PART 4: CAPITAL STRUCTURE AND PAYOUT POLICY4 Over the last two decades, numerous international companies raised capital in the US IPO market.
Both established international companies and non-US entrepreneurial firms frequently make initial
stock offerings to US investors, either publicly via a straight IPO or to institutional investors through
a Rule 144A offering. This special type of offering allows issuing companies to waive some disclosure
requirements by selling stock only to sophisticated institutional investors, who may then trade the
shares among themselves.12-3b THE INVESTMENT PERFORMANCE OF US INITIAL
PUBLIC OFFERINGSAre IPOs good investments? The answer seems to depend on the investment horizon of the investor and
whether or not the investor can purchase IPO shares at the offer price. If an investor can buy shares at
the offer price and then flip them – sell them on the first trading day – then the returns on IPOs are on
average substantial. But if the investor buys shares in the secondary market and holds them for the long
term, the average returns are much less rewarding.Positive Initial Returns for IPO Investors (Underpricing)
Year in and year out, in virtually every country around the world, including Australia, the very short-term
returns on IPOs are surprisingly high. In the United States, the share price in the typical IPO closes
roughly 15% above the offer price after just one day of trading. Researchers refer to this pattern as IPO
underpricing, meaning that the offer price in the prospectus is consistently lower than what the market is
willing to pay. To capture this initial return, an investor must be fortunate enough to receive an allocation
of shares from the investment banker and to sell those shares at the first opportunity. Investors who buy
IPO shares when open-market trading begins usually receive much smaller returns, and take on much
greater risks, than do investors who participate in the initial offering.
Clearly, underpricing is a pervasive phenomenon. However, the long-run performance of IPOs
presents a different puzzle.exampleThe US-based maker of fashion accessories, Vera
Bradley, went public by selling shares in an IPO
on 21 October 2010. Shares in the company were
offered to initial investors at US$16, but after
one trading day the company’s share price stood
at US$24.85 – a one-day gain of more than 55%!
Even investors who purchased shares on the
open market fared well, as Vera Bradley’s shares
doubled in the six months following their IPO.Contrast that performance with the experience
of Mecox Lane, an e-commerce fashion retailer in
China. Mecox conducted an IPO on the Nasdaq
in October 2010 and saw its share price rise from
the US$11 offer price to US$17.50 on its first day
(a gain of 59%). However, Mecox’s share price fell
by more than 50% in the firm’s first six months as a
public company, trading below US$6 per share by
May 2010.Negative Long-term IPO Returns
Early research on the long-run performance of IPOs has not been encouraging for investors. It showed
that investors who buy IPO shares at the end of the first month of trading and then hold these shares
for five years thereafter fare much worse than they would have by purchasing the shares of comparable,
size-matched firms. On average, investors’ net returns are more than 40% below what they would have
earned after five years of alternative equity investments.Rule 144A offering
A special type of offering in
the US market, first approved
in April 1990, that allows
issuing companies to waive
some disclosure requirements
by selling stock only to
sophisticated institutional
investors, who may then trade
the shares among themselves
flip
To buy shares at the offer
price and sell them on the first
trading day
IPO underpricing
Occurs when the offer price in
the prospectus is consistently
lower than what the market is
willing to bear
IPO initial return
The gain (or loss) when an
allocation of shares from an
investment banker is sold at
the first opportunity