The Underpricing of Infrastructure IPOs: Evidence from China

Qile Tan and Bill DimovskiDeakin University

Initial Public Offering (IPO) underpricing:

• IPOs are common around the world • Before 2009, the US was the leading issuer of IPOs in terms

of total value. Since then, China has been the leading issuer, raising $73 billion (almost double the amount of IPO money raised on the NYSE and NASDAQ combined) in 2011

• Underpricing/first day returns to subscribers on average are also common. Facebook issue $38, close day1 $38.23

• Underpricing appears more severe in emerging markets

Australia Lee, Taylor & Walter; Woo; Pham; Ritter 1,562 1976-2011 21.8% Canada Jog & Riding; Jog & Srivastava; 696 1971-2010 6.7% Kryzanowski, Lazrak & Rakita; Ritter China Chen, Choi, & Jiang; Jia & Zhang 2,102 1990-2010 137.4% France Husson & Jacquillat; Leleux & Muzyka; 697 1983-2010 10.5% Paliard & Belletante; Derrien & Womack;

Chahine; Ritter; Vismara Germany Ljungqvist; Rocholl: Ritter; Vismara 736 1978-2011 24.2% Greece Nounis, Kazantzis & Thomas; 373 1976-2011 50.8% Thomadakis, Gounopoulos & Nounis Hong Kong McGuinness; Zhao & Wu; Ljungqvist & 1,259 1980-2010 15.4% Yu; Fung, Gul, and Radhakrishnan; Ritter India Marisetty and Subrahmanyam; Ritter 2,964 1990-2011 88.5% Jordan Al-Ali and Braik 53 1999-2008 149.0% Malaysia Isa; Isa & Yong; Yong; Ma 413 1980-2009 62.6% United Kingdom Dimson; Levis 4,877 1959-2011 16.1% United States Ibbotson, Sindelar & Ritter; Ritter 12,340 1960-2012 16.8%

source: Ritter (2013)

Equally weighted average initial returns for 12 countries

Some theoretical explanations for underpricing

Rock (1986) - IPOs need to be underpriced to continually attract uninformed investorsWelch(1989) – Underpricing allows for subsequent issues at a higher priceTinic (1988) suggests underpricing is like an insurance and prevents against damages to underwriters/directors Ruud (1993) – underwriters price support the issue for a short timeBeatty and Ritter (1986) – greater uncertainty, greater underpricing – older entities, larger entities, those with more reputable auditors and with banking and venture capital relationships – lower underpricing

Underpricing in different industries

• Dimovski and Brooks (2008) – gold 13.3% (while industrials around 25%)

• REITs – US – Wang, Chan and Gau(1992) negative 2.82%, Ling and Ryngaert (1997) 3.6%, Bairagi and Dimovski (2011) 4.6%

• A-REITs – Dimovski (2009) 2.6%• J-REITs – Kutsuna et al (2008) 0.5%• Infrastructure – Australia 3.5% but not stat sig diff to zero• Infrastructure – India 25%

Characteristics of infrastructure:

• high entry barriers• monopoly characteristics• long duration• large investment scale• inelastic demand• stable, tax effective and predictable cash flows via government

regulation and long-term contracts• low correlation with major asset classes• low volatility of cash-flows (Newell, Chau and Wong, 2009)

What is infrastructure? • It provides the essential services for a community's

economic and social needs, eg:– transport: toll roads, airport, sea ports, rail, and bridges;– energy and utilities: electricity, water, and gas;– communications: mobile phone networks,

telecommunication networks, and satellite systems; and – social: healthcare, education, and correctional facilities.

(RREEF, 2005; and UBS, 2006a)

Previous studies of infrastructure IPOs:

• Hong Kong Dewenter and Field(2001) 1996-1997, 7 infrastructure IPOs

report a 4.67% underpricing (not statistically significant). • AustraliaDimovski (2011) 1996-2007, 30 infrastructure IPOs report a 3.5%

underpricing (not statistically significant). • IndiaRitchie, Dimovski and Deb (2013) 2004-10, 49 infrastructure IPOs

report a 25.4% underpricing (statistically significant).

Previous studies of infrastructure IPOs:

Author(s) Market Number of IPOs Year Initial return Significance

Dewenter and Field (2001) Hong Kong 7 1996-1997 4.67% NO

Dimovski (2011) Australia 30 1996-2007 3.50% NO

Ritchie, Dimovski and Deb (2013) India 49 2004-2010 25.40% YES

Tan and Dimovski (current study) China 154 1993-2012 91.10% YES

Characteristics of the Chinese stock market:

• Two types of shares: A-share and B-share• Long delay between offering date and listing date Average 260 calendar days for A-share IPOs (Su and

Fleisher, 1999)• High government ownership • Highly speculate market

Data:

• 154 A-share infrastructure IPOs issued during1993 to 2012

• Prospectuses were downloaded from Shanghai and Shenzhen stock exchanges

• CSMAR database is used for index returns and in the case of missing data in prospectus

Summary statistics for the Chinese infrastructure IPOs during 1993 to 2012

　 Mean Median Max. Min. SD

First day return (%) 91.124 81.675 633.333 -68.364 80.311

Time delay (days) 31.299 16.000 608.000 2.000 55.371

Offer size(USD) 315,208,543 85,050,000 8,182,707,993 4,453,507 863,030,000

Offer price (CYN$) 9.603 6.380 69.000 1.500 10.297

Firm Age 3.656 2.000 22.000 0.00 3.880

Government ownership (%) 48.325 59.520 88.352 0.00 28.656

Market return (%) 0.725 -0.684 178.788 -51.185 20.419

• Dependent variable: Initial returns

• Independent variables:– Stock exchange dummy– Market index return– Time lag between

offering and listing date– Firm age

– Offer price– Logarithm log of issue

size– Government ownership

after issuing– Pricing method dummy– Underwriter reputation

Methodology:

• Ordinary Least Square (OLS)• Model 1:• Utilizing all variables except Time Lag and Market return

• Model 2:• Utilizing all variables

Regression results:• In model 1 (LAG and MARKET are not included) offer price, stock exchange and issue size are highly

significant with expected signs.

• In model 2 (LAG and MARKET are included) stock exchange, time lag and issue size are highly

significant with expected signs.

• Issue size (in log form) is significant with expected sign in all partitions in both models.

• Underwriter reputation and Government retention are not significant across all partition in both models.

Results:

Summary:• The average initial return for Chinese infrastructure

IPOs during 1993 to 2012 is 91.1%, which is statistically significantly different to zero and relatively higher than in India and Australia.

• Infrastructure IPOs in China carry less uncertainty in the valuation of the IPO comparing to the whole market.

Summary:• In China, the offer price and issue size appear to be

helpful in the prediction for the underpricing of infrastructure IPOs.

• Government retention and underwriter reputation do not have significant predicting power in our study.

• When time lag and market return being included in the regression model, the time lag and issue size can better explain the underpricing.

Thank you for your time