Yeah about that open IPO window . . . 

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Craig Coben is a former global head of equity capital markets at Bank of America and now a managing director at Seda Experts.

When asked in 1972 about the effect of the French Revolution, Chinese premier Zhou Enlai was quoted as saying that it was “too early to say.” Historians now think he was talking about the student protests of May 1968, but it’s a useful reminder of the danger of reaching a knee-jerk verdict about an historical event.

Many observers have cited the recent flotations of UK chip designer Arm, food delivery start-up Instacart, and marketing automation firm Klaviyo as heralding a revival of a hitherto dormant IPO market. Arm’s listing priced at the top of its range; Instacart raised its range and set its IPO price also at the upper end; and Klaviyo priced above the range. 

Moreover, the three IPOs enjoyed crackerjack debuts, with Arm closing up 25 per cent on the first day of trading, Instacart popping 43 per cent at the opening on Tuesday, and Klaviyo soaring as much as 32 per cent yesterday. As MainFT wrote:

September’s third successful IPO could open the gate for a procession of start-ups that had shelved plans to go public owing to the downturn, according to venture capital investors in those companies. 

This isn’t just VC chatter either. Here’s what David Kostin, Goldman Sachs’ chief US equity strategist, said last Friday:

After a two-year drought, the US IPO market re-opened this week in dramatic fashion. Our IPO Issuance Barometer has been at a level consistent with the typical frequency of IPOs since June, suggesting a more normalized IPO backdrop going forward.

But the “Big Mo” has quickly turned into big mush. Arm shares have fallen in four straight sessions and are now less than 4 per cent above the IPO price. Instacart shares have traded off and are a whisker above its IPO price, while Klaviyo stock flirted with the $30 IPO price before rebounding nine per cent into the close. 

With such after-market (and intraday) volatility, it’s difficult to know what to make of the share price action.

Part of the problem stems from the relatively limited number of freely tradable shares in each IPO. Arm’s free float stands at around 10 per cent, Instacart at below eight per cent and Klaviyo at roughly 7.5 per cent. To put this into context, the average free float for US IPOs in the last five years has hovered around 20 per cent.

Moreover, all three deals have sizeable allocations to cornerstone investors — in Instacart’s case up to 60 per cent of the deal, not to mention a “Directed Share Program” (ie, a friends & family allocation) for an additional five per cent — and while cornerstone investors are not legally prevented from flipping their shares in a US IPO (unlike the six-months lock-up for Hong Kong IPOs), there is a reputational cost to trading out of them early.

In other words, the supply of shares on offer has been tightly rationed, presumably to cultivate a sense of scarcity.

While the small free floats of the three IPOs are nowhere near as extreme as the Nasdaq listing of Vietnamese electric vehicle maker VinFast — whose stock price is utterly divorced from reality due to a free float of less than one per cent — they still raise pertinent questions.

On one level, it makes sense to limit the number of shares available in an IPO. If a company or shareholder floods the market with too many shares, it erodes what practitioners call “pricing tension,” giving investors the whip hand over the pricing. Moreover, the underwriters seek to scale back share allocations to investors, incentivising them to buy stock in the after-market. It is imperative to leave IPO buyers hungry for more.

Nevertheless, a gnawing concern arises as to whether such stringent free floats might impair the price discovery process in unpredictable and potentially undesirable ways. When there’s not a lot of stock to buy or sell, share prices can move abruptly, even discontinuously, from relatively small trades.

For risk management reasons, true believers may decide to sell their holdings prematurely if the shares come under pressure, fearing that the lack of liquidity will impede their ability to exit later. Conversely, short sellers may also steer clear: with so little freely available stock, it is often difficult or expensive to borrow shares to sell them short, and there is also a heightened risk of a painful squeeze if the share price rises, amid a scramble to cover the short position. 

The question, then, revolves around identifying the threshold at which a free float is so low that it distorts behaviour in wild ways. VinFast’s minuscule free float rendered its share price an irrelevance. But is an IPO of sub-10 per cent of a company too small?

The reality is, none of us know. It is highly context-dependent and circumstance-contingent: 8 per cent may be acceptable in buoyant markets, but more problematic when reopening the IPO window after a two-year freeze. It is also possible that, for example, Arm’s small free float is more palatable because the dollar amount of the free float — around $5bn — is so large. 

As Zhou would say, it is too early to tell whether these low-float IPOs will unthaw the frozen new issue market.