Market Performance on Australian IPOs - Case Study Example

IPO UNDER PRICING Name University Professor Course Date Introduction IPO is a situation where a private limited company starts selling its shares to the general public. Going public is a very important action that the company can take because it help the company raise its capital from the general public majorly through IPO. Raising working capital through IPO is essential in ensuring that the privately owned company will not source for funds through debts. The private company that has a stronger demand also has a higher IPO prices but this does not mean that the company is valuable. Identical companies might have varied IPO valuation as a result of timing of IPO in comparison with the market demand. This report is very important in providing financial advice to different investors who want to invest in IPO firms in consumer Discretionary, Financials and Information Technology sectors. To ensure that the client gets sound financial advice on the use of IPO, a serious investigation and research must be done on the Australian IPO market. This report also provides the results obtained after analyzing long run IPO performance by selecting IPO firm which has taken two years after listing on the ASX. Finally, this report also reveals the reason for the occurrence of short run IPO under pricing and also ensures that the results obtained are used to compare these reasons. 1. Short-run IPO under-pricing The assessment of short run IPO for Australian market has attracted attention of many people in previous studies because of the initial wealth of investors. Underpricing of IPO is also considered a common short run market phenomenon and therefore most people view it as universal. To evaluate under-pricing phenomenon, usually researchers use first listing day average return which is described as the closing price performance from the issuing date to the time trading ends (Chan, Wang & Wei 2004; Chang et al. 2008; Dimovski & Brooks 2005). Different researchers determined that the examination of short run market performance using first day returns does not generate adequate information to shareholders and therefore it is absolutely right to use two day return when conducting short run market analysis. The appropriateness for not using first day returns is that the investors still have little information about newly listed company and also the market does not gained a reasonable time period to settle down. The use of second day return is there important because it is able to provide more information about the beneficiary of the short run under-pricing and finally it does not have price variation between the first day and the final day of trading. To provide the solutions for the problems encountered when first day return is used to evaluate short run under-pricing IPO is simply to increase the duration between the beginning and the end of trading. According to Ritter (1991), the assessment of short run market performance can be achieved by using opening period that has both first day and post day returns. The use of both first day return and post day listing are considered appropriate measure for assessing short run market performance according to Aktas, Karan & Aydogan 2003). Other researchers on the same subject believe that short run market performance can be appraised through dividing first day return into two parts namely first day primary market return and the second secondary market return. Splitting of first day return into two parts also provide solution to the problems encountered when only first day return is used in evaluation. The result of previous researches reveals that splitting first day return when evaluating short run market performance can provide more useful information to investors; it is therefore this report employs the use of first day primary market returns and secondary market returns. Ritter (1998) outlined a list of asymmetric theories like winner’s curse that provides an explanation for the purpose of conducting short run performance. All these theories were evaluated by different IPO researchers through the creation of multiple regression models that have varied determinants. The multiple regression models can only generate determinants but it has no capacity to provide related marginal probabilities which can reflect changes in short run market performance. Marginal probabilities provides much more important information to investors because of the prevailing change in economic and financial factors that triggers uncertainty in the IPO market. Most importantly, there are some researchers that usually prefer the use of binary regression model when determining related probability of occurrences and it is compared to multiple regression models. The introduction of binary regression model therefore generates additional information to IPO investors to ensure that they make proper decision before investing. The essential for the use of marginal probability is that it indicates directional changes and also helps to identify the most important determinants that influences changes in short run performance. The previous Australian IPO evaluation indicated that no analysis has been made for short run market performance determinant with the assistance of both binary regression model and marginal probability. 2. Data and Methodology 2.1 Sample Selection To ensure that there is an effective examination of short run market performance for an Australian IPO, it is vital to gather information relating to it from connect4 database which mainly has information relating to IPOs only. To achieve the purpose of this study, it is necessary to mainly evaluate selected listed prices that provide equity4 IPOs on ASX starting from 1 November 2014 to 31 December 2014. The sampled data was collected using stratified random sampling method and the industry was used as the main determinant. To provide appropriate examination for industrial IPOs, all the available IPOs that existed during this were grouped into seven different categories by applying industrial criterion. IPOs relating to financial, property and mining were omitted from the sample following the argument of (Dimovski & Brooks 2004; Ahmad-Zaluki, Campbell & Goodacre, 2007)5. Other IPOs relating to mergers, takeovers were also not included because they do not affect the performance of IPOs of a firm. Because the listed IPOs are many only 33% of all the listed IPOs were selected but IPOs relating to information technology were selected 100%. Based on this, only 254 IPOs that were selected to represent the final sample for analysis and these represented only 47% of all IPOs listed during the whole period of the study. 3. Results and Discussion 3.1 Short-Run Market Performance Analysis Short run market performance for Australian IPOs was analyzed using descriptive statistics where the mean, median, minimum, maximum and standard deviation were determined for initial returns. Initial returns was determined for each company by getting the difference between listing price and issuing price divide by listing price x 100%. mean 3.614% median 0.000% minimum -22.0% maximum 55.0% Standard Deviation 17.31% Table 1: descriptive statistics results The average initial returns for Australian IPO was determined as 3.614%. This showed that it is underpriced as compared to USA as from 1 November 2014 to 31 December 2014. It also has 0% median of initial returns showing that the investors expected 0% returns when initial returns for all the companies were arranged in ascending or descending order. The maximum value for Initial return was 55.0% while the minimum value was -22.0%. It therefore showed that the maximum value or initial returns that the investor could earn must be below 55% but must be above -22%. Industrial analysis was also conducted using the same data. The result of my analysis showed that financial industry has a mean of initial return of 8.5%, information technology had 1.22%, consumer discretionary 2.20%, health care 5.57%, Real estate 4.30%, Energy -20%, industrials 18.20% and materials 7.5%. Industrials sector in Australia could provide highest level of initial returns with a minimum return of -12% and a maximum return of 47.60%. It is followed by financial sector which had a mean initial return of 8.50% with a maximum initial return of 55.0% and a minimum of -4%. It is followed closely by Material sector which has a mean initial return of 7.5%, then health care sector with 5.57% and the least industrial sector had -20%. Table 2: The results are displayed in the table below Industry Mean Max Min Financials 8.50% 55.00% -4% Information technology 1.22% 14.30% -18% Consumer discretionary 2.20% 3.90% -10.10% Health care 5.57% 36.90% -22% Real estate 4.30% 5% 4% Energy -20.0% -20.00% -20% Industrials 18.20% 47.60% -12% Materials 7.50% 15.00% 0% The result of my analysis showed that industrial sector generates higher initial returns and therefore most investors would prefer investing it. It is followed by financial sector that showed an average initial return of 8.5%. Energy sector showed a negative average initial return and most investors would not prefer it because it is underpriced. 3.2 Long- Run IPO performance Analysis In the examination of long run IPO performance, three different industrial sectors were selected randomly. The industrial sectors selected included consumer Discretionary, Financials, and Information Technology sectors. These industries were examined after two years from the date of listing on the ASX by applying 2-year holding period returns. When conducting my analysis the formula below was used to ensure that we determine the correct result. Where Pt =adjusted closing price on the initial trading day P2= Adjusted closing price on the 2-year anniversary 3.2.1 Financial Sector ASX Code Company Name Initial returns P2 2 year holding period return 8IH 8I Holdings Ltd 55% 0.710 184% BTI Bailador Technology Investments Limited -4% 1.075 12% CBC CBG Capital Limited -2.50% 0.855 -12% MPL Medibank Private Limited 7.00% 2.58 21% NAC Naos Absolute Opportunities Company Ltd -2.00% 1.135 16% PIC Perpetual Equity Investment Company Limited -2.50% 0.98 1% 2- Year holding period return for financial sector is higher than initial return. This showed that the investor would prefer to invest in long run IPO because they are likely to earn higher investment returns than investing in short run IPO. The maximum 2-year holding period was 184.0% while the minimum returns that an investor can earn are – 12%. 3.2.2 Consumer discretionary Sector Company Name initial return P2 2 year holding period return APN Outdoor Group Limited 3.9% 5.26 98.49% Evolve Education Group Limited 1.5% 1 -1.48% Godfreys Group Limited 3.6% 1.03 -63.86% Lovisa Holdings Limited 7.0% 3.81 78.04% Oohmedia Limited -1.6% 4.77 151.05% Simonds Group Limited -10.1% 0.42 -73.75% Surfstitch Group Limited 0.0% 0.185 -81.50% This sector also performs fairly well because it showed a higher returns on 2-year holding period than initial returns. The result indicated that it has a maximum return of 98.49% and a minimum return of -81.50%. Based on my analysis, its mean return was only 15.28% an indication that investors can only earn 15.28% when they invest in consumer discretionary sector. Although this return is higher than the returns that the investor could earn when invested in short run IPO, it is lower than other industrial sectors such as finance and information technology. 3.2.3 Information Technology Sector Company Name initial return P2 2 year holding period return Aconex Limited -5.3% 4.32 140.00% Catapult Group International Limited 2.0% 2.61 365.24% The Citadel Group Limited 0.0% 5.04 124.00% DTI Group Limited 14.3% 0.41 19.53% Datetix Group Ltd 0.0% 0.34 -66.00% Latam Autos Limited -18.3% 0.215 -12.24% Information technology sector is more attractive than other sectors. It has the highest maximum returns (365.24%) than all these sectors with a minimum return of -12.24%. This showed that the investors have a range of companies to invest in and still generate higher income level. When it is compared with short run IPO, the long run IPO generates higher returns to investors because the company takes a longer time generating returns to investors. The results summary of 2-year holding period returns Recommendation I would recommend the investors to invest more in information technology specifically in Catapult Group International because it is able to generate more return on 2 year holding period. The second best industry is financial sector which can generate long-run performance of 48%. It will also ensure that the investor get higher returns than when they invest in short run IPOs. 4. Discussion According to previous research on Australian IPO showed that it has been underpriced by 29.2%. This kind of information was provided by Finn and Higham (1988) and confirmed by Lee, Taylor and Walter (1996) determined that it was underpriced by 29.6% in the short run market. The result of other researches such as mining IPO has been determined to be underpriced by 13.3% and resource IPO has the highest underpricing of approximately 107.18%. The resaech conducted by Da Silva Rosa, Velayuthen and Walter (2003) indicated that venture capital-backed and non-venture capital-backed IPOs are underpriced by only 25.47% while privatized IPOs are underpriced by only 11.96%. According to the study concluded by Bird and Yeung (2010) and Bayley, Lee and Walter (2006) significantly showed that the general Australian IPOs are underpriced by 37.35% and 26.72% respectively. In the contrary, US IPO has undergone through serious research and according to Johnston and Madura (2002) who have dwelled on internet and non internet IPO showed that initial return was most useful for examining short run market performance. Their result also indicated that the degree of underpricing is not statistically significant as a result of the disappearance of internet sector in USA. The global literature focuses on short run market performance indicated that degree of underpricing and related determinants depend on economic condition, nature of the industry and market condition. For that matter it is vital to evaluate the degree of underpricing and also to determine the determinants using current market prices due to economic dynamics. Conclusion This is a very important research paper that examines short run market performance on Australian IPOs. It is mainly based on different companies ranging from materials to chemicals. These companies had different listing years and issuing years and these kinds of data were used to help in the analysis for their IPOs. To determine the appropriate results first listing and post listing returns were used. In order to examine postlisting returns CARs was used. In this study we were able to provide the results obtained after analyzing long run IPO performance by selecting IPO firm which has taken two years after listing on the ASX. Finally, we were also able to reveal the reason for the occurrence of short run IPO under pricing and also ensure that the results obtained are used to compare these reasons. Bibliography Aggarwal, R & Conroy, P 2000, ‘Price discovery in initial public offerings and the role of the lead underwriter’, The Journal of Finance, vol. 55, no. 6, pp. 2903–2922. Ahmad-Zaluki, NA, Campbell, K & Goodacre, A 2007, ‘The long run share price performance of Malaysian initial public offerings (IPOs)’, Journal of Business Finance and Accounting, vol. 34, no. 1–2, pp. 78–110. Aktas, R, Karan, MB & Aydogan, K 2003, ‘Forecasting short run performance of initial public offerings in the Istanbul Stock Exchange’, Journal of Entrepreneurial Finance, vol. 8, no. 1, pp. 1–17. 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Bird, R & Yeung, D 2010, Institutional ownership and IPO performance: Australian evidence, Working paper series 6, Paul Woolley Centre for Capital Market Dysfunctionality, University of Technology Sydney, NSW, viewed 4 December 2012, . Boabang, F 2005, ‘The opening, short, medium and long term performance of Canadian unit trust initial public offerings (IPOs)’, Journal of Business Finance & Accounting, vol. 32, no. 7–8, pp. 1519–1536. Appendix Company Name Status ASX Listing Date Issue Price closing price GICS Sector initial return 8I Holdings Ltd Trading 17/12/2014 0.20 0.310 Financials 55.0% Aconex Limited Trading 09/12/2014 1.90 1.800 Information Technology -5.3% APN Outdoor Group Limited Trading 11/11/2014 2.55 2.650 Consumer Discretionary 3.9% Bailador Technology Investments Limited Trading 21/11/2014 1.00 0.960 Financials -4.0% Catapult Group International Limited Trading 19/12/2014 0.55 0.561 Information Technology 2.0% CBG Capital Limited Trading 19/12/2014 1.00 0.975 Financials -2.5% The Citadel Group Limited Trading 13/11/2014 2.25 2.250 Information Technology 0.0% Centuria Metropolitan Reit Trading 10/12/2014 2.00 2.073 Real Estate 3.7% DTI Group Limited Trading 09/12/2014 0.30 0.343 Information Technology 14.3% Datetix Group Ltd Trading 05/12/2014 1.00 1.000 Information Technology 0.0% Ecargo Holdings Limited Trading 28/11/2014 0.40 0.355 Industrials -11.3% Estia Health Limited Trading 05/12/2014 5.75 4.484 Health Care -22.0% Emperor Range Group Limited Trading 12/11/2014 0.20 0.230 Materials 15.0% Evolve Education Group Limited Trading 05/12/2014 1.00 1.015 Consumer Discretionary 1.5% Godfreys Group Limited Trading 10/12/2014 2.75 2.850 Consumer Discretionary 3.6% IPH Limited Trading 19/11/2014 2.10 3.100 Industrials 47.6% Latam Autos Limited Trading 17/12/2014 0.30 0.245 Information Technology -18.3% Lovisa Holdings Limited Trading 18/12/2014 2.00 2.140 Consumer Discretionary 7.0% Medibank Private Limited Trading 25/11/2014 2.00 2.140 Financials 7.0% Mustera Property Group Limited Trading 28/11/2014 0.20 0.210 Real Estate 5.0% Naos Absolute Opportunities Company Ltd Trading 12/11/2014 1.00 0.980 Financials -2.0% Orion Health Group Limited Trading 26/11/2014 5.70 5.800 Health Care 1.8% Oohmedia Limited Trading 17/12/2014 1.93 1.900 Consumer Discretionary -1.6% Perpetual Equity Investment Company Limited Trading 18/12/2014 1.00 0.975 Financials -2.5% Pacific Smiles Group Limited Trading 21/11/2014 1.30 1.780 Health Care 36.9% Simonds Group Limited Trading 17/11/2014 1.78 1.600 Consumer Discretionary -10.1% Surfstitch Group Limited Trading 16/12/2014 1.00 1.000 Consumer Discretionary 0.0% Tian Poh Resources Limited Trading 11/11/2014 0.20 0.200 Materials 0.0% UIL Energy Ltd Trading 06/11/2014 0.20 0.160 Energy -20.0% Total average mean   3.614% Financials 51.0% 8.50% median   0.000% Information technology -7.3% 1.22% minimum   -22.0% Consumer discretionary 4.4% 2.20% maximum   55.0% Health care 16.7% 5.57% MAD     Reat estate 8.6% 4.30% Standard Deviation   17.31% Energy -20.0% -20.0% Industrials 36.4% 18.20% materials 15.0% 7.50% Read More