Case study – IPO Under-Pricing (30 marks: 10 + 6 + 12 + 2)

A written report of 2,500 words max. (excluding tables, figures and references)

Background

You are a financial adviser at Dynamic Investment Ltd. Your company offers a comprehensive and strategic financial services to high net worth clients. You have recently been assigned a job to provide financial guidance to clients who are interested to invest in IPO firms in consumer Discretionary, Financials and Information Technology sectors. It is well known that many IPOs in the US were issued at prices substantially below the first-day closing market prices. However, the evidence on the existence of short-run IPO under-pricing phenomenon in the Australian stock market in the recent years is lacking. To help you providing sound professional advices to the potential clients, your boss asks you to investigate and prepare a report on the following issues.

Questions

1. Assessment objective: This question assesses your understanding of the calculation of initial return and ability to analyse and interpret the Australian IPO market (Topic 4 Learning outcomes).

In other words, does this phenomenon perhaps also exist in the Australian stock market? To answer this question, you need to investigate the short-run IPO performance in the Australia stock market. To measure the short-run IPO performance, you will have to calculate and analyse the initial return of IPOs that were listed on the Australian Securities Exchange (ASX) from 1 November 2014 to 31 December 2014. The initial return (Ritter 1991, p. 7) equals:

[(The first trading day closing price – issue price) / issue price] * 100.

Download the list of IPO firms with their issue price and the first trading day closing price from Morningstar DatAnalysis Premium. Remove those IPOs without issue price in the spreadsheet downloaded from DatAnalysis and IPOs with ‘Suspended’ status. Also, make sure you select the adjusted price for the closing price. Describe the sample selection process. You should list any assumptions made during the data selection process.

Critically analyse the results of your calculation using the entire sample and describe the insights that could be gained from the calculation. For instance, you should describe the results of the analysis using simple descriptive statistics, such as mean, median, minimum, maximum, etc., or the frequency distribution.

Next, categorise your IPO firms into groups using industry sector, repeat the analysis and describe what additional insights you could gain from the analysis.

Wherever appropriate, the summary of your analysis and/or results (e.g., in a brief table, chart or graph) should be presented in the main text of your report. However, the data, detailed calculation/analysis and results should be presented in the Excel spreadsheet, which must be embedded in the Appendix section of your report. Note that 1 mark is allocated for organising and presenting the calculation/analysis and results in the embedded Excel Spreadsheet and report. In addition, you must properly reference (Harvard style) all sources of information used.

(10 marks)

2. Assessment objective: This question assesses your ability to calculate and compare percentage return (Topic 5 Learning Outcome), and examine the long-run IPO performance (Topic 4 Learning Outcome).

Pick one industry sector out of the following three industry sectors: consumer Discretionary, Financials, and Information Technology sectors. Examine the performance of the IPO firms in the chosen industry sector 2 years after they were listed on the ASX using the 2-year holding period return. Compare and contrast the 2-year performance with the initial return calculated for this industry sector in Question (1).

The formula for 2 year holding period return (Ritter, 1991, p.14) is

é P  – P ù

2 – year holding period return = ê  2

ë     Pt

ú ´100

û

P2 = the adjusted closing price on the 2-year anniversary. If the first trading day is Dec 1, 2014, then the 2-year anniversary is Dec 1, 2016; if the 2-year anniversary is a non-trading day, then use the adjusted closing price of the trading day immediately prior to the 2-year anniversary.

Pt = the adjusted closing price on the first trading day.

Next, calculate the 2-year holding period return for All Ordinaries Index by using the adjusted closing value on 1 Dec 2014 as Pt and adjusted closing value on its 2-year anniversary.

Based on your analysis result in Questions (1) and (2), would you recommend a client to invest in the IPO firms in your chosen industry? Why or Why not? You are required to provide justification(s) to support your recommendation.                                           (6 marks)

3. Assessment objective: This question assesses your understanding of the reasons for the occurrence of short-run IPO under-pricing and ability to compare and contrast these reasons using the results of an empirical study (Topic 4 Learning Outcome).

Select and discuss one theory/proposition that in your opinion provides the most plausible explanation for the occurrence of short-run IPO under-pricing in the US and/or Australian stock market. Perform some background research and use the findings to justify your selection.

Then pick one stock market from the selected OECD markets1. Describe one study that empirically investigates the existence of short-term IPO under-pricing in the stock market you have chosen. To answer this question, you are expected to describe the study (including the sample of IPO firms examined, the degree of IPO under-pricing in the selected market and the factors explaining the degree of under-pricing in the selected stock market) and  the empirical results on  the factors explaining the short-term IPO under-pricing, and discuss the reason(s) proposed by the study to explain the existence of IPO under-pricing in relation to the theory you have identified and discussed for US and/or Australian stock market.

In attempting the above task, you are expected to use at least four academic references. You may use articles from academic journals or textbooks, but not Wikipedia, Investopedia or other non- academic Internet websites. You must properly reference (Harvard style) all sources of information used.

(12 marks)

1 The selected OECD markets are Austria, Canada, France, Greece, Italy, Spain and Sweden.

4. Please note: 2 marks are allocated for referencing. (2 marks)

(10 + 6 + 12 + 2 = 30 marks)

Useful resources and referencing

You should read and understand Chapters 5, 6 and 12 of your textbook and Topics 4 and 5 lecture slides. You are expected to do research outside of your lecture time, using library/online sources, process the information gathered, and write an organised, well-thought-out response to the assignment questions. Here are some useful resources:

1. ASX  2014,   IPO   the   road   to   growth   and   opportunity,   retrieved   20   January   2017,

<http://www.asx.com.au/documents/products/ASX_IPO_Brochure.pdf>.

2. Ritter, JR 1991, ‘The long-run performance of initial public offerings’, The Journal of Finance, 46, no. 1, pp. 3–27.
3. Chapters 2, 3 and 4 from: Rosenthal, JA 2012, Statistics and Data Interpretation for Social Work, Springer, New Available as a Deakin University Library e-book.

A number of resources relevant to Assignment 2 can be found on Library Resources Guides website (http://deakin.libguides.com/c.php?g=558227&p=3840186) and the Padlet website (https://padlet.com/buslaw221/MPF753) developed specifically for MPF753 Finance.

The list of IPO firms, initial offering price, historical closing prices, and all other relevant financial information should be obtained from Morningstar DatAnalysis Premium – a library database that can be accessed via the Deakin Library website. Instructions on how to obtain the information from DatAnalysis are given in a separate instruction document and short video clips (posted on the MPF753 Finance Library Resources Guide and MPF753 Padlet website). The value of All Ordinaries Index must be obtained from Yahoo Finance. Downloading instructions have been given in a separate document. The Assignment 2 details will be discussed during the Week 4 or 5 Lecture (will be recorded). You are strongly advised to attend (watch/listen) that lecture (recorded lecture and video clips) before you start to work on your assignment. In your report, embed the Excel spreadsheet containing the data you will use for the calculations.

Good referencing and carefully checking all your references are important. Make sure you leave enough time to do this. For this assignment, you must use the Harvard referencing style, as described in the Deakin guide to referencing. Click on the ‘Harvard’ tile’, top left, to access the Harvard guide online or download a PDF copy. The Deakin guide to referencing also provides useful information on academic integrity, general referencing principles and how to integrate your sources into your writing through summarising, paraphrasing, etc.