Recent IPOs by both ARM Holdings (ARM) and Instacart (CART) prompted a fair amount of conversation about IPOs on a few of the most recent episodes of Street Check, a podcast I cohost with my colleague Chris Preston. Naturally, we looked back to 2021 IPOs to see how they’re holding up, given that it was such an active period for companies coming public.
We discussed the IPO allocation process, why companies going public is a good sign for the market in general, and, our biggest takeaway, that you’re better off avoiding IPOs in favor of more mature shares in the same or an adjacent sector (if you’re really enticed by a particular IPO, look for peers that could benefit from strength of the initial offering).
Part of our rationale behind that is a recent Goldman Sachs analysis of 5,000 IPOs in the last 25 years that found two criteria that make for a successful IPO investment. Per Goldman’s Chief U.S. Equity Strategist, David Kostin (who helmed the team of analysts), these two criteria are:
“Greater than 40% annualized sales growth in their second and third years after flotation and positive net income by their eighth quarterly earnings report.
“Two-thirds of IPOs with these characteristics outperformed the Russell 3000 in their first three years with the typical company outperforming by 22 [percentage points].”
The same study found that IPOs that price above their expected range typically rise 38% on the first day of trading, while those that do not are typically flat.
That’s intuitive at the very least: Stocks that are highly sought-after generate more investor interest and oversubscription, which is what leads to higher prices when shares are allocated and initiate trading.
Stocks that aren’t in demand don’t generate investor enthusiasm or cause IPO runners to start raising their ranges.
As much as the Goldman analysis serves as a word of warning about buying IPOs before they can prove their balance sheet bona fides, it also offers us a checklist of sorts for companies that have gone public recently.
Specifically, the second criterion of positive net income by their eighth quarterly earnings report is a binary and easily confirmed metric.
And with the end of 2023 barreling towards us, most of 2021’s IPOs have had adequate time to report a full eight quarters, meaning all we need to do is look at the companies that came public in 2021 and look for positive net income by Q8.
A few caveats since we don’t have the specific methodology of the Goldman Sachs analysis: 1) To manage results and control for one-off events we’re screening for 2021 IPOs that have achieved positive net income and remained there.
That removes a company like Coinbase (COIN) from consideration because they briefly achieved profitability during the cryptocurrency froth before going back to losing money and failing to post positive net income.
2) As Kostin noted, the other criterion is 40% sales growth in years two and three. With only two years of post-IPO data, we won’t have year-three information for any of the 2021 IPOs. We will, however, have analyst projections for year-three sales growth, which is an adequate starting point.
3) Keep in mind, the Goldman analysis showed that only two-thirds of IPOs with these characteristics outperformed the Russell 3000, so odds favor outperformance, but there’s no guarantee.
4) Lastly, 2021 featured a lot of SPACs. SPACs (special purpose acquisition companies) are subject to less stringent oversight and reporting requirements than IPOs, often leading to less mature companies using them as take-public vehicles. For this reason (and because Goldman’s analysis was focused on IPOs), SPACs were removed from consideration for this list.
So, with those caveats in mind, we dug through the companies that came public in 2021 to identify those that tick both boxes (or, given our use of analyst estimates for year three, tick a box and a half).
We sorted through dozens of companies, and most failed the net income test, including all but one of the 10 largest IPOs of 2021.
That company, Coupang (CPNG), came public in March of 2021 at a $60 billion valuation, second only to Rivian (RIVN) in terms of size. (Rivian has not reported positive net income in any period since its IPO, which disqualifies it).
But Coupang does deserve an honorable mention, and is probably worth keeping on your radar, as South Korea’s emergent e-commerce leader achieved profitability but is not growing sales at the 40% level (mid-teens this year and more of the same expected next year).
Shares have lost 64% of their value since the IPO and carry a weak buy rating from covering analysts, with an average price target just over 22.
Some notable (high-profile but didn’t tick the boxes) also-rans, in addition to Coinbase, Rivian and Coupang, are dating software stock Bumble (BMBL), web host/e-commerce/marketing provider Squarespace (SQSP), craft and hobby retailer Joann (JOAN), oat-based milk producer Oatly (OTLY), EV-maker Lucid (LCID) (also a top-ten IPO by valuation at the time it came public) and Singapore’s ride-hailing and delivery app Grab Holdings (GRAB) (also top ten).
After drastically paring down our list based on the net income test, we turned to sales growth and estimated sales growth, which in addition to squeezing out Coupang, eliminated a stock we’ve covered here at Cabot before, digital media verification company DoubleVerify (DV), which is lower by a much more modest 18% since coming public and, like Coupang, is simply not growing sales fast enough.
But it did lead us to …
The Only Investable 2021 IPO So Far …
Shoals Technologies (SHLS), the Tennessee-based provider of electrical balance of system (EBOS) solutions for solar energy projects in the United States. Per Shoals, “EBOS encompasses all of the components that are necessary to carry the electric current produced by solar panels to an inverter and ultimately to the power grid.
“EBOS components are mission-critical products that have a high consequence of failure, including lost revenue, equipment damage, fire damage, and even serious injury or death. EBOS components that [they] produce include cable assemblies, inline fuses, combiners, disconnects, recombiners, wireless monitoring systems, junction boxes, transition enclosures and splice boxes.”
The original pitch was to offer up 50 million shares at a price range of 19-21, but that was raised to 70 million shares in the 22-23 range. Even that adjustment didn’t satisfy investors’ appetites as the company ultimately came public in January with 77 million shares priced at 25. On its first day of trading, SHLS rose nearly 24% to close just shy of 31 per share.
Since then, shares have been cut in half, and the chart is nothing to write home about, with SHLS trading below both its 50- and 200-day moving averages. That said, shares are technically oversold and may be putting in a bottom here near 15, above April 2022’s all-time low at 10. It’s still in “falling knife” territory but is definitely worth monitoring for signs of a reversal; a close above 18 (52-week lows) would be a good start.
One final note on Shoals: Sales growth is pegged at 52.9% in 2023 with estimates at 36.4% next year, so that number will need to slightly exceed expectations to reach Goldman’s threshold of 40% sales growth in both years two and three. Even so, shares carry a buy rating and an average price target of 31 from covering analysts, about double where they’re trading today.
5 More 2021 IPOs to Watch
|Company (Ticker)||Rating||Average Price Target ($)||Performance Since IPO (%)||Est. 2024 Sales Growth (%)|
|Karat Packaging (KRT)||Buy||27.33||23.3||10.6|
|FinWise Bancorp (FINW)||Buy||11||-30.2||13.8|
|Petco Health and Wellness (WOOF)||Weak Buy||6.62||-87.3||1.3|
Since we had to put our thumb on the scale with sales growth a little to even get one winner past the finish line, none of the names above meet the Goldman Sachs criteria.
So to broaden our pool of candidates we expanded beyond “net income by Q8” to “currently generating a positive net income” and lowered our sales growth expectations.
We were left with around a dozen 2021 IPOs to look into further and identified five that: a) are rated “hold” or above on average by covering analysts, b) are trading below their one-year price targets and c) have positive estimated sales growth.
One candidate that was omitted despite having higher estimated sales growth than any names on the list was Nu Holdings (NU), the company behind Brazil’s NuBank, which was just downgraded by New Street Research.
But the names that made the list each offer a potentially unique angle for investors.
Karat Packaging (KRT), for instance, produces environmentally friendly single-use packaging options, primarily for restaurants. They’re the best-performing name of the bunch, carry the highest analyst rating (halfway between a buy and strong buy) and are trading at a very reasonable 15x trailing earnings.
By a similar token, FinWise Bancorp (FINW) trades at an unchallenging 6x trailing earnings with the same analyst rating. The Utah-based bank holding company has lost 30% since its IPO but is 58% below all-time highs. Prospective investors should take note that the company has faced allegations of predatory lending and calls to downgrade its Community Reinvestment Act (CRA) rating. Shares are also very thinly traded, with about 13k trading hands each day. A CRA downgrade or regulatory action would make this company a non-starter, but the possibility of steps to clean up their business practices coupled with more cash-strapped consumers make this one to check in on from time to time.
AppLovin’ (APP), the next entry on the list, is a California-based software company that leverages data analytics and artificial intelligence (AI) to help businesses improve and monetize their mobile applications. The software is used by more than 150,000 apps and reaches 2 billion devices in 130+ countries. The company is intermittently profitable and barely squeaked by on positive net income in their most recently reported quarter. Shares also have only about 10% upside until they reach their price target, but the AI angle is too big of a trend to ignore.
The next two names on the list, FIGS (FIGS) and Petco Health and Wellness (WOOF), may offer something to turnaround investors as each is more than 80% below its IPO price but both remain profitable, if just. FIGS, the direct-to-consumer healthcare apparel (scrubs primarily) brand, was all the rage in the early days of the pandemic when our collective attention was on medical professionals but has lost relevance for investors since. But as their recent Q2 report showed, they haven’t lost relevance for their customers, as their active customer count rose 20% and the firm posted strong showings for revenue growth and profitability.
Revenues are only expected to grow in the mid-single digits going forward (next 5 years estimated at 6.1% annually) but increased promotional activity (while a drag on margins) could help, and a balance sheet that carries essentially no debt ($21M) offers a long runway for growth.
Petco, on the other hand, is carrying $1.6 billion in net debt against a market cap of only $1 billion and has repaid $75 million of outstanding principal YTD as part of its effort to retire $100 million of debt in 2023.
Much of the company’s total debt of $3 billion was incurred as part of a $1.7 billion term loan in 2021 to refinance debt maturing in 2022 (retired just over $1.6 billion), which, fortunately for the company, was prior to the recent rate hikes. The new term loan matures in 2028, so the company has some time to figure things out (and hope rates head lower). Even so, the company’s paydown efforts will be a multi-year (if not multi-decade) effort.
The company is facing existential risks, with a 4-10% chance of bankruptcy in the next 12 months per CreditRiskMonitor (the aforementioned Joann is also flagged in that article), so the company needs to show that it’s firing on all cylinders and executing just about perfectly.
So why include it on the list? Despite the heavy debt burden, Petco does have one ace up its sleeve: Pet spending is incredibly durable during a recession. In 2008, retail sales for pet-related goods rose 5.1% despite the financial crisis; during the covid-induced downturn of 2020, spending on pets rose 16.1% and it’s expected to continue growing at 8% per year for the balance of the decade.
WOOF is not one to buy today, or even this year, but throw it on your watch list and keep tabs on their debt paydown efforts. If they can thread this narrowly-eyed needle, good things could be in their future.