Kylie Gilbey discovered some huge gaps when she started researching the returns from stock market listings.
Most of the research comes out of the US and only looks at large initial public offerings (IPOs).
In the US market, IPOs that issue shares at less than $5 are considered ‘penny’ stocks under the Penny Stock Reform Act of 1990 and are therefore speculative.
The existing research is usually restricted to companies that are still listed, with any delisted stock assumed to be a failure.
The research is also limited to relatively short periods, typically three to five years.
Ms Gilbey, who is working towards a PhD at the University of Western Australia, has undertaken an ambitious research project to fill the data gap.
With guidance from co-authors Sharon Purchase at UWA Business School and Terry Marsh at the University of California Berkeley Haas, Ms Gilbey has analysed the returns from every IPO on the ASX between January 1 1999 and December 31 2019.
That’s a total of 2,018 listings.
She believes it’s the first study to directly compare the long-term returns from all stocks: from those with a large market capitalisation on listing (above $700 million) through to small and micro-cap stocks (valued at less than $75 million).
The results are stark and very positive for Western Australia.
The researchers found that returns from small- and micro-cap IPOs have on average been much stronger than for large-cap IPOs.
The inclusion of delisted IPOs in the analysis had a major impact; it greatly boosted returns, defying the perception that a delisting equates to a failure.
This was particularly important, as 63 per cent of the companies in the survey ended up delisting during the 20-year period.
Ms Gilbey carved up her analysis to capture two types of return: the ‘stag’ profit on the first day of listing and the long-term buy-and-hold return.
An investor who was able to buy into every small- and micro-cap IPO on the ASX at the issue price and sell the shares after the price ‘pop’ on the first day of trade would have made a 19.45 per cent average one-day gain.
Investors who did the same for every large IPO would have achieved a much smaller stag profit of 7.88 per cent.
There was an even bigger differential for buy-and-hold investors, who invested in every new IPO on the day of listing and held their shares right through to December 31 2019 (or until the date of delisting).
The study used a ‘dynamic rebalancing’ approach, where profits were taken on successful IPOs to fund investments in new IPOs.
This matched the ‘backtesting’ methodology adopted by many ASX investors.
The annualised average return on a market-weighted portfolio of small- and micro-cap IPOs was 18.62 per cent.
For large IPOs, the weighted average return was just 2.28 per cent.
In keeping with this pattern, IPOs filed in WA delivered the best returns.
The 855 WA IPOs during the 20-year study period had an average value of just $27.1million, reflecting the large number of listings by junior explorers.
They delivered an average return of 20.86 per cent, more than any other state. By sector, metals and mining, energy and software delivered the best returns.
Ms Gilbey said the historical record conflicted with the widespread ‘higher risk/less profitable/failure to grow’ perception of the ASX small-cap IPO market.
“Taken together, the results are at odds with much of the existing literature and some of the financial press, purporting to document negative small-cap IPO returns on average,” she said.
Ms Gilbey said the common perception may stem from the fact that most IPOs delivered negative returns.
Like a diversified venture capital portfolio, however, the average return is boosted by spectacularly positive returns from some of the success stories.
Copper and goldminer Sandfire Resources, for instance, listed in 2004 at 20 cents per share and is now worth $7.37 per share.
Credit Corp Group listed in 2000 at 50 cents per share and is now trading at $35.45 per share.
A third example is diversified miner and contractor Mineral Resources, which listed at 90 cents in 2006 was trading at $16.67 on December 31 2019.
The stock has rallied much further since then, currently trading at $65.97.
Global context
The researchers recognise the big differences between the ASX and overseas exchanges.
In comparison with 20 years ago, fewer public corporations were listed in the US and many other countries and tended to be, on average, larger, older and less profitable. The trend in ASX listings is an exception.
“They have grown, mainly on account of small/micro caps, which have constituted approximately 78 per cent of all new ASX listings over the last two decades,” Ms Gilbey said.
The researchers emphasised that the ASX was the only major exchange that allowed small- and micro-cap stocks to list on the main board with large companies, with the same regulatory requirements.
Other exchanges require small/ micro IPOs to list on a second board exchange, such as London’s Alternative Investment Market or Canada’s TSX Venture Exchange.
The second board exchange IPOs frequently underperform, for reasons including lack of liquidity or visibility, poor governance and lack of analyst exposure.
“So, current literature states that small-cap IPOs generally underperform in the long run,” Ms Gilbey said.
The ASX’s standardised listing rules allowed the researchers to disprove that perception.
“By listing all IPO sizes on one market under the standardised regulatory listing environment, the ASX allows a direct comparison of small/micro to large IPO performance returns,” Ms Gilbey said.
Hybrid VC market
She said the ASX had two other traits that distinguished it from its international counterparts.
One was the role it played as a source of early-stage equity, in the absence of a large or mature venture capital industry.
“Venture capital and private equity funding has been particularly low in Australia in comparison to many other countries with similar economic structures, such as Canada, the US or the UK,” Ms Gilbey said.
“It’s important for the ASX to understand that it is an important source of funding for small caps, which are critical for economic growth.”
While many observers see the ASX and venture capital as starkly different, Ms Gilbey characterises the Australian market as a hybrid.
“Public listings are supported with VC-like and angel-investor skills supplied by a localised financial ecosystem of brokers, lawyers and other technical advisors,” she said.
“They play roughly the same role as a general partner in the traditional VC business, with the qualification that they face more retail investors, whereas the latter deals predominantly with institutional clients.”
Nonetheless, the small size of Australia’s VC market drives a high rate of early-stage listings by entrepreneurs seeking risk capital.
Another distinguishing feature of the ASX is that individual investors hold a higher fraction of equities than typically seen globally.
Some 62 per cent of all Australian equity ownership is held as ‘free float’, which Ms Gilbey defines as retail and other investors who directly hold shares but whose holdings are not large enough to trigger the 5 per cent public disclosure requirements.
This is one of the highest retail ownership rates globally, standing in sharp contrast to 19 per cent in the US, 39 per cent in Germany and 22 per cent in the UK.
“Both the sell and buy sides arguably contribute to the ‘Wild West’ perception of small- and micro-cap IPOs,” Ms Gilbey said.
First-day premiums
Ms Gilbey’s research found that stag premiums varied by size of company in Australia.
It was 19.46 per cent for the small IPOs, 15.75 per cent for the medium sized and 7.88 per cent for the large offerings.
This was consistent with extensive research finding larger IPO premiums reflect the higher uncertainty about the value of small stocks prior to their listing. In reality, a premium for an investor is a discount for the business owner selling shares.
Accordingly, the academic research in this field typically refers to discounts rather than premiums, as this amount represents an opportunity loss incurred by the vendors.
Ms Gibney has calculated that the discount on all the IPOs she studied equated to $24.6 billion left on the table by the companies being floated.
She also found that, despite the predominance of small IPOs in Australia, the average stag premium on listing day was remarkably like that for larger US exchange IPOs.
In the US, the average first-day premium was 16 per cent between July 1 2009 and June 30 2019.
“Therefore, the IPO discounts do not appear to be driven by Australia’s distinctive industry composition,” Ms Gibney concluded.
The research found the first-day premiums varied over time in both Australia and the US. They were highest in 1999, during the dot.com boom.
IPO numbers and premiums in both markets then hit a low around 2001, following the tech wreck, before steadily climbing with the bull market until the GFC.
That prompted another dip in IPO activity and premiums, followed by a gradual recovery up to 25 per cent discounts in 2019.
Buy-and-hold returns
The returns for buy-and-hold investors were calculated in three ways.
The first was to look just at price movements for stocks still listed at December 31 2019; that generated a return of just 1.25 per cent when small, medium and large stocks were combined.
The second was to add dividends by the 676 companies that actually paid a dividend and were still listed; that lifted returns a little, to 1.66 per cent.
The third step made all the difference.
After including returns from companies that had delisted – 63 per cent of the 2,018 companies in the sample – returns jumped 12.95 per cent.
This effect was seen across all IPO size categories: small, medium and large.
Putting it modestly, Ms Gilbey said this highlighted a ‘wrinkle’ that had been largely overlooked in current literature.
She added the research results highlighted that delistings should not be deemed failures.
“Companies delist for various reasons that do not necessarily represent company failure, such as a restructuring, takeovers, mergers, privatisation or relisting on another international exchange better suited for the company’s purpose,” Ms Gilbey said.
She said a common occurrence was junior miners intentionally delisting for positive reasons, such as a successful exploration outcome and pursuant to acquisition by larger mining groups.
It has also been common for companies to convert from the riskier no liability (NL) status to limited liability (Ltd) upon reaching desired profitability levels.
Ms Gilbey said the average return from large IPOs during the past 10 years was heavily influenced by two very successfully delisted firms.
Trade Me Group was bought by UK-based private equity firm Apex Partners for $NZ2.56 billion, and Vega Group was acquired by US company Equifax Inc for $US1.9 billion.
Ms Gilbey’s preliminary research on delisted companies has found that only 17 per cent of IPOs should be categorised as straight failures.
A large number has entered schemes of arrangement and she is yet to conclusively establish their success rate.
That is a topic for her next research project.
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