History Was No Guide: SARS, COVID and the Equity Capital Markets

Josh Weismer
Josh Weismer Managing Director, Head of Equity Capital Markets
December 21, 2020

Just nine months ago, I posited that we had seen this coronavirus movie before, during the SARS outbreak.  While the early days of the COVID-19 outbreak did in fact track with that 2002-2003 event, allowing us to draw some lessons from it, the intervening months have seen a tremendously different outcome, namely an extended global pandemic accompanied by buoyant markets and elevated new issue activity.

When my previous article ran on March 16, only a handful of Americans were reported to be infected.  As of December 15, there were over 16 million cases and more than 300,000 deaths in just the US.  We have witnessed economic hardship across the country.  Rolling shutdowns have taken place in some states even as other states have remained open.  Unemployment skyrocketed early and though it has since tapered off, it remains nearly double what it was in February.  All amidst one of the most contentious elections in history. 

An unexpected shift in volatility

Given these numbers, we expected to see the VIX surge to historic levels, which it did.  But interestingly, the index retreated rapidly even as the uncertainty remained.  Whereas the VIX remained in elevated territory (above 27) for 8 months in 2008/2009, it was above 27 for just 14 weeks this year, despite GDP shrinking by 32% in the 2nd quarter of 2020.  Indeed, any turmoil the markets experienced early in Q2 seem to have melted away, save for a couple of minor setbacks along the way.  Predictably, we also witnessed investors punishing sectors most impacted by the pandemic, such as travel and leisure, while initiating massive flows into healthcare and technology.

A bit of help from monetary and fiscal policies

Given the upheaval COVID has caused, why are we seeing relative stability across indices?  The lack of volatility has come up against a couple of predictable responses, foremost among them the early resolve of the Fed.  Not only did the Fed double down on previous moves in the fall of 2019 by dropping interest rates to zero on March 16, in the same month it announced another round of quantitative easing, adopted flexibility for banks’ capital requirements, and created a new facility to buy corporate paper.  The second factor was the relatively quick, surprisingly uncontentious passage of the initial stimulus bills through Washington.  The CARES Act, along with the Families First Coronavirus Response Act, made over $2.3 trillion available to American families and businesses, authorizing $1,200 direct payments to individual taxpayers and creating the Paycheck Protection Program for businesses, among other financial assistance programs.  Together, these actions ensured that there was significant liquidity in the system, boosting balance sheets and providing lower cost financing.

A surprising contributor to market liquidity

Contributing further to the confluence of events, there were some unexpected developments.  Among them, was a jump in retail investing during the COVID lockdowns.  A recent industry report found retail traders made up nearly 25% of stock market volume following COVID-driven volatility, whereas, these same investors accounted for just 10% of the market's trades in 2019.  As coronavirus policy out of the Fed created a risk backstop, money that would have been spent on eating out or travel piled up. With the emergence of inexpensive apps making trading easier and more affordable, profit-seeking retail investors surged into the market, adding to the liquidity already injected by institutional investors.

Our view of what happened and of what’s to come

The result of this unexpected liquidity on primary market equity issuance has been nothing short of spectacular.  The conventional IPO market turnaround was remarkable. As I mentioned in March, the IPO market is always the last to reopen after a crisis or period of sustained volatility.  Earlier this year, when COVID had all but shuttered the IPO markets in late Q1 and early Q2, we saw companies briefly postpone IPOs and work through the challenges of virtual roadshows.  But since late Q2, despite considerable economic uncertainty, IPOs have seen incredible interest, raising $162.9 billion across 417 transactions, which is the most since 2014.  The average IPO for 2020 is up more than 85% from offer to current, creating even more reason for investors to chase returns in subsequent IPOs.  The week of October 26th is the best example of this strength – during that week, the VIX averaged 36.34, never seeing a close below 32.5, yet 10 non-SPAC IPOs priced that week to raise $5.6 billion, driven by significant investor demand.  As we look towards 2021, expect the IPOs to keep coming.  There remain, by one VC’s estimate, 70 companies worth more than $5 billion, and given the eye-popping returns of the IPO class of 2020, why wouldn’t they take their shot?

The SPAC market has completely rewritten history this year, with 242 deals pricing to raise more than $81 billion;  in this frenzy, we saw almost as many listings – 50 – in October than occurred all of 2019. Yes, you read that correctly.  While we saw fewer in November, and deals started out of the gate trading below trust value ($10.00), most of the inventory in the market is trading at a premium today.  We continue to see M&A transactions announced, with PIPE commitments that are oversubscribed, and what seems like an endless pipeline of electric vehicle (EV) and EV-related companies, taking advantage of the market’s love for anything related to energy transition.  With more than $81 billion raised so far this year, assuming a 5x deal size versus SPAC size tells us that this product could drive more than $400 billion of M&A deals over the next two years from 2020 SPACs alone.  Given what we are hearing from investors who are committing more capital to the product, 2021 will see a continuance of SPAC activity, particularly as the M&A flow accelerates.

The follow-on financing market has also exceeded expectations, with more than $250 billion raised YTD.  Companies first raced to shore up their balance sheets earlier in the year, and then the trend moved to newly minted IPOs rushing quickly back to the markets to take advantage of their soaring share prices and investor demand.  While we expect 2021 issuance to be more muted than 2020, the continued strength of the IPO market, along with sponsors seeking liquidity for the public portfolio companies, should yield another strong year for follow-ons.

Convertible issuance played out as we suspected, leading the reopening of the equity capital markets.  Initially, this was the instrument of choice for companies looking for liquidity to bridge them to the other end of the crisis, but much like the follow-on market, as time passed we saw companies taking advantage of all-time highs in share prices to put low cost capital on their balance sheets.  

YTD, we’ve witnessed 172 transactions to raise $103.4 billion, but more importantly, we’ve seen the product become more mainstream, with non-traditional convert investors such as pension funds, endowments and sovereign wealth funds allocating money to the product.  Additionally, management teams, directors and investors have embraced the product like never before, and with investors still starved for yield, we firmly believe we will see another strong year for converts in 2021.

Our final thoughts as we leave behind 2020

Nine months ago, if someone had told you we would be in a global pandemic during the holiday season with 16 million Americans infected, would you have wagered 2020 IPOs would break all-time records? Or that the stock market would be breaking records?  That we’d see more SPACs priced than in all of prior history?  If so, you might find yourself retired on a beach somewhere - socially distanced of course - but if not, enjoy the rest over the holidays and get ready for a still busy 2021.


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