market?

Josef 21:40

Yeah, in our opinion, again, the SPAC way of going public is a good way. It's uh typically for really high risk companies to do that. It has really developed as an alternative way uh to bring, again, like high risk mall moonshot ideas to the market. The risk is higher. Than probably in an IPO. However, interestingly, if you look at like the star performers in the quantum space, in the in in AST mobile space, and so forth, those all have been specs. It's interesting, those dynamics in the short run are not there. Those have different performance dynamics compared to spin-offs and IPOs. Yet in the long run, if you are invested in the right spec, it definitely makes sense to add it to your asset allocation. So our decision has been since the big uh re kind of reoccurrence of specs a few years ago to also consider and uh add specs into the portfolio when we have an opportunity.

IPO Opportunities Outside The US

Ryan 22:49

Yeah. So it becomes a part of your uh your process as you have evolved in the way you're thinking about it. Um, the other interesting thing for me is as a US uh centered investor, a lot of what I'm focused on is typically with my own home bias, um, US IPOs, um, US companies in general. And sometimes we can forget about what's happening overseas. And um, so I'm I'm not as tuned in with the dynamics of the IPO market overseas. Um, could you maybe give us a few thoughts on what's happening outside the US with their IPOs?

Josef 23:25

Again, like um it's IPO activity is on the rise. Definitely in Europe, uh has been relatively strong in the Chinese market, especially in Hong Kong, uh, in the Japanese market. So there's significant activity here to date into Hong Kong. Lots of deal flow lined up of companies out of Europe want to go public into the US or on their on their on their homeland. Uh typically, what we see in the European markets is mostly nowadays private equity-backed firms where private equity uses the IPO as a kind of way and means to get out of the position and to create liquidity for the shareholders. So typically more old economy deals in Europe, some of them quite interesting to invest in. Uh, what we see in the Chinese markets is deals coming um into China mostly, uh, are really high uh tech related uh companies uh right now. High growth prospects uh with uh more uh more risk as well, what I would say. Uh, some individual companies we talk about is um uh Inoi is coming, that's uh utility um uh industrial company, private equity back that just filed, and they will be coming into the US. Then we have a large defense contractor out of the UK, Dancaster, coming also uh into the US. Aura, uh the sports ring, fitness, uh ring makers. They're also uh gonna come into the US.

Ryan 25:02

When you say coming to the US, you mean they're there foreign companies that are listing in the US?

Josef 25:06

They will be listing here because obviously the US market is the preferred market for the liquidity. What we see quite interesting deals coming into the Hong Kong market. One of them I want to highlight is Sungenta. It's a big agricultural manufacturer, Swiss-based, which was bought by a Chinese company years ago, and uh and it's gonna be basically spun-off slash IPO into the Hong Kong market later in the year. So overall, international deal flow quite interesting as well from private equity to venture capital backed companies. Um interestingly, these deals are cheaper when compared to the US. There's more a buyer's market for those companies abroad, given that there's more uh less uh less in investor enthusiasm in in buying those companies when compared to the US. Uh however, we see deals coming, and uh and that's uh a very positive development for equity capital markets as a whole.

Ryan 26:10

Yeah. Would you say that the performance dynamics that we discussed earlier um in terms of sort of the skewed performance um for the IPOs in the US, does that also apply overseas?

Josef 26:24

Absolutely. We see uh the same dynamics happening. The initial pop abroad, however, is a little smaller, but the aftermarket performance dynamics are basically the same.

Ryan 26:36

Yeah. Yeah. Oh man. Well, that's a lot to uh a lot to think about, a lot to consider. Um I uh I really appreciate you uh joining us on the podcast, especially as mentioned. We look on the horizon and it seems like there's just um a lot of opportunity in that space. And again, people are wondering how what to do with that? How do you think about investing in it? So uh I appreciate the discussion.

A Surprising Book On Bison

Ryan 27:01

I have one more curveball that I didn't tell you I was gonna ask you about, and it really doesn't have anything to do with IPO investing. Um, but I have gotten in the habit of asking my guests of the podcast um for book recommendations. And so um, you know, you're you're uh you're a doctor, you're a PhD. Um I I uh I'm not looking for a a PhD level economics book, but is there anything that uh you've read recently that you made you think that um you would recommend to the viewers of the podcast? Um it doesn't have to be finance related either.

Josef 27:33

It can be just a finance-related book, it has probably something is similar. It's called The Destruction of the Bison. It's a PhD, uh kind of free ride of a PhD of a US-based author. I forgot his name, but it shows the rise and the fall of the bison in the US. Really? And it has a lot of interesting similarities sometimes to the finance market, how the bison was dominant, what caused this extinction, extinction from various, obviously, forced factors, but also natural factors. And I think a really, really great uh read. Uh it's not uh too heavy, uh, so it's a destruction of the bison.

Ryan 28:17

All right. So that uh destruction of the bison is by Andrew Eisenberg. And that was uh the full title, The Destruction of the Bison in Environmental History 1750 to 1920. It's definitely something I don't know about, so we'll have to check that out. So thanks for the recommendation.

Josef 28:35

Thank you for having me, Ryan.

Ryan 28:36

Well, um always nice to talk with you, Joseph. Thanks for joining us on uh the podcast. We'll have to do this again sometime. And thanks to all of you as well for joining us on this episode of the First Trust ROI podcast. We'll see you next time.