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New capital market activity offers hope for a reopening
In the first half of 2023, investors showed optimism that pushed stock indices to the high end of the year-to-date range, albeit primarily through price gains concentrated in a few large cap tech companies. While strong gains in the broader stock market often lead to open capital markets, interest rate and macro risks have caused a “bifurcation” between rising stock markets and relatively quiet capital markets.
Credit conditions continue to tighten, but issuers have largely been able to push out near-term maturities this year. Still, unresolved questions around inflation and a possible recession remain top concerns.
The US economy entered the second quarter on a weaker footing compared to the previous quarter. Recent data suggest that consumer spending remains positive but is moderating, and increased uncertainty is weighing on business investment planning for the near term. We expect growth to continue to moderate in the coming months as the cumulative impact of Federal Reserve rate hikes, recent tightening in lending standards and relatively elevated inflation limit upside for business and consumer spending.
Business investment remains a significant downside risk. Higher borrowing costs and tighter credit conditions will likely continue to challenge businesses, particularly those in rate-sensitive industries. Capital spending continued to shrink in the first half of the year. Monetary policy uncertainty is high, too. Although the Fed decided to skip a rate hike in June for the first time since March 2022, continued strong payroll growth and elevated inflation mean further rate hikes are likely, per the Fed’s most recent dot plot, which charts projections for the central bank’s key short term interest rate.
The US economy has withstood Fed tightening so far, but economic momentum from earlier in the year is waning, and risks remain tilted to the downside for the remainder of 2023. Even if the US avoids an official recession, economic growth will likely be subdued and many companies could still find themselves in a “profits recession” in the near term.
The headline IPO news is that a recent $300 million restaurant offering has opened the IPO window ever so slightly. A few more IPOs are scheduled for the last week of June. Although uncertainties remain, volatility has generally remained on the low side, and both issuers and investors are warming up to current valuations. We believe the IPO backlog may potentially start to clear and the market could start to pick up throughout the rest of this calendar year and early next year.
US debt markets showed resilience during the largest rate hiking campaign since the 1970s and 1980s. While credit conditions and lending standards continued to tighten during Q2, borrowing activity was largely confined to refinancing near-term maturities. There have been some bright spots, including leveraged buyout (LBO) announcements, providing optimism for the back half of 2023, but the high interest rate environment and economic uncertainty continue to serve as headwinds for the market.
“PwC maintains its generally positive outlook for the US IPO and debt capital markets in the long term, providing a strong platform for growth which should see the US through upcoming economic volatility.”
Spring shows a hint of optimism for the IPO window
- Q2 quarter-to-date saw four traditional IPOs raising $4.9 billion. Although this was a quiet quarter for IPOs, two notable IPOs made successful debuts during this time, with one IPO pricing above its initial range, then opening 90% above its pricing. This is an optimistic sign for the IPO window.
- A single issuance accounted for nearly 70% of proceeds this quarter and almost half of the year-to-date proceeds, making it among the ten largest IPOs of the past decade.
- The S&P 500 rose 7% quarter-to-date (up 14% year-to-date). The four traditional IPOs that went public this quarter outperformed broader markets and returned an average of 27% quarter-to-date, although it's difficult to draw conclusions due to the low IPO volume and a lack of breadth in S&P 500 stocks.
- Q2 saw 41 SPAC merger announcements and eight SPAC merger completions. The eight completions had an average return of 8%.
- Looking ahead, we could see a resurgence in IPO activity assuming stability in interest rates and the economy, and listing companies’ willingness to accept valuation resets.
AI provides bright spot for VC funding
- Venture capital saw $36 billion of investment in Q2, slightly off the previous period’s figure and continuing its descent since the highs of 2021.
- The emergence and rapid maturation of artificial intelligence continues to grab headlines. The industry raised nearly $13 billion in Q2 and many wonder whether the hype is justified or if the market is on the verge of an AI bubble.
- Funding continues to be difficult for startups. VCs are reluctant to continue funding high-growth, high-burn businesses and are urging these companies to cut expenses and focus on product and profitability ahead of any potential exit.
- Of the 13 IPOs in 2023, eight have been backed by either venture capital or private equity.
- Looking ahead, there’s a lot to be optimistic about. Tech innovation continues to grow at an exponential rate and firms still hold large amounts of dry powder. Activity will likely start increasing as the valuation gap narrows, companies and founders shift focus from growth at all costs to profitability, and more stability is seen in the economy.
US debt markets still grappling with higher rates
- The US debt capital markets raised $416 billion in Q2 across the investment grade (IG) bond, high-yield (HY) bond and leveraged loan (LL) markets.
- Notably, the IG bond market saw the fourth largest offering ever to support M&A by a pharmaceutical business. Cash-flush corporates remain in an advantageous position in the M&A space.
- In the leveraged finance market (HY and LL), we saw issuance of $127 billion with 28% supporting M&A and LBO activity. The high interest rate environment has stalled dealmaking among leveraged companies.
- The market is now seeing a tug-of-war take place between the broadly syndicated and private credit markets.
- Private credit continues to support the market, but the broadly syndicated markets have started to fight back, even retaking some select deals away from the private debt markets.
- Distressed activity continues to increase. Valid concerns remain among PE-backed companies that were bought out using floating rate debt in 2020 and 2021 prior to the Fed’s interest rate hikes. Defaults in the leveraged loan market are at their highest levels in two years and they’re projected to keep rising.
- With tighter lending standards continuing, there’s a renewed focus on interest coverage and leverage ratios among lenders.
- Looking forward, as rates begin to normalize in 2024 and the market gains further clarity into any potential recession and the economic outlook, there will likely be an increase in issuance, particularly of M&A and LBO offerings.
Note: IPOs with deal values of less than $25 million, best efforts offerings, oil and gas royalty trusts, business development companies, pricing on OTC Bulletin Board and OTC Pink Sheets are excluded from this narrative. Data from SEC filings and third-party databases are as of 6/22/23.
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