CNBC Comment: Watch out for the IPO boom froth

CHEER has returned to London’s initial public offering (IPO) market. By the end of October, over $24bn (£14.8bn) had been raised in European IPOs in 2013, more than double the corresponding amount at the same point in 2012. And almost half of 2013’s total was raised on the London Stock Exchange.

But investors may want to watch out for froth as they crack open the champagne bottles. As the market has returned to health, there is a fear that some will fall prey to over-exuberance.

First, while the current rebound seems to have come from businesses which had been planning to come to the market for a while, there will always be companies whose valuations at flotation don’t hold up in the long term. The risks are shown by smaller insurer Esure, which has lost 20 per cent off its valuation since its flotation in March.

Secondly, many of the businesses listed in recent months have been spun out by private equity houses or other large owners, like Royal Bank of Scotland’s flotation of Direct Line. Such IPOs hold risks for investors, as owners may simply be getting rid of their less attractive assets.

Yet Direct Line, like other high profile IPOs of the year, has performed well since flotation. Royal Mail, estate agent Foxtons, and Madame Tussauds’s owner Merlin Entertainment have all hit or exceeded expectations. There has even been an investigation launched by the UK government into whether Royal Mail, the largest European IPO to price as of the end of October, was sold off too cheaply.

But whether the short-term benefits shareholders have received can be sustained is a different question. The average one-day return for London Stock Exchange-listed IPOs stood at 6.5 per cent in 2013 at the start of November, the highest level since 2003. A boom in IPOs is usually viewed as a signal of general return to health in the economy and optimism among local investors. But this is not yet the case in moribund Europe, where growth is still slow after a double-dip recession, or even in the faster-growing UK.

This is where we get to the crunch point. Europe’s boom has been fuelled by inflows from US investors, who are awash with cheap capital after a succession of loose monetary policy manoeuvres by the US Federal Reserve. Whether the IPO boom can continue when these measures come to a close – as they surely must soon – is another matter.

Catherine Boyle is a writer and on-air correspondent at CNBC. Twitter: @cboylecnbc