FRBSF Economic Letter
2000-36 | December 8, 2000
The year 2000 has been sobering for investors in firms that have had initial public offerings, or IPOs, in recent years. Those investors include, of course, employees holding stocks and stock options in these firms. This year, returns on stocks of firms that had gone public in recent years fell sharply, following heady returns in 1999. Moreover, the so-called post-IPO pops (first-day aftermarket returns) have been subdued since the first part of this year compared to those for firms going public last year, though on average the pops still have been decidedly positive.
This Economic Letter takes a look at developments in the IPO market, with a special focus on firms in California. The analysis follows up on the work in an earlier Letter (2000-07) that assessed the wealth effects for employees of California firms with IPOs from 1997 through 1999. The analysis indicates that declines in stock prices this year of firms that had gone public before 2000 did cut into the value of the firms and thus the wealth of the employees holding their stock and stock options. Shares of California firms with IPOs in recent years have performed as poorly as their counterparts in other regions. However, the declines in market values overall have not been as dramatic as the run-ups had been over the previous three years. Finally, while the pace of IPOs has slowed this year, the addition of the market value of California firms with IPOs in 2000 has offset some of the loss in value of firms with earlier IPOs.
From 1997 through 1999, 323 California-based firms had IPOs. Last year, in particular, was a banner year, with some 158 firms in the state going public and raising about $16 billion. While the firms involved are in a variety of sectors, most are high-tech and Internet-related firms.
The stock market, especially in the high-tech and Internet-related stocks sectors, was extremely strong last year. The Nasdaq increased about 85%, while the Bloomberg technology index was up 160%. The market value of the stock of firms with recent IPOs rose even more. Figure 1 shows that the first-year return on IPOs skyrocketed in 1999 and into the first quarter of this year, peaking well above 300%.
For the 323 California firms with IPOs over the three years 1997-1999, the stratospheric rise in stock prices raised their combined market value to $676 billion as of mid-February 2000. That accounted for a little less than half of the market value of U.S. firms with IPOs over the same three-year period. Information available concerning employee participation in stock option plans and shares of stocks in firms held by employees along with an assumption about the exercise prices on the options were used to estimate the value of the per-employee net equity interest related to options in the California firms that had IPOs. The figures reported in the earlier Letter showed that, as of mid-February, about 134,000 employees of California-headquartered firms with IPOs in 1997-1999 realized a gain in equity interests related to or stock options of about $500,000 per employee.
Most of the firms that had IPOs during 1997-1999 took a hit when the market’s evaluation of stock values drove the Nasdaq down about 35% (measured from mid-February through late November of this year–the Nasdaq peaked in March). Assessing the impact of the decline in stock prices of the 1997-1999 IPO firms is complicated by the fact that some of the 323 firms are no longer traded as separate entities. As of late November, data were available for 252 firms from the original set of 1997-1999 IPO firms. The combined market capitalization of the 252 firms that continue to trade independently fell from $623 billion as of February 18 to $362 billion as of November 27, a decline of 42%.
Translating these figures into estimates of the change in per-employee equity interest is tricky. A very conservative estimate would assume a market value of zero in late November for firms that are no longer trading independently. Under that assumption, the average net equity interest related to stock options for the 134,000 employees in California would be about $175,000, compared to the mid-February figure of about $500,000. One alternative estimation would assume that the firms that are not trading separately have been absorbed into other ongoing firms and that the imputed value for the employees fell by the same percent as the value of the surviving 1997-1999 IPO firms. In that case, the estimate of per-employee interest in late November would be $190,000. Both of these updates of per-employee interest are estimated as if the stock options remained unexercised, or, if exercised, that the underlying stock purchased had not yet been sold. In practice, some unknown amount of this IPO stock wealth has been converted into holdings of other financial and real assets, such as housing (see Krainer and Furlong 2000).
The market value of California’s 1997-1999 IPO firms is down substantially since mid-February, with a percent decline similar to that for IPO firms nationwide. To illustrate, the two panels in Figure 2 present data on the dollar and percent changes of market values of 1997-1999 IPO firms that were still trading as of November 27, 2000, for California and the U.S., as well as for Washington, Massachusetts, and Pennsylvania. Panel A shows that for the U.S., the drop in dollar value was about $634 billion between mid-February and late November; California’s loss of $261 billion in market value is the single biggest decline among the states in dollar terms. However, as Panel B illustrates, in terms of percentage changes, Washington, Massachusetts, and Pennsylvania experienced substantially larger percentage losses than California and the U.S.
Among the 252 continuing California IPO firms, 206 lost market value between mid-February and late November. However, these losses were partly offset by strong gains at other firms. In contrast, the results for the state of Washington were dominated by losses in market value of more than $10 billion each at three Internet-focused firms, Infospace, Amazon, and Real Networks.
With the shake-up in the stock market, especially for tech and Internet-related firms, it is not surprising that the pace of IPOs has slowed in 2000. Even so, through late November of this year, 100 additional California-headquartered firms (292 for the U.S) had IPOs, raising close to $8.5 billion (about $45.5 billion for the U.S.). The market response to IPOs in 2000 has been more subdued than in the recent past. This is suggested by the sizes of the so-called post-IPO pops (the first-day aftermarket returns). Figure 3, which plots the first-day returns for IPOs from Ritter (2000) for U.S. firms, shows that through the very early part of this year, on average, firms making IPOs saw their stock prices increase substantially from the initial offer prices during the first day. Since early this year, the first-day returns have come down and are closer to those experienced in the 1990s prior to the second part of 1998.
While the more measured market response suggests that some of the mystique of IPOs has faded, initial offerings in 2000 have raised additional funds for California firms and increased the marketability of employee equity interests. For the 100 California firms with IPOs through October 2000, the market value of the group stood at about $66 billion in late November (the market value for all U.S. IPO firms in 2000 stood at about $358 billion). These California firms have about 25,000 employees. Two San Francisco Bay Area firms, Handspring–a maker of hand-held devices–and ONI Systems–a fiber optic network equipment company–have the largest current market value among IPO firms this year; each was valued at about $7 billion in late November.
What, then is the net impact of IPO developments on the wealth in California? Taking into account the value of the new IPOs, the net loss in marketable wealth for firms with IPOs from 1997 to 2000 likely is just about three-fourths of what would be suggested by declines in stock prices.
It is clear that the decline in value of the stocks of many California firms with IPOs in recent years has cut into wealth in the region, and that can be expected to take some of the steam out of spending, particularly on durable goods. However, even with the decline, the accumulated wealth in connection with IPOs is still notable. In part, this is due to the fact that the declines in values this year have not totally offset the impressive rise in stock prices that occurred through the end of 1999. In addition, while some of the mystique of IPOs has faded, the emergence of additional California firms with successful IPOs in 2000 has offset some of the decline in market value among the earlier cohort of IPO firms.
Krainer, John, and Fred Furlong. 2000. “Tech Stocks and House Prices in California.” FRBSF Economic Letter 2000-27 (September 15).
Mattey, Joe. 2000. “California’s IPO Gold Rush.” FRBSF Economic Letter 2000-07 (March 10).
Ritter, Jay. 2000. “A Few Factoids about the 1999 IPO Market” and “Updated data (1960-October 2000).” University of Florida. http://bear.cba.ufl.edu/ritter/ipodata.htm (accessed November 17, 2000).
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