THE RELEVANCE AND FAIRNESS OF THE JSE ALTX PRE-IPOSHARE PRICING METHODOLOGIES

Jacques Salvator Richard Magliolo

Student no: 182020000

Dissertation submitted in fulfilment of the requirement for the degree of

MASTER COMMERCII

in the

Faculty of Business and Economic Sciences

at the

Nelson Mandela Metropolitan University

Supervisor: Professor HR Lloyd Co-supervisor: Dr N Bruton

November 2012

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TABLE OF CONTENTS

LIST OF TABLES _________________________________________________________ ix

LIST OF FIGURES ________________________________________________________ ix

DECLARATION____________________________________________________________x

DEDICATION ____________________________________________________________ xi

ACKNOWLEDGEMENTS ___________________________________________________xii

ABSTRACT_____________________________________________________________ xiii

CHAPTER 1: INTRODUCTION – THE IPO SCENE________________________________1

1.1 INTRODUCTION ______________________________________________________1

1.2 PREFACE TO RESEARCH ______________________________________________3

1.3 THE IPO PROCESS: IMPORTANCE WITHIN ECONOMICS ____________________7

1.3.1 Overview of Global Pricing Methods ____________________________________9

1.3.2 The South African Industry __________________________________________10

1.4 PROBLEM STATEMENT AND OBJECTIVES OF THE STUDY _________________11

1.4.1 Problem Statement ________________________________________________11

1.4.2 Research Objectives _______________________________________________12

1.4.3 Main Problems____________________________________________________13

1.4.4 Sub-problems ____________________________________________________13

1.4.5 Methodology Displayed _____________________________________________14

1.4.6 Scope of the Study ________________________________________________15

1.4.7 Limitations of the Study _____________________________________________16

CHAPTER 2: LITERATURE REVIEW _________________________________________17

2.1 INTRODUCTION _____________________________________________________17

2.2 THE ISSUE OF UNDER-PRICING _______________________________________17

2.3 POST-IPO PRICING __________________________________________________19

2.4 OVERVIEW OF EXISTING IPO PRICING__________________________________20

2.4.1 Global Marketplace IPO Pricing Methodologies __________________________20

2.4.1.1 Fixed Pricing IPO Methods _______________________________________21

2.4.1.2 Book-Building _________________________________________________24

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2.4.1.3 Auction-Style IPO Pricing ________________________________________24

2.4.1.4 The P/E Ratio Pricing Methodology ________________________________27

2.5 CONCLUSION _______________________________________________________28

CHAPTER 3: OVERVIEW OF EXISTING THEORY _______________________________30

3.1 INTRODUCTION _____________________________________________________30

3.2 OVERVIEW OF IPO THEORY___________________________________________31

3.3 THE LINK BETWEEN THEORY AND PRACTICE ___________________________32

3.3.1 Wave and Signalling Theories________________________________________32

3.3.2 Under-pricing Theories _____________________________________________35

3.3.2.1 Prospect Theory and Under-pricing ________________________________37

3.3.2.2 Information Asymmetry Theories, Book-building and Under-pricing________38

3.3.2.3 Signalling Theory and Underwriting ________________________________41

3.3.3 Wave Theory and Under-pricing ______________________________________42

3.3.4 Choosing to Go Public______________________________________________43

3.4 INTERNAL VERSUS EXTERNAL FORCES ________________________________43

3.4.1 Life Cycle and Market-Timing Theories_________________________________43

3.4.2 Problems with Evaluating Theories Regarding IPO Timing__________________45

3.5 SHARE ALLOCATION THEORIES _______________________________________45

3.6 VALUATION AND WAVE THEORIES _____________________________________46

3.6.1 The Link to Long-Run Performance ___________________________________46

3.7 A SYNTHESISING THEORY____________________________________________49

3.7.1 Under-pricing, Information Asymmetry, Wealth Prospects and IPO Performance 49

3.8 LITERATURE SYNTHESIS AND CONCLUSIONS ___________________________50

3.9 CONCLUSION _______________________________________________________54

CHAPTER 4: THE JSE AND ALTX ___________________________________________55

4.1 INTRODUCTION _____________________________________________________55

4.2 IPO AND ECONOMICS: THEORETICAL AND ANALYTICAL ISSUES ___________55

4.3 SOUTH AFRICAN EXCHANGES ________________________________________59

4.3.1 JSE and AltX _____________________________________________________59

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4.4 GLOBAL EXCHANGES: SMALL AND MEDIUM ENTERPRISE (SME) ___________64

4.5 METHODS OF OBTAINING AN IPO: SOUTH AFRICA _______________________65

4.5.1 The JSE_________________________________________________________66

4.5.2 The Alternative Exchange (AltX) ______________________________________69

4.5.2.1 AltX - A South African SME Stock Exchange _________________________71

4.5.2.1.1 Analysis of Schedule 21 of the JSE’s Listing Requirements __________71

4.5.2.1.2 Advantages for Companies Listing on AltX _______________________73

4.5.2.2 Listing Requirements ___________________________________________74

4.5.2.2.1 Section 21.1: General________________________________________76

4.5.2.2.2 Sections 21.2 To 21.4: Conditions for Listing______________________76

4.5.2.2.3 Section 21.2 (a): A Market for SMEs ____________________________76

4.5.2.2.4 Section 21.2 (b): Timing Issues ________________________________76

4.5.2.2.5 Section 21.3: Listing Requirements _____________________________76

4.5.2.2.6 Section 21.3 (a): Appoint a Designated Advisor (DA) _______________76

4.5.2.2.7 Section 21.3 (b): Share Capital Requirements_____________________76

4.5.2.2.8 Section 21.3 (c): Public Interest in AltX Companies_________________77

4.5.2.2.9 Section 21.3 (d): Director Education ____________________________77

4.5.2.2.10 Section 21.3 (e): Appointment of a Financial Expert _______________77

4.5.2.2.11 Section 21.3 (f): Financial Forecasts ___________________________77

4.5.2.2.12 Section 21.3 (g): Directors’ Shareholding________________________77

4.5.2.2.13 Section 21.3 (h): Non-executive Directors _______________________77

4.5.2.2.14 Section 21.4: Warning Statements on Documents_________________78

4.5.2.2.15 Section 21.5: Publication ____________________________________78

4.5.2.2.16 Section 21.6: Corporate Governance___________________________78

4.5.2.2.17 Section 3.84 (c) ___________________________________________78

4.5.2.2.18 Section 3.84 (d)___________________________________________79

4.5.2.2.19 Section 21.7: Public Shareholders _____________________________79

4.5.2.2.20 Section 21.8: Issues for Cash ________________________________79

4.5.2.2.21 Section 21.9: Pre-Listing Statements ___________________________79

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4.5.2.2.22 Section 21.10: Financial Information ___________________________80

4.5.2.2.23 Section 21.11: Transactions__________________________________80

4.5.2.2.24 Section 21.12: Related Party Transactions______________________82

4.5.2.2.25 Section 10 of the JSE Listings Requirements ____________________82

4.5.2.3 Other Important Issues __________________________________________82

4.5.2.3.1 Sections 21.13 to 21.39: Designated Advisors_____________________83

4.5.2.3.2 List of DA Functions _________________________________________83

4.5.2.4 Responsibility of DAs ___________________________________________85

4.5.2.4.1 Section 21.17 ______________________________________________85

4.5.2.4.2 Section 21.18 ______________________________________________85

4.5.2.4.3 Section 21.19 ______________________________________________85

4.5.2.4.4 Section 21.20 ______________________________________________85

4.5.2.4.5 Section 21.21 ______________________________________________86

4.5.2.4.6 Section 21.22 ______________________________________________86

4.5.2.4.7 Section 21.23 ______________________________________________87

4.5.2.4.8 Section 21.24 ______________________________________________87

4.5.2.4.9 Section 21.25 ______________________________________________87

4.5.2.4.10 Section 21.26 _____________________________________________87

4.5.3 The Alternative Investment Market (AIM) _______________________________87

4.5.3.1 Suited for SMEs _____________________________________________88

4.5.3.2 Nomads and Brokers__________________________________________89

4.5.3.3 Movement to the Main Board ___________________________________90

4.5.3.4 Eligibility of Companies Applying to AIM ___________________________90

4.6 DETERMINING FINANCIAL MARKET EFFICIENCIES _______________________91

4.6.1 Impact on Price Determination _______________________________________91

4.6.1.1 Types of Market Efficiency _______________________________________92

4.6.1.1.1 Need for Market Efficiency ____________________________________92

4.6.1.1.2 Levels of Market Efficiency____________________________________92

4.6.1.2 Efficient Stock Market Trading ____________________________________93

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4.6.1.3 Stock Market Anomalies _________________________________________95

4.6.1.4 Theoretical Deductions to Determine Market Efficiencies _______________95

4.7 ALTX SHARE PRICE VERSUS EARNINGS EFFICIENCIES ___________________97

4.7.1 The Global Experience _____________________________________________99

4.8 FINDING INTRINSIC VALUE: IPOs______________________________________101

4.8.1 Valuing IPOs ____________________________________________________103

4.8.2 Estimation of Intrinsic IPO Value_____________________________________108

4.8.3 Comparable Firm Method to Estimating Intrinsic Value ___________________109

4.8.3.1 Choosing Matching Firms _______________________________________109

4.8.3.2 Empirical Evidence ____________________________________________113

4.9 DETERMINANTS OF IPO PRICING _____________________________________115

4.9.1 Investor Sentiment________________________________________________115

4.9.2 Post-IPO Ownership Retention ______________________________________116

4.9.3 Firm Size _______________________________________________________117

4.9.4 Board Prestige___________________________________________________117

4.9.5 Age of the Firm __________________________________________________118

4.9.6 Theoretical Underpinning __________________________________________118

4.10 CONCLUSION _____________________________________________________119

CHAPTER 5: EMPIRICAL ANALYSIS AND INTERPRETATION ___________________121

5.1 INTRODUCTION ____________________________________________________121

5.1.1 Main Goal_____________________________________________________122

5.1.2 Research Methodology __________________________________________122

5.2 TESTING ALTX SHARE PRICING EFFICIENCIES _________________________122

5.2.1 Share Performance versus Financial Results ___________________________122

5.2.1.1 Implications and Recommendations_______________________________126

5.2.2 AltX versus Foreign Junior Boards ___________________________________127

5.2.3 Sector Analysis __________________________________________________129

5.2.3.1 TSXV Companies By Sector ___________________________________130

5.2.3.2 AIM By Sector ______________________________________________131

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5.2.3.3 AltX By Sector ______________________________________________132

5.3 CONCLUSION ______________________________________________________133

CHAPTER 6: ALTX COMPANIES ARE OVERVALUED AT IPO LISTING ____________135

6.1 INTRODUCTION ____________________________________________________135

6.2 THE OVER-VALUATION HYPOTHESIS __________________________________135

6.3 ALTX – STAGGERING FALL ACROSS ALL SECTORS______________________136

6.3.1 Historic Background: Performance Outline _____________________________138

6.4 ALTX IS NOT AN EFFICIENT MARKET __________________________________143

6.5 IPO PRICING_______________________________________________________144

6.6 BIAS IN IPO PRICING ________________________________________________147

6.6.1 Value Drivers____________________________________________________148

6.7 CONCLUSION ______________________________________________________149

CHAPTER 7: CONCLUSIONS AND RECOMMENDATIONS ______________________152

7.1 GENERAL COMMENT _______________________________________________152

7.2 CONCLUSION ______________________________________________________153

7.2.1 AltX IPOs_______________________________________________________156

7.3 RECOMMENDATIONS _______________________________________________156

7.3.1 Need to Improve SA Equity Markets __________________________________156

7.3.2 Need a Set of Guidelines to Eliminate Pricing Discrepancies _______________157

7.3.3 More Variables Need to be Analysed _________________________________159

BIBLIOGRAPHY _________________________________________________________162

APPENDICES ___________________________________________________________184

1: JSE MAIN BOARD and ALTX: DIFFERENCES _____________________________184

2: GLOBAL IPO RESEARCH SUMMARIES __________________________________188

3: THE ALTX SAMPLE DATABASE ________________________________________195

4: ALTX DATABASE INFORMATION _______________________________________197

5: ALTERNATIVE INVESTMENT MARKET DATABASE INFO____________________199

6: TSX VENTURE STOCK EXCHANGE _____________________________________200

7: FOREIGN EXCHANGE RATES__________________________________________201

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8: TIME LINE IN ESTABLISHMENT OF THE JSE AND ALTX ____________________202

9: ALTX P/E RATIOS____________________________________________________204

10: JSE VERSUS ALTX IPOs: 2003 to 2007__________________________________206

A. ALTX LISTING PERFORMANCE _____________________________________206

B. JSE LISTING PERFORMANCE ______________________________________207

11: GLOSSARY ________________________________________________________208

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LIST OF TABLES

TABLE 2.1: GLOBAL IPO METHODOLOGIES __________________________________20

TABLE 4.1: ALTX COMPANIES USED IN THE SAMPLE__________________________59

TABLE 4.2: ALTX COMPANIES: IPO PRICING _________________________________61

TABLE 4.3: USA IPOS _____________________________________________________62

TABLE 4.4: JSE MARKET CAPITALISATION __________________________________66

TABLE 4.5: INDICES PERFORMANCE: YEAR-ON-YEAR ________________________66

TABLE 4.6: ALTX MARKET CAPITALISATION _________________________________69

TABLE 4.7: ALTX HIGH NET WORTH COMPANIES _____________________________71

TABLE 4.8: SECTION 21 OF THE JSE LISTING REQUIREMENTS _________________75

TABLE 4.9: ALTX SCHEDULES 9.3 TO 9.5 ____________________________________81

TABLE 5.1: STATISTICAL MEASURE OF THE AAR ____________________________123

TABLE 5.2: 16-DAY EVENT PERIOD RESULTS AND STATISTICAL ANALYSIS _____123

TABLE 5.3: FIVE DAY EVENT RESULTS AND ANALYSIS _______________________125

TABLE 5.4: ALTX VERSUS TSXV AND AIM___________________________________127

TABLE 5.5: COMPARING INDICES__________________________________________129

TABLE 6.1: ALTX SECTORS_______________________________________________136

LIST OF FIGURES

FIGURE 4.1: AVERAGE FIRST DAY RETURNS: USA IPOS _______________________62

FIGURE 4.2: ALTX INDEX __________________________________________________98

FIGURE 5.1: 16-DAY EVENT PERIOD RESULTS AND STATISTICAL ANALYSIS ____124

FIGURE 5.2: CAAR_______________________________________________________124

FIGURE 5.3: ALTX 15 INDEX_______________________________________________128

FIGURE 5.4: TSXV SECTOR BREAKDOWN __________________________________130

FIGURE 5.5: AIM SECTOR BREAKDOWN ____________________________________131

FIGURE 5.6: ALTX SECTOR BREAKDOWN __________________________________132

FIGURE 5.7: THE MARKET INDICES REBASED TO 100 AT 1 JULY 2008 __________133

FIGURE 6.1: ALTX PRICE GRAPH __________________________________________138

FIGURE 6.2: ALTX INDEX P/E RATIO________________________________________141

FIGURE 6.3: JSE SMALL CAPITALISATION INDEX P/E RATIO___________________141

FIGURE 6.4: THE JSE ALL SHARE P/E RATIO ________________________________142

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DECLARATION

I, Jacques Salvator Richard Magliolo, declare that the research work reported in this

dissertation is my own, except where otherwise indicated, used as a reference and

acknowledged. It is submitted for the Master’s degree of Business and Economic Sciences at

the Nelson Mandela Metropolitan University.

This dissertation has not, either in whole or in part, been submitted for a degree or diploma to

any other universities.

Signature of candidate: ___________________

Date: November 2012

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DEDICATION

I dedicate this work to my wife Susan Magliolo, who supported me during this very difficult

period of research and writing this dissertation, continuously keeping me motivated every

step of the way; especially when I really wanted to stop researching the many variables that

make up IPO pricing decisions.

I also want to thank the Nelson Mandela Metropolitan University Faculty of Business and

Economic Sciences for their commitment to this research and their encouragement to

undertake academia as the next phase of my career.

This dissertation is also dedicated to the memory of my father Giacomino Jacques Magliolo,

who always encouraged me to do my best.

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ACKNOWLEDGEMENTS

The author wishes to express sincere appreciation to Professor Hendrik Lloyd and Dr Neal

Bruton for their assistance and encouragement in undertaking and completing this

dissertation.

In addition, thanks to numerous financial institutions, merchant banks and corporate financial

advisors whose familiarity with the needs and ideas of the topic was extremely helpful during

every phase of this undertaking.

A special thanks to the JSE’s AltX research staff and especially former AltX head Noah

Greenhill, designated advisors and sponsors Michelle Krastanov, Kevin de Villiers, Miller

Moela and Don Truda.

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ABSTRACT

This three year in-depth study was prompted after a decade of working as a corporate

advisor for numerous stockbroking firms’ corporate advisory and listing divisions. An

overwhelming lack of discernible pricing methodology for IPOs on the JSE’s Main Board and

failed Venture Capital and Development Capital Markets was transferred to the new

Alternative Exchange (AltX).

This prompted lengthy discussions with the former head of the JSE’s AltX Noah Greenhill.

Such discussions are set out in this dissertation and relate to pricing methodologies and the

lack of guidance or legislation as set out in the JSE’s Schedule 21 of the Listing

Requirements.

Before analysis of AltX companies’ IPO pricing methodologies could be undertaken, it was

critical to assess foreign bourses and how these countries undertook pricing. This research

and conclusions were derived after the investigation of 44 different countries’ IPO

methodologies as set out in Appendix 2.

Analysis of the 63 currently listed AltX companies and their share price performances was

conducted and used as the sample for this research. Analysis of these companies, which

covers numerous diverse sectors and market size, highlighted a critical and significant lack of

coherent pricing methodology.

The AltX Index’s historic rise and fall between 2008 and 2009 was used to highlight both the

effect of IPO pricing relative to financial performance and AltX performance relative to two

similar global bourses, namely the UK’s Alternative Investment Market (AIM) and the

Toronto-based TSX Venture Capital Market (TSXV).

Findings highlight that AltX-listed companies’ share prices perform poorly.

Launched in October 2003, AltX is an alternative listing platform for smaller companies

compared to the more established JSE Main Board Exchange. This new exchange will

ultimately replace the JSE’s Development Capital Market and the Venture Capital market

(Magliolo, 2004).

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This dissertation establishes that companies listed on AltX are not proving beneficial for

investors.

In 2003, many JSE analysts stated that prospective investors would have to regard the risk-

return profile of the companies listed on this relatively new Exchange to determine how these

profiles would compare to firms listed on the longer established JSE Main Board Exchange.

As such, many institutional analysts were sceptical that the new Exchange would attract a

meaningful amount of new company listings and thus prove successful as an investment

opportunity alternative.

These analysts’ predictions were correct in that 100 companies have been listed on AltX, but

only 63 remain listed. These 63 companies thus form the sample basis for this dissertation.

AltX is also minuscule when compared to AIM, which has 1,293 listed companies and TSXV

with 2,375. These analysts were also correct in that AltX listed companies have not provided

a meaningful platform for investors to see a real return on their investments.

In conducting research on the Exchange since it was launched, this study focuses and sheds

light on the 63 currently listed AltX companies. It looks at their IPO offer price, assesses the

IPO pricing methodologies conducted by Designated Advisors (DA) and how these shares

have performed to date.

It must be noted that this research information is relevant for investment and financing

decision-making today, principally for entrepreneurs wishing to list their businesses and for

investors looking for alternative investment platforms.

The findings of this research appear to be contrary to expectations and to corporate finance

theory. The results indicate that, on average, IPO offerings by AltX companies have not met

institutional expectations on a nominal and risk-adjusted basis since the Exchange was

launched.

In contrast to documented evidence in global economic and financial literature, it was found

that the risk of returns of investing in AltX companies was indeed higher than that of the JSE

Main Board companies. An analysis was conducted on foreign bourses’ indices, using the

same time frame to compare performances.

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As a consequence of the enormous importance of IPOs, understanding how IPOs work is a

fundamental part of understanding financial markets generally.

IPOs play a crucial role in allocating resources in market economies. By accessing external

sources of funds through an IPO, the new firm is able to acquire that capital necessary for

firm growth and product innovation. Equity financing may be particularly attractive for "high

risk" entrepreneurial ventures and such enterprises represent an important motive force of

economic development.

Yet, main research findings on AltX highlighted that, overwhelmingly, entrepreneurs seeking

to raise capital by listing their companies do not benefit:

Only 11% of the AltX companies surveyed make up over 70% of the worth of the

sector.

The average share price of these companies is today 47.5% lower than when they

listed.

10 companies had share prices unchanged during the sample period.

19 companies had negative growth.

It is established that the JSE Listing Requirements do not prescribe how Designated Advisors

calculate a pre-IPO share price prior to listing. This issue formed part of the lengthy

discussions held with Noah Greenhill, who pointed out that JSE documentation scrutinised

does suggest a number of methods to determine share price prior to listing. These have also

been assessed and set out in this dissertation.

The focus of this dissertation is thus centred on whether the current adopted methodologies

to establish a fair and reasonable pre-IPO share price is effective. To achieve this, global

pricing methodologies were assessed within the framework of various valuation techniques

used by South African Designated Advisors.

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CHAPTER 1: INTRODUCTION – THE IPO SCENE

1.1 INTRODUCTION

One of the investment opportunities that is always guaranteed to get pulses racing among

both retail and institutional investors is the chance to invest in an Initial Public Offering (IPO)

(JSE Newsletter, The JSE Alternative: 19 July 2012).

An IPO is the first sale of shares by a private company to the public. IPOs are often issued by

smaller, younger companies seeking the capital to expand, but can also be done by large

privately owned companies looking to become publicly traded.

Wilhelm Hertzog, portfolio manager at investment house RE:CM (AltX Showcase

presentation; JSE Auditorium, 2012), states that “while the chance to get in at the ground

floor of a new AltX company may be an extremely enticing prospect for many investors, there

is ample evidence, both globally and in South Africa, that shares bought in an IPO

underperform the market substantially over long time periods.”

Research by Govindasamy (2010: 53-55) to determine the long run (two years) performance

of IPOs listed on the Johannesburg Stock Exchange (JSE) in South Africa between 1995 and

2006, found that IPOs underperformed the JSE by 50% and 47% on an Abnormal Return

(AR) and Cumulative Abnormal Return (CAR) basis respectively. Both are explained in

Appendix 11.

“In an IPO, one typically has a situation where informed insiders are selling to the less

informed public,” says Hertzog. “The incentive is for the sellers to maximize the proceeds

from the sale of the shares, which means that the IPO price is unlikely to represent attractive

long- term value for a buyer of those shares. The investment odds are stacked heavily

against the buyer.”

As such, investors should be wary of participating in IPOs in sectors where a large number of

IPOs are taking place. Arcay Moela stockbrokers director Kevin de Villiers (2011) says: “AltX

IPOs tend to happen in sectors where stock prices are above intrinsic value due to short-term

optimism towards the sector. An example of that was the local construction sector around

2006/7.”

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De Villiers said in 2006 and 2007 that the listed property sector in South Africa attracted a

large number of IPOs, which should have been a warning signal. With the global reach for

yield that is currently happening, the local listed property sector’s share prices have been

driven up to generally unattractive levels.

It can thus be argued that investors should be cautious when considering an investment in

the sector and even more so for a new listing in the sector.

According to Ernst & Young 2012 research globally, there has been a preponderance of IPOs

in emerging markets, with Hong Kong being the leading market for new listings in 2011. This

dissertation steers well clear of those markets in general and new listings in those markets in

particular.

According to Wilhelm Hertzog, portfolio manager at RE:CM (2012) deciding whether an IPO

offers value involves the same process of valuing a business as one should engage in prior

to deciding whether the shares of any other business offers value. What complicates matters

is that typically there is a limited amount of financial history available for a company coming

to the market in an IPO, which can make it more difficult to establish long-term economics of

the business at hand. This makes it more difficult to estimate intrinsic value with any degree

of accuracy.

The Ernst & Young (Pinelli, 2012: 18-19) research highlights that there are numerous

examples of IPOs that did not benefit investors, with a number of examples from the

construction sector listings boom in 2006/7.

An example that attracted media attention in 2012 was the liquidation of AltX-listed company

Sanyati (Sapa, 2012).

However, this dissertation’s research highlights that there are exceptions for AltX listed

companies. Some IPOs stand out as exceptions to the rule, where IPO businesses have has

delivered financial results that have met and exceeded the high expectations reflected in the

share price at the time of its IPO.

Locally, exceptions include Eland Platinum, which listed early in 2006 and was bought out by

mining giant Xstrata for almost five times the IPO price less than two years later (JSE

website, Google finance website, Xstrata SENS, 2006).

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Michelle Krastanov, director at stockbrokers Arcay Moela said, at the listing of AltX company

RGT Smart in 2010: “The reason why investors invest in AltX IPOs is to experience growth of

smaller SME companies. Stockbrokers have a contract with these companies and the JSE to

help them achieve long-term success.”

Unfortunately, too many AltX companies have failed, as highlighted in this research.

1.2 PREFACE TO RESEARCH

In-depth primary research conducted during the past five years on a considerable body of

literature globally on IPOs will be used throughout this dissertation to substantiate that

practically no attention has been given by major stock exchanges to establishing a realistic

pre-listing share price.

From these conclusions, a hypothesis will be drafted and tested on a range of AltX

companies.

Miller Moela – partner at South African JSE Sponsors and Designated Advisors Arcay Moela

– said in 2010, at the RGT Smart Limited listing discussion, with directors of RGT:

“It is extremely important that a strong analytical method is used to determine your (RGT

Smart’s) share price that is fair and realistic before the listing”.

A number of stockbroking conferences and discussion groups will be highlighted throughout

this dissertation to substantiate the importance of establishing a methodology to pinpointing a

realistic pre-IPO share price. Despite the large literature on IPOs and primary analysis of

markets and new listing since 1996 (as director and head of research of South African

Stockbrokers Global Securities), it has been difficult to get a satisfactory answer from the JSE

or stockbrokers as to why there does not exist a set of guidelines as proposed in this

dissertation. This dissertation seeks to shed light on this issue. In fact, South African

stockbrokers and Designated Advisors Arcay Moela are vociferous in stating that AltX is in

danger of seeing many delistings. There could be more than 50% of listed AltX companies as

entrepreneurs flee to the safety of the unlisted market (De Villiers, 2011).

The problem lies in AltX companies’ shares falling radically since listing; by an average 50%

in the 63 AltX companies analysed in this dissertation (JSE Share Database, 2012). The

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analysis is conducted between the listing dates of these companies and the mid-November

2012. In addition to the 63 AltX companies, 13 companies were analysed but excluded from

the analysis, as these companies were either suspended or were transferred from other

sectors, i.e. these were not newly listed AltX companies.

De Villiers (2011) states that, following the Stock Market crash in September 2008, AltX has

seen a significant increase in investors seeking larger companies which are well-established

and listed by the JSE on their main board. This has resulted in smaller companies which are

newer to the bourse and have a shorter history, experiencing a lull in investor appetite for

small cap stocks over the past two years. During the same period in which AltX companies’

shares were assessed, the JSE All Share Index has climbed by 114.7% and the JSE Small

Cap Index by 107.6% (JSE website, 2012).

In the 2011 JSE Newsletter article, De Villiers (2011) explained that many investors fear there

will be a financial collapse which will depress the prices of smaller companies. This is likely

to result in many investors maintaining significant reserves in both cash and stocks of larger

companies.

Part of the dissertation is thus an analysis of factors that lead to many companies’ owners

believing that their pre-IPO share prices must be higher than intrinsic fair value. This value is

described as the company’s net asset value per share, which is calculated by dividing

Ordinary Shareholder’s Interest by ordinary shares in issue and expressed as a percentage.

This must then be aligned to a comparison between the companies’ demand for capital and

the level of investor sentiment that will follow the listing. This is a crucial part of the analysis

to be carried out in this dissertation.

At its height, in November 2007 and early 2008, the AltX index stood at a record 5,041 points

and during that year 37 companies listed on it. It now stands at 1,069 points. This dissertation

will highlight reasons for the poor performance of AltX companies. AltX has, since October

2003, seen 80 companies list, three move to the JSE Main Board and a possible 50% delist

over the next three years (De Villiers, 2011). In comparison, the UK’s version of AltX, called

The Alternative Investment Market (AIM) has - since its launch in 1995 – listed over 2,900

companies.

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The JSE Alternative: Page 5 March 2011, states:

Delisting was carried out for several reasons or a combination of them:

Due to the lack of liquidity in the share and price implications.

The on-going costs of remaining listed.

The onerous burden of compliance.

Opportunity costs of executive time being tied up in compliance.

Compromised by too much disclosure of proprietary information.

Lack of institutional investors.

A private offer was better than remaining listed.

The more direct comparison to AltX is AIM, which has higher annual growth in listings than

AltX, but also very few delist as a consequence of share prices; rather, AIM companies tend

to delist after mergers and acquisitions have taken place (Gregoriou, 2006).

To highlight the problem of the current pre-IPO pricing system in South Africa, African mining

houses have opted to list on AIM rather than AltX since the launch of AltX in 2003. For

instance, AltX listed Kibo Mining is also listed on AIM.

This issue will form part of this dissertation’s investigation. Furthermore, initial investigation

into the US small capitalisation market showed that listings increased by 23,000 in 2007/8.

On average, shares initially rose by 25%, only to fall by the Dow Jones Industrial Index

average of 47% by 2009. Adverse share price selection methods are also statistically

significant in economic terms (Gregoriou, 2006).

In fact, Lowry (2003, 36) asserts that variation in investors’ uncertainty regarding the true

intrinsic value of a firm’s pre-IPO share price can cause demand irregularities for the IPO,

causing the shares to fluctuate. This dissertation examined investor sentiment as a possible

determinant of IPO pricing. In addition to increasing understanding of why firms go public with

certain price levels, this dissertation also contributes to the broader literature on the listings

methods used internationally and their efficacy.

For instance, the French have an auction system for pre-IPO share prices (Appendix 2).

Under such a system of determining a pre-IPO share price, a prospectus is drafted and then

sent to investors, who conduct their own research on the proposed listing and then make an

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offer. The highest bidders get the shares and this determines the average price at listing.

Such a system is assessed as part of this dissertation.

During the past decade, both developing country and world markets have demonstrated that

the valuation methodology for IPOs is strongly influenced by the current economic conditions

(Espinasse, 2011).

A thorough evaluation system to determine a share price must include socio-political,

business, economic and technological trends (Magliolo, 2003: 32-98). It was such analysis

during the 1997 emerging market crash, which led to extensive primary analysis of merging

markets and related listed companies performance and, ultimately, investor share

acquisitions and performance (Draho, 2004).

From a market perception point of view, this study attempts to discern whether high-volume

periods (strong bull markets) represent times when investors are prepared to to a premium

for IPO shares and a study must be conducted on developing/emerging markets to determine

whether there is evidence of higher temporary valuations on pre-IPO share prices.

However, a significant body of academic literature has identified several unique empirical

patterns (Kleeburg, 2005) where high inflows of IPOs have been associated with temporary

increases in the valuation of such shares. This means investors will overpay for the securities

when there is a listing boom. Ritter and Welch (2002) found an average first-day return of

18.8% of 6,240 US IPOs between 1980 and 2001. Latest statistics is outlined in the later part

of this research. These findings indicate that temporary overvaluations also contribute to the

periods of high IPO volume.

Through its various functions, including underwriting, corporate advisory and retailing —

underwriters play a crucial role in the on-going public process. If they are confronted with too

many opinions on share price differentials, these underwriters may have to assess the

difference between the costs and benefits.

Underwriters argue that under-pricing an IPO does lower risk of the share falling after listing,

in practice, however, these underwriters receive a fee that is proportional to gross floatation

income. This contradiction means that under-pricing is rare and the value of the firm on the

first day of trading tends to be over-price.

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Such methods can (and does) influence IPO initial returns and the dynamics of aftermarket

trading. It is therefore believed that current IPO pricing methods will usually be to the

advantage of the larger institutions and owners of the company (Draho, 2004).

Decades ago buyers and sellers around the world were mostly individual investors, but

markets have become more "institutionalized" (mbendi.com). Today, buyers and sellers are

largely institutions (e.g., pension funds, insurance companies and mutual funds)). The rise of

the institutional investor has brought with it some improvements in market operations (JSE

website).

The JSE is currently the only Exchange in South Africa licensed by the Financial Services

Board (FSB) in terms of the Securities Services Act 36 of 2004 and provides the platform

(Trading Venue) for the public sale of shares to investors and also caters for the subsequent

trading thereof (JSE Website).

The JSE provides financial data on shares trading which is utilized in making decisions on

investments. The JSE has operated as a market place for the trading of financial products for

nearly 120 years (Appendix 8). In this time, the JSE has evolved from a traditional floor based

equities trading market to a modern securities Exchange providing fully electronic trading,

clearing and settlement in equities, financial and agricultural derivatives and other associated

instruments and has extensive surveillance capabilities.

The JSE is also a major provider of financial information, securities, surveillance and risk

management (JSE and AltX websites).

In terms of JSE ownership, foreign ownership should be balanced against foreign assets,

while corporate cross-holdings and free float impairments should be excluded to avoid double

counting. Consequently, the remainder of the JSE is dominated by local institutions which

control about 70% of the JSE’s remaining assets (JSE website).

1.3 THE IPO PROCESS: IMPORTANCE WITHIN ECONOMICS

Several theories have been put forth regarding IPO under-pricing (Karlis, 2000). One of

these economic theories is the Adverse Selection Theory, which states that investors are

typically divided into groups of the uninformed and informed.

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Informed investors are aware of the true market value of the company's stocks.

Uninformed investors follow market and media advice to place money into stocks with

scant knowledge of the company.

The theory also assumes that the investment bank involved will have nearly perfect

knowledge of the real value of the firm (Karlis, 2000). The supply of common stock for a

company is held constant (Karlis, 2000). This results in price fluctuations according to the

demand in the marketplace for the stock. This demand also falls into two categories of the

informed versus uninformed investor demand.

If the IPO price was accurate, the uninformed investors would lose money or breakeven as

the informed investors would only be investing in valuable IPOs. Therefore, the informed

investors would be the only ones making profit (Karlis, 2000). This means that the uninformed

investors would not participate in IPO markets.

This would result in a reduced demand for IPOs. In order to compensate for the difference

between the informed and uninformed investors, companies under-price IPOs as a way of

encouraging uninformed investors to be more willing to put money into IPOs. This results in

higher demand for later issues of stock (Karlis, 2000).

Another theory regarding the under-pricing of IPOs involves the Principle-Agent Theory

(Karlis, 2000). This model assumes that the firm issuing the IPO does not know the true

value of the company and relies on auditing and an investment bank for accurate information.

The investment bank and the issuing firm agree on the IPO contract. The contract is written

based on a report prepared by the investment bank for the issuing firm (Karlis, 2000).

The contract price must involve a minimal level of expected returns for the investment bank.

It must also ensure that the IPO price is sufficiently low for the investment bank to profit. In

this case, the investment bank would be the agent. The issuing firm is under-pricing the IPO

in order to leave money for the investment bank (agent) and encourage full disclosure.

Under-pricing serves as a method of reducing the bank’s price of accurate information (Karlis,

2000).

This theory is assessed later in this research.

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1.3.1 Overview of Global Pricing Methods

Pricing methods for IPO offerings vary considerably and are significantly contested in global,

investor discourse. IPOs are atypical stocks issued by either young companies or those that

are moving from a privately owned to publicly traded status; in both instances, the companies

issuing the IPOs have not yet been traded on a Stock Exchange and, consequently, are less

thoroughly evaluated than long-standing, publicly traded companies (Daily, Certo, Dalton and

Roengpitya, 2003).

The crux of the challenge in IPO pricing stems from a lack of past performances on the

exchange, as conventional pricing methods are inapplicable when a stock has no

performance record (Prasad, Vozikis and Ariff, 2006).

The norm is for the issuer of traditional IPO to seek out the assistance of an underwriting firm

that will aid the company in pricing the IPO and introducing it effectively to the market.

Alternative methods such as auction-style, book-building and price-to-earnings ratio

techniques may relinquish the role of the underwriter altogether (Anand, 2006).

Issuers attempt to maximize the proceeds from their initial offer, often resulting in under-

pricing of IPOs. Reasons for under-pricing of IPOs increasing proceeds for the issuer were

covered in the previous section on Adverse Selection Theory and Principle-Agent Theory

(Karlis, 2000).

Because under-pricing holds a myriad of consequences for issuers, buyers and the global

market as a whole, the link between under-pricing and valuation techniques is a critical one.

This review of literature explores common pricing techniques for IPOs, affording particular

attention to IPO pricing trends in national and global markets. Excluded from the review is

any theoretical or empirical study predating the year 2000. This will provide approximately 11

years of information, which is judged to be sufficient as at least one full investment cycle will

be represented. Additionally, only scholarly, peer-reviewed literature is employed. The review

aims to answer the following, salient questions:

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• How do the IPO pricing techniques of fixed-price, auction, book-building and price-to-

earning (P/E) ratio compare to one another?

• What relationship, if any, exists between the aforementioned pricing techniques and

under-pricing?

• What IPO pricing trends exist in the 21st century marketplace?

• What forces inform the pricing technique that will be utilised by the issuer?

• What evidence, if any, exists to support a universal IPO pricing method?

1.3.2 The South African Industry

Valuation of IPOs occupies an extremely important place in both South African macro- and

micro-economics and in financial markets, as it provides public capital market participants

their first opportunity to value a set of corporate assets and, consequently, one of the few

methods available for the public to participate in the growth of public companies (Gregoriou,

2006). Valuation of IPOs is also quite relevant from an economic efficiency perspective: this

is the first opportunity that managers of such companies get to observe the price signals from

the public capital markets (Draho, 2004).

As such, any increases of share price prior to listing, via valuation methodologies, could have

long-term implications for the company and shareholders alike. These increases often start

even before the company is listed. The norm, in many countries including South Africa, is to

sell shares at a discount (under-priced) to true value prior to listing, so the share can jump on

the first day of listing (Espinasse, 2011).

The JSE’s former head of corporate finance Noah Greenhill (head of AltX, 2011) has argued

that this under-pricing of a share price results in many companies having price-to-earnings

ratios which are inflated, which is confirmed by Kleeburg (2005), who says that entrepreneurs

get the credit for this profitability.

This effectively means that the quoted fair value of a firm is thus significantly higher than the

quoted pre-IPO price. This results in many instances of directors offloading shares after

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listing. They can then take advantage of the significant share price jump on the first day

(Draho, 2004).

Fortunately, the ability to do this is limited on AltX with 50% of shares in lockup after listing,

closed periods and the impact on the share price of directors selling heavily. It is well known

that IPOs are under-priced in virtually all countries. In fact, this practice is getting worse

(Gregoriou, 2006).

Average first-day US IPO returns increased from 7.4% in the 1980s, to 11.2% in the early

1990s, to 18.1% in the mid-1990s and to 65% in the early to mid-2000s (Ritter and Welch,

2002). Latest data from the SEC is set out in this dissertation.

Therefore, this dissertation focuses on establishing that AltX pricing methodologies are not

efficient and that a pre-IPO share price valuation methodology needs to be established for

the South African stock market. It is argued that it is becoming increasingly important to

create a set of guidelines to determine a fair and reasonable share price prior to listing on an

exchange. The specific focus is on the JSE Ltd.’s AltX-listed companies.

1.4 PROBLEM STATEMENT AND OBJECTIVES OF THE STUDY

1.4.1 Problem Statement

This study is an empirical analysis of the short and long-term share performances of JSE’s

AltX IPOs. It aims to shed light on the price determinants of IPO’s in the context of South

Africa. This country was chosen as it is a leading emerging market characterised by high

information asymmetry, low efficiency, thin trading and the presence of market manipulations

(Espinasse, 2011).

While an over-pricing system may not be a significant problem during strong bull runs, as the

share price ultimately do rise above the initial share price and inherent value. It is the

suspected level of over-pricing at the IPO stage that leads to a potential problem of falling

prices in South Africa. This dissertation will set out the current system and suggest variables

that should be used to establish a more equitable method of determining a share price prior

to listing.

Using a sample of AltX IPO’s from the date of the Exchange being formed in October 2003 to

November 2012, it was found that the average cash flow generated by these companies

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stands at a discount of 93% to share price. In essence, share prices were inflated exorbitantly

and to the detriment of shareholders.

The level of pricing should be related to age of the firm, its size, profitability, cyclical nature,

comparative peers, global and regional market conditions and the size of the offer. It appears

also that under-pricing is driven by irrational logic by those seeking for short run capital gains

(Gregoriou, 2006). These results remain unchanged after controlling for the presence of

institutional investors and the existence of liquidity contract.

IPOs offer a company liquidity and easy access to capital, but also bring risks of share price

volatility and decline in share value. Predicting the performance of IPOs is important for both

investors and companies to be listed. The search for a reliable way to establish a fair and

reasonable stock price should reduce speculative elements from IPOs and bring investors

with long-term visions to the fore.

1.4.2 Research Objectives

The following were main and critical objectives:

• Completing in-depth research and analysis of the major global bourses in relation to

IPO pricing to establish a foundation for the AltX analysis.

• To establish that AltX‘s pricing methodologies are inefficient.

• To establish that current analytical methods of price determinants are not adequate to

establish a pre-IPO share price that is fair and reasonable to shareholders.

• To establish whether a new set of guidelines should be formulated to determine a fair

and reasonable pre-IPO share price.

This study introduces the use of a sequence of criteria (based on a variety of determinants) to

assess and determine the value of an IPO’s share price prior to listing on a stock exchange.

Finding factors that will contribute to the value of IPOs prior to listing on a Stock Market is

largely an unexplored field.

This study will also investigate the use of economic indices and specific Stock Market factors

and peer analysis variables as inputs to the IPO valuation model. The growth of small cap

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companies around the world has aroused interests in systems to predict Stock Market share

performance.

1.4.3 Main Problems

Specifically, the following issues will also be examined:

• IPO under/over pricing

• IPO process issues

Historically, empirical studies have had difficulty in determining why firms go public due to

data constraints. This researcher’s relationship with the JSE’s AltX’s Noah Greenhill (former

head of AltX) allows him to overcome this constraint and directly ask the listings department

of the JSE why (and how) they conduct an IPO. Traditional textbook explanations such as

lowering the cost of capital and the pecking order of financing are not among the most

important reasons for conducting an IPO and thus the determination of a share price.

1.4.4 Sub-problems

This study is the start of an important development in the field of share price determination at

the pre-IPO level. After a thorough assessment of the JSE’s Schedule 1 to 21 (to include

AltX), the problem statement can be set out as follows:

• There are no rules in South Africa (from the Companies Act to JSE listing

regulations/schedules) to determine an accurate share price for a company before it

lists on the JSE or on AltX.

• Pre-IPO share prices in South Africa are currently determined using a variety of

methods, from DCF to Net Sales or Asset values. Companies that are in similar

industries can thus be valued using different methods and, consequently, different

values can be obtained for similar companies.

• The valuation method and thus determination of ultimate share value is completely left

up to the stockbroker and entrepreneur involved in the listing process. This occurs

frequently with the valuation benefiting the owners instead of the long-term investors.

• This dissertation will investigate how the US, Europe and Far Eastern countries

determine a pre-IPO share price. This researcher’s experience in stockbroking

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suggests that these countries also do not have an enforced methodology to establish

a fair price.

• This dissertation aims to highlight that the AltX’s pricing methodologies for pre-IPOs

are inefficient.

1.4.5 Methodology Displayed

This study will be split into historic and current trends and practices relating to pre-IPO share

prices, both from a local and foreign markets’ perspective. The ultimate conclusions to this

dissertation will be to establish that a set of guidelines to achieve a fair and realistic share

price before a company lists on an Exchange is essential. The specific focus is the listing of

companies on the AltX.

Historic research conducted during the past decade has thus avoided (omitted) analysis on

whether share prices are related to the company’s true value at the listing date. This

dissertation aims to address and provide additional understanding of IPOs, share prices and

values under listing conditions.

In general, this dissertation uses both publically available documents (obtained from offer

circulars, prospectuses, business plans and company announcements to the market) and

discussions (primary research) with the JSE Listings Department and sponsors/designated

advisors to explain the pre-IPO share prices in South Africa. Consequently, this dissertation

seeks to examine the ability of public information to explain:

Listing day and short/long-term returns once the IPO has listed.

The relationships between the pre-IPO offer price and the short-term share

movement.

This dissertation must look at available information and assess how public information

is used by investors to value new stocks before and after listing day and in the short

to medium term. The negative effect of “manipulation” or – stated differently using

beneficial methods of valuation (such as a DCF) – must be confirmed in this

dissertation. This is crucial as the share price process in IPOs could have negative

consequences for investors in South Africa.

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The South African market must also be assessed relative to foreign markets. It is also

important to set out historic profiles and trends of the JSE and AltX as a precursor to

the proposed set of guidelines.

This study must also investigate the common methods used by stockbrokers to

determine stock prices of IPOs. What are the positives and how can these be used in

a fair set of guidelines?

Primary research must then be applied to the above to resolve the best manner to

identify a system that will result in a fair and easy to understand methodology to justify

an IPO share price.

Two sample sets were used in this dissertation, as follows:

a. The first sample relates to the overall performance of AltX and companies

listed on this exchange. Of the 100 companies listed on the Exchange since

AltX was launched in 2003, 63 currently remain in operation. These cover all

market segments and it was concluded that it was important to use all the

companies as sample to obtain a complete and more realistic analysis to

determine the strength of their listing. The timeframe is therefore October 2003

to November 15, 2012, when this dissertation was completed.

b. The sample second relates to the financial and earnings strength of AltX

companies listed between 2008 and the end of 2009. This timeframe was

chosen as AltX achieved its highest growth and decline since its launch.

1.4.6 Scope of the Study

This study will focus on the equities listed on the AltX Stock Exchange, a division of the JSE

Ltd. It is important to note that, while this study focuses on AltX, there are sections that

require comparisons between AltX and similar exchanges from other parts of the world.

Data for companies from the earlier Venture Capital Market and Development Capital Market

might be used in this study if AltX listed company data is too limited. The study will not be

limited to any specific sector on the exchanges as the small amount of companies listed for a

significant period already makes analysis difficult.

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1.4.7 Limitations of the Study

Due to the nature of the AltX Exchange there are several limitations to this study:

• Lack of information. The AltX Exchange was only created in 2003 (The JSE Alternative,

2010) and therefore at this time only a maximum of 5 years of data is available. The

problem is that most companies have not been listed for this period and the study will

have to be done with less data points for many of the companies.

• Thin trading. Low volumes and infrequent trading has been shown to bias risk return

predictors (Dercksen, 2008: 5). The AltX listed companies are much more thinly traded

than main board listed companies and this will make the evaluation of the different asset

pricing models problematic.

Chapter 2 reviews previous literature on IPOs and sets out the phenomenon of over- and

under-pricing in view of research conducted on 44 countries IPO pricing methodologies

(Table 2.1 and Appendix 2).

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CHAPTER 2: LITERATURE REVIEW

2.1 INTRODUCTION

This chapter consists of five general sections, which are more thoroughly outlined in the main

body of this dissertation. The first section discusses the overall issue of over- and under-

pricing of IPOs. The next section covers what happens to the IPO’s share price after listing.

There is then a discussion of the existing IPO research, which is followed by a discussion of

global IPO pricing methodologies. The discussion of IPO pricing methodology has a number

of sub-sections.

2.2 THE ISSUE OF UNDER-PRICING

IPOs represent the first time a firm will sell stock to the public and this places a considerable

amount of pressure on managers and executives to price the stock correctly (Andrews and

Welbourne, 2000). Aside from affording the organisation some often substantial funds, IPOs

provide the added benefit of bringing public attention to a new or previously privately owned

firm, with investors and analysts engaging in unprecedented discourse regarding the firm’s

performance and future possibilities.

The IPO, in short, has a weighted impact on the firm, representing a major event in the

organisation’s life cycle and often increasing the vulnerability of the firm (Andrews and

Welbourne, 2000; Daily et al: 2003). According to Andrews and Welbourne (2000), the

precarious time period of IPO issuing is made fragile by several forces, all of which are

closely akin to those faced by start-up businesses.

Even a firm with a certain amount of longevity as a privately owned company enters into

unexplored, volatile territory when pricing IPOs. Management is unable to dedicate their

focus entirely to enhancing firm productivity and directors are generally unprepared for the

lengthy amount of time during which their attention is focused on the IPO (Andrews and

Welbourne, 2000: 95; Nikbakht, Shahrokhi and Martin; 2007: 311; Sun, Lee, Li and Jin,

2010).

At a time when the firm must effectively prove to prospective investors that it is worthy of

funding, lowered productivity can be particularly detrimental. Internal stakeholders such as

Chief Executive Officers (CEOs) are charged with creating demand for the firm’s stock, often

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campaigning nationally or globally in order to generate enthusiasm and sensitise the

landscape for the IPO (Anand, 2006; Andrews and Welbourne 2000, Daily et al 2003;

Nikbakht, Shahrokhi and Martin, 2007).

In order to garner the highest price for the initial offering of stock, internal stakeholders must

effectively manage investor and underwriter perceptions. This means conforming to market

expectations regarding how the organisation will make decisions, structure itself and

maximize its potential earnings (Andrews and Welbourne, 2000). This may result in insecurity

within the organisation and lower earnings which jeopardize the price of the IPO.

Particularly when previously privately owned firms are going public, the investment

community scrutinises the organisation intensely and systematically, often affording attention

to unpredictable factors such as underwriter reputation and stock prices are uniquely

positioned within a complex landscape of other financial traits (Andrews and Welbourne,

2000; Sun et al., 2010; Varshney and Robinson, 2004).

Precisely what catalyses often gross under-pricing of IPOs is a heatedly contested subject

within investment literature (Daily et al., 2003; Maynard, 2002; Prasad, Vozikis and Ariff,

2006; Sun et al., 2010). However, the fragile, internal state of the firm, possible distraction of

management and consequently lowered productivity at the time just prior to IPO introduction

undoubtedly plays a role in the under-pricing of stocks at a time when the goal is to maximize

the IPO.

IPO under-pricing represents an anomaly in the investment world, with scholars indicating

that initial under-pricing may be used to generate interest and others denouncing such tactics

as counterproductive; in the former perspective, under-pricing can result in substantial,

investment gains for stockholders allocated shared at the introductory price.

In the latter perspective, under-pricing represents lost capital for the firm. Alternatively, under-

pricing may result from firms, or more specifically their underwriters, protecting against the

potentially destructive force of over-pricing the IPO, after which time the stock may

immediately fall in value and thereby lose all marketability (Prasad, Vozikis and Ariff 2006;

Varshney and Robinson, 2004).

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2.3 POST-IPO PRICING

IPOs and related pricing methods have always attracted media attention prior to a listing. Yet,

the focus has usually been on under-pricing, liquidity issues and the normal positive gain of a

new issue immediately after flotation. Research to pricing the IPO prior to listing is mainly an

unexplored field. This conclusion was derived after investigation of 44 different countries’ IPO

methodologies as set out in Appendix 2. This dissertation draws information from this

research, which has been compiled over a three year period, but is derived from research

undertaken over the past five years.

These are recurring phenomenon in many markets. The following references first

documented a systematic increase from the offer price to the first day closing price. There is

ample research to substantiate that the IPO has not been correctly priced prior to listing

(Draho, 2004; Espinasse, 2011; Kleeburg, 2005; Barber and Lyon, 1997; Brav, Geczy and

Gompers, 2000; Ibbotson and Jaffe, 1975). On the other hand, no research could be found

establishing that fair value before a listing takes place.

The profit made when an IPO is incorrectly priced prior to listing is sometimes called

abnormal initial return (AIR) (Gregoriou, 2006). A number of theories of IPO under-pricing

have been put forward and tested against the data of various stock markets. Research

suggests that there is an abnormal return and, in fact, it has been found that this

phenomenon exists to a much higher degree in emerging markets such as South Africa

(Kleeburg, 2005).

As an emerging stock market, the AltX Stock Market has a unique environment which is

strongly controlled by institutions (+75%). Therefore, the lack of a set of guidelines usually

means that few organisations benefit from IPOs, which is contradictory to the aim of the

public benefiting from participating in a company’s future growth (Espinasse, 2011).

Hence, explanations for incorrect pricing in South Africa’s IPOs appear more complex than

those found in first world countries (Draho, 2004). Initial findings from studies in other

countries cannot thus be automatically extrapolated to South Africa (Gregoriou, 2006).

This is the reason this study is an empirical analysis of the short and long-term share

performances of JSE’s AltX IPOs. It aims to shed light on the price determinants of IPOs in

the context of South Africa.

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2.4 OVERVIEW OF EXISTING IPO PRICING

This section includes the fixed pricing of IPOs and book-building. This is followed by a

discussion of auction-style IPO pricing and pricing methodology. A comprehensive database

of countries IPO pricing methods is set out in Appendix 2.

2.4.1 Global Marketplace IPO Pricing Methodologies

The critical nature of pricing the IPO effectively, garnering the stock the maximum price

without over-pricing or under-pricing the IPO and jeopardising the marketability of the IPO,

has resulted substantial discourse on the effect of pricing methods on the IPO’s success (Sun

et al., 2010).

Table 2.1 highlights methods used by the 44 countries analysed as set out in Appendix 2.

The analysis identified that 32 countries used fixed-price methodologies, 31 used the book-

building method and nine countries used the auction system of determining an IPO price. It is

also noted that 17 countries used two methods and five countries used all three methods to

determine a share price prior to listing a company.

TABLE 2.1: GLOBAL IPO METHODOLOGIES

Countries IPO Pricing Methodologies

Fixed-Price Book-building Auction

Argentina X

Australia X X

Austria X

Bangladesh X

Barbados X

Brazil X X

Canada X

Chile X X X

China X X X

Czech Republic X

Finland X

France X X

Germany X

Hong Kong X X X

Hungary X X

India X X

Indonesia X

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Countries IPO Pricing Methodologies

Fixed-Price Book-building Auction

Ireland X X

Israel X X

Italy X X

Japan X X X

Jordan X

Kenya X

Korea X X

Malaysia X

Mexico X

Netherlands X X

New Zealand X X

Norway X

Pakistan X

Paraguay X

Peru X X

Portugal X

Singapore X X

South Africa X X

Spain X

Sri Lanka X

Sweden X X

Switzerland X X

Taiwan X X X

Thailand X

Turkey X

United Kingdom X X

United States X X

Sources: Business Consultants International database, 2012, Global Exchange Websites and World Federation of

Exchanges

2.4.1.1 Fixed Pricing IPO Methods

Fixed-price IPOs represent the most traditional method of pricing through which the issuer, or

more specifically the issuer’s underwriter, sets a price that is relatively immutable (Maynard;

2002; Prasad, Vozikis and Ariff, 2006). Investors can then subscribe to the IPO at the fixed-

price or pass on the opportunity.

Substantial evidence suggests that while fixed-price IPOs rarely result in over-pricing and the

consequent loss of marketability of the stock, they are frequently, in fact, still under-priced. In

developing nations such as India and Malaysia, the potential for fixed-price IPOs to be

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undervalued by as much as 50% is very real and firms may lose valuable capital at their

inception (Bell, Moore and Al- Shammari, 2008; Prasad, Vozikis and Ariff, 2006).

In American and European markets, fixed-price IPOs are under-priced on a lesser average of

10%, with under-pricing being just as frequent in these markets but not as extensive as it is in

the developing world (Prasad, Vozikis and Ariff, 2006).

Moreover, emerging markets that under-price their IPOs using a fixed-price method, is short-

run as investors immediately buy stock at the low, introductory price and catalysing a rise in

prices very early in the IPO’s life cycle. Prasad, Vozikis and Ariff (2006) note, however, that

under-pricing in developing nations can extend far longer into the IPO’s duration, thereby

losing the company significant funds as a result of the under-priced stock.

In short, less developed markets are predisposed to long-term under-pricing when IPO

pricing is fixed, but markets in all nations are more greatly predisposed to under-pricing in the

context of fixed-price IPOs (Bell, Moore and Al-Shammari, 2008; Prasad, Vozikis and Ariff,

2006). Common themes in fixed-price IPO offerings are strategic under-pricing of IPOs in the

developed world in order to garner investor interest and comparatively inadvertent under-

pricing in developing nations.

Andrews and Welbourne (2000) highlight that the 10% under-pricing rate in American and

European markets may be altogether false, merely a result of investor enthusiasm when a

new stock is introduced rather than an outcome of actual IPO under-pricing.

In developing nations and Asian markets in particular, fixed prices emerges as a substantial

problem in the literature, linked to greater perceived risk of the IPO by investors, a reward of

sorts for those who invest in a risky IPO and a potential result of underwriter incentives

(Prasad, Vozikis and Ariff, 2006).

A higher degree of information asymmetry may exist in developing nations than in developed

nations, however, that can skew the data on under-pricing of fixed-price IPOs (Sun et al.,

2010). Prasad, Vozikis and Ariff (2006) suggest that fixed-price IPO under-pricing and the

level of uncertainty about stock value on the part of the investors are inextricably bound to

one another, with greater uncertainty fostering greater under-pricing.

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By extension, fixed-price IPOs present a particular challenge in developed nations where the

perceived risk may well be greater than the actual risk, thereby devaluing the price of the

IPO. Malaysian firms, for example, are required by law to set a fixed-price at the time of

application to the Securities Commission, but the extreme volatility of the Malaysian market

fosters significant risk of price-change on the short-term (Prasad, Vozikis and Ariff, 2006).

Specifically, the Malaysian market has nearly 32% standard deviation in both directions, while

the New York Stock Exchange only has 13% standard deviation. Under-pricing in Malaysian

markets then emerges from forced fixed-pricing and purposefully low prices aimed at

offsetting possible negative changes in market conditions (Prasad, Vozikis and Ariff, 2006).

IPO legitimacy is a salient issue that disproportionately affects emerging economies (Bell,

Moore and Al-Shammari, 2008). IPOs in developing nations need to enhance perceived

legitimacy in order to garner investment by stakeholders in developed nations. Bell, Moore

and Al-Shammari (2008) conclude that a strong, empirical link exists between the country of

origin’s values in the developing world and investors’ perceived legitimacy of IPOs.

For example, an American or European investor would be more likely to perceive the fixed-

price of an IPO within a nation that is democratic and economically free as legitimate. In turn,

the perceived legitimacy of IPOs is aligned closely with the connection between developing

nations’ values and those of the developed nations from which investors may hail.

In general, fixed-price IPOs are becoming less common in the global market, slowly being

trumped by auction and book-building pricing. The benefits of fixed-pricing stem from the

initial predictability of returns, but this method is the most prone to under-pricing, significantly

more so than other methods. In developing nations, fixed-price method for valuing IPOs can

present a particular challenge, as these markets are more volatile and determining an

accurate fixed-price is then nearly impossible (Prasad, Vozikis and Ariff, 2006).

Moreover, the role of the underwriter in traditional, fixed-price IPO valuation is a significant

one and underwriter reputation and agendas can have a substantial influence over investor

confidence, thereby allowing prices set by certain underwriters to be priced purposefully

higher than those set by other, perhaps less known underwriters (Sun et al., 2010); this

potential does not exist in pricing methods that relinquish the underwriter.

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2.4.1.2 Book-Building

Book-building methods have been highlighted as having lower potential for under-pricing than

fixed-price methods and are increasingly popular in American and European markets

(Espinasse, 2011). Book-built IPOs are formed when the issuer’s underwriter sets a price

range through which the investor is allowed to bid for shares; this range, like that set for

Dutch auction-style IPOs, is rooted in an estimated value of the company as well as the

range at which comparable companies are trading in the same market (Kleeburg, 2005).

The issuer compiles a “book” of investors that are willing to pay for shares at a given price,

thereby allowing the issuer to ascertain the price range at which shares should be valued

according to investor demand. Unlike fixed-price methods, book-building aims to match

supply with demand (Anand, 2006).

Ideally, book-building allows for investors to get a fair price for the IPO and the company

concurrently receives fair compensation. Fixed-price IPOs, however, have the potential to

garner investors much greater returns than book-building due to under-pricing (Howton,

Howton and Olson, 2001).

Among investors, book-building may then be far less favoured than fixed-price pricing.

Overall, however, evidence suggests that book-build IPOs are more efficiently priced than

fixed-price IPOs that are vulnerable to market volatility and initial investor enthusiasm

(Anand, 2006).

Auction-style IPOs and Dutch auction-style IPOs in particular, may well represent a solution

to the condemnation of book-built methods by investors and the inefficiency of fixed-price

IPOs.

2.4.1.3 Auction-Style IPO Pricing

Auction-style IPOs have emerged as increasingly popular following the advent of the World

Wide Web. Supports of the auction method suggest that it lowers the potential for under-

pricing and improves allocation, as the price is based almost solely on the demand of

investors (Anand, 2006).

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Critics of auctions suggest that the method is conversely prone to under-pricing and can also

birth inefficient unions between underwriters who are excluded from participation (Anand,

2006; Sherman and Jagannathan, 2006).

Dutch auctions are the most popular form of IPO auction-style pricing in which the price

descends on the number of bids received (Anand, 2006; Sherman and Jagannathan, 2006).

The price of the IPO is set high initially and then gradually lowers according to the number of

shares sold. Unlike fixed-price methods, underwriters are not generally used by the issuers.

Instead, the issuer establishes an acceptable price range and the maximum number of

shares that can be sold. Investors then bid by citing the number of shares they wish to

purchase and their desired price within the issuer-set range.

Following bid submission, the issuer determines the clearing price, or the price at which all

shares will be sold. The clearing price represents the highest price at which the pre-specified

number of shares can be sold within the established range (Anand, 2006).

Unlike traditional pricing methods, there is no intermediary and the issuer has substantial

discretion over both price and allocation (Anand, 2006). Anand (2006) asserts that while

auction methods may be both effective and efficient for well-known and widely traded firms,

less well-known firms are plagued with risk in auction-style IPOs.

Information asymmetries, for example, are more prevalent among young, unknown firms and

can significantly influence an IPO auction. Anand (2006) describes the challenge of bidding in

a Dutch auction:

“To put in a bid as soon as the price has come down to the full value of the object to the

bidder maximizes the probability of obtaining the object, but guarantees that the gain

from securing it will be zero; as the announced price is progressively lowered, the

possibility of a gain emerges, but as the gain thus sought increases with the lowering of

the point at which a bid is to be made, the probability of securing this gain diminishes.

Each bidder must thus attempt to balance these two factors in terms of whatever

knowledge he has concerning the probable bids of others (Anand, 2006: 233).”

Unlike traditional, ascending auctions in which the bidder who values the product most will

generally win, descending auctions may promote the opposite result, with bidders who value

the product less effectually winning (Anand, 2006).

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The role of the underwriter, as virtually non-existent in auction-style pricing, has been

heralded by some researchers and condemned by others. Underwriters in both fixed-price

and book-built IPOs have the potential to influence the prices with their reputation and

agendas (Anand, 2006; Sherman and Jagannathan, 2006).

For example, an underwriter for both fixed-price and book-built IPOs has an incentive to

under-price the shares in order to ensure sales. Anand (2006) suggests that underwriters’

strategic under-pricing of IPOs is solely responsible for the IPO under-pricing trends affecting

national and global markets alike.

Auctions can also eliminate the potential for IPOs to be exclusively offered to a specific pool

of investors. Whereas the underwriter may be affiliated with a group of investors or demand

that potential investors be connected with the investment bank for which s/he works, auctions

are more accessible (Anand, 2006).

Whereas both book-built and auction-style IPOs are more accurately indicative of investor

demand than fixed-price IPOs, auctions set prices directly resulting from competitive bidding

(Sherman and Jagannathan, 2006).

Evidence is mixed with respect to the prevalence of under-pricing in auction-style IPOs.

Anand (2006) explains that while both book-built and auction IPOs have lesser rates of

under-pricing than fixed-price IPOs, the rate of under-pricing in auctions is not significantly

decreased from that of book-built IPOs.

The absence of the intermediary and linking price discovery more closely with market

demand should decrease under-pricing very significantly, but this is true only for well-known

companies and not for young unknown firms (Anand, 2006).

Additionally and more saliently, IPO prices are often far lower for young companies in

auctions than they are for established firms. Underwriters create awareness, thereby

affording the firm greater legitimacy during IPO valuation (Marshall, 2004). Additionally,

underwriters have a network of clients that aid in interest generation, a force that does not

exist in auction-style IPOs.

Because greater demand directly raises prices, underwriters and thus either fixed-price or

book-built IPOs, may well be necessary for less known organisations. Additionally, auctions

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have the potential to attract unstable investors that may make investment decisions without

doing due diligence, thereby decreasing the market efficiency.

Anand (2006, 236) writes “since the interested-enough-to-register population in a Dutch

auction is merely a subset of the investor universe, demand… will be suppressed. Retail

shareholders also have a greater impact on price in a Dutch auction than they would have in

a traditional underwritten offering…. Dutch auctions may not therefore be superior in terms of

price discovery”. Firms that use auctions to price IPOs must then be wary of who is

participating in the auction.

2.4.1.4 The P/E Ratio Pricing Methodology

New firms may not have an established P/E ratio and there is a strong correlation between

IPOs that are graded higher and optimum P/E ratios (Kim and Ritter, 2001), because there is

a market investor perception that higher P/Es are generally less risk-averse blue chip

companies, but this is not always true, as highlighted by Michael Mailello (2006). Companies

with higher IPO grades generate higher P/E multiples, because they embody more optimum

growth prospects.

While the underwriters may consider P/E ratios when setting prices for privately owned firms

that are going public, young firms such as AltX-type listings may not have this benefit. Stable

investors may then not pursue these firms at all in traditional IPOs and auction-style IPOs

become preferable (Draho, 2004). Alternatively, young firms may place themselves in a

precarious position in the absence of an underwriter, thereby decreasing long-term

marketability when shares sell at a lower than anticipated price (Anand, 2006).

However, in South Africa the auction method of determining a share price is not used (Table

2.1), but the P/E ratio is regularly used for smaller companies listing on the AltX via a

comparable listing methodology (De Lange, 2012). The methodology is investigated in this

dissertation, as no prior research has been conducted on the use of P/E ratios in South Africa

to determine a fair price prior to listing a company.

For instance, in the AltX listing of RGT Smart in 2010, a P/E ratio methodology was

developed to compare RGT to similar companies on the JSE Main Board. This comparative

P/E methodology was successfully used in calculating a share price of 10 cents. Two years

later, the share has fluctuated between 8 cents and 12 cents.

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Miller Moela, partner at Stockbrokers Arcay Moela, said at the launch of RGT in April 2010:

“Magliolo’s P/E Ratio methodology should be incorporated in a set of guidelines….” (Moela,

2010).

It must be noted that this dissertation research assessed AltX P/E ratios relative to the JSE

Small Capitalisation Index and found that AltX P/E valuations are at an historic 5.8 times,

while the JSE Small Cap Index (for the same period) is at 14.15 times (Figures 6.2 and 6.3).

What is known about the P/E ratio is that it is “mean reverting” which means that both high

and low P/E’s move back to the average over varying periods of time (De Lange, 2012).

Over the last 50 years the P/E on the JSE has had an average of 11.9 times with a standard

deviation of 1.68 (Figure 6.4).

2.5 CONCLUSION

The literature highlights that book-building and auction-style IPOs represent a closer link

between investor demand and price than do fixed-price IPOs as these have the substantial

potential to be affected by the role of the intermediary.

However, underwriters are valuable for firms seeking legitimacy, thereby the book-building

method is preferable for young firms in order to benefit from the least possible gap between

demand and price without losing the benefit of investor awareness that the underwriter

provides.

The P/E ratio has a strong relationship with the IPO and there is a greater correlation

between under-pricing and fixed-price methods than both auction and book-building valuation

techniques (Gregoriou, 2006).

Overall, book-building represents the most widely used method in American and European

markets, with auction-style pricing becoming more popular (Kleeburg, 2005). Current trends

suggest that auction-style methods may well gain greater legitimacy as time passes and if a

universal channel for creating investor awareness in auctions can be determined, the

technique may gain exponential popularity.

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Significant gaps in the literature exist with respect to auctions and P/E Ratio pricing methods

in developing nations, though some research suggests that developing nations have policies

in place to prevent auction-style valuation.

Overall, a universal method for IPO valuation does not seem to be imminent, as all firms have

different needs according to age, location and goals when pursuing IPO pricing.

Chapter 3 investigates existing IPO theories, focusing on share allocation and valuation

techniques as a precursor to analysis of the JSE and AltX.

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CHAPTER 3: OVERVIEW OF EXISTING THEORY

3.1 INTRODUCTION

In examining different IPO theories for this dissertation, it was concluded that there are 10

common and most frequently used theoretical and empirical studies related to pre-IPO pricing

methods. These have been assessed and are discussed hereunder. The most frequent

themes apparent in the literature were information asymmetry and under-pricing as the two

variables related to wave, signalling and prospect theories.

The causal connections between IPO variables, including under-pricing, hot market waves

and owner participation, were prevalent but conflicting in the literature. Specifically, Daily et

al. (2003) and Ritter and Welch (2002) highlight that under-pricing is higher at the start of an

IPO wave and firms use under-pricing in order to signal their financial stability to investors.

The latter authors make the unique assertion, however, that underwriters will strategically

encourage firms to go public when under-pricing is high, thereby fuelling the price wave.

The most common connection in the literature is the information asymmetry-under-pricing

relationship, with Ritter and Welch (2002) citing that their model shows under-pricing

approaches zero as information asymmetry is similarly reduced. Given these conclusions,

firms would have considerable incentive to create information symmetry in the market; and

yet, none of the 10 common themes makes any such suggestion.

Both Habib and Ljungqvist (2000) and Bachmann (2005) synthesise the variables by citing

that uninformed investors will cause under-pricing, as under-pricing is used in order to fill in

information gaps. When the prospect of wealth loss for owners is less, under-pricing is

higher, suggesting that underwriters play the foremost role in under-pricing and have

considerable incentive to do so.

Firms believe under-pricing is necessary in order to compensate investors for their risk and

the long-run performance of under-priced IPOs is greater than that of those which are not

significantly under-priced (Daily et al., 2003). However, because more financially stable firms

are more likely to under-price, it may not be the actual under-priced IPO that determines

long-run performance. The prospect of wealth loss plays a key role in how powerful internal

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stakeholders are involved with the IPO process (Espinasse, 2011). Lower prospects of loss

encourage the use of under-pricing and IPO pricing methodologies.

3.2 OVERVIEW OF IPO THEORY

An increase in IPO activity due to the proverbial dot-com phenomenon has boosted an

increase in discourse, particularly that of a theoretical nature, with respect to IPO pricing

(Daily et al., 2003). Since the early 1960s, IPOs have been empirically tested and

conceptualised within a range of contexts, but the bulk of IPO theories has been generated

only since the turn of the millennium. Theories remain divergent from one another, however

and the fields of finance and management have sourced a spectrum of hypotheses related to

IPO pricing and performance.

Cognisance of IPO theory is critical to this study, with any meaningful conclusions drawn

about IPO performance and this pricing stemming from a thorough understanding of existing

theoretical frameworks. This chapter explores the existing theories related to IPOs, affording

particular attention to how the theories frame the movement from the private to public

domain.

In essence, the manner in which a firm handles its IPO is indicative of one of the most major

organisational transitions a firm can undergo (Daily et al., 2003). The IPO itself may generate

the first knowledge received by the public about the firm, with the company charged in most

nations to provide a series of documentation citing how the IPO-generated capital will be

utilized.

Potential investors, in turn, examine these documents and assess the possible return

prospects relative to the price of adopting an equity position. Within this simplistic course of

events, however, a range of possible forces can affect IPO performance; such IPO theory

articulates the connection between these forces and IPO outcomes.

IPOs have traditionally garnered high first-day gains as compared to the performance of the

rest of the market (Draho, 2004). This supports a range of theories related to under-pricing,

market signals, share allocation and long-run performance. The market price of the stock,

largely defined by supply and demand, is indicative of the firm’s overall value. By extension,

the large first-day gain represents the IPO issuing price, as dictated by the underwriter and

issuer, ideally is less than the actual value of the firm (Espinasse, 2011).

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The differences between offering price and first-day closing price may be significant and

frequent, dismissing assertions that auditing errors are responsible for apparent under-

pricing. Karlis (2004: 83) cites that “while skyrocketing first day prices seem to impress a

large portion of the general public as well as the media, there are those in the investment

community who view this price discrepancy as a major flaw in the auditing process of the

investment bank”.

Similar issues occur on the JSE and AltX. Research indicates that in the period from 2003 to

2012, AltX share prices have fallen by an average of 50%. While the comparable JSE Small

Cap Index has risen by 107% (JSE website, 2012).

Determining market prices and price movements (called waves) are at the heart of several

theories, both are related directly and those related indirectly to under-pricing (He, 2006). The

literature suggests that the large majority of IPO theories are bound to market waves and

signals, with the internal firm environment largely ignored due to lack of empirical potential.

According to PriceWaterhouseCoopers (PwC) survey (2010), the outcomes of IPOs once

they enter the marketplace are far more easily assessed than internal factors that may be just

as influential, if not more influential, on the choice to go public and long-run performance of

the firm. Moreover, PwC states in the same survey that the theoretical literature highlights the

inability to evaluate firms that choose not to go public, which may be markedly telling in terms

of both internal and external forces.

The following sections explore IPO theories, acknowledging the link between theory and

practice in particular and seeking out potential gaps in IPO theory.

3.3 THE LINK BETWEEN THEORY AND PRACTICE

3.3.1 Wave and Signalling Theories

The role of managerial decision-making in the IPO process is significant, with the impact of

theory fuelling the choices of managers to varying degrees (Brau and Fawcett, 2006).

Motivations for moving into the public domain, precise timing of the IPO, the selection of the

underwriter, the role of determining a pricing methodology, process issues and the converse

choice to evaluate all of these factors and still remain private are practical actions often

grounded in theory. Brau and Fawcett (2006) explored these specific factors with respect to

theory using surveys of 356 CEOs in global organisations with various industry distinctions.

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They highlight the uniqueness of their data because the bulk of empirical evidence regarding

IPOs generally stems from stock return statistics.

The constraints inherent to existing data garnered from stock returns or evidence gathered by

exchange organisations disallows for clear examination of the link between theory and

practice. Brau and Fawcett (2006) assert that their study successfully explored the theory-

practice gap with respect to IPOs, with CFO identification of the creation of public shares for

acquisitions being the most integral motivation for moving into the public domain.

While a significant portion of textbook IPO literature suggests that IPO decisions are

influenced by a need to lower the cost of capital, the authors cite that most managers do not

acknowledge this as a primary motivation. The technology industry, in particular, tends to

frame IPO decisions as a means of gaining legitimacy, with the enhancement of reputation

more of a motivational factor than actual financial gains.

Wave theory suggests that IPOs come in waves due to pricing discrepancies associated with

the influences of hot and cold markets. Brau and Fawcett (2006) compared actual practice to

wave theory’s implications, with the timing decisions of IPOs analysed in detail. CFOs

generally timed their decisions based on market and industry stock price returns, rather than

the strength of the IPO market individually. Moreover, smaller firms and those backed by

venture-capital leant more credence to the strength of the IPO market overall; this did not

discount wave theory entirely but raised important questions regarding the fuel for IPO

waves.

Underwriter selection criteria are grounded in the overall reputation of the underwriter, quality

of the research department and industry-specific knowledge. Brau and Fawcett (2006)

suggest that unlike the other issues under examination that are likely to shift due to economic

forces, the motivations behind underwriter selection were enduring and similar pre and post-

recession. IPO spinning, or the strategic allocation of shares to potential internal

stakeholders, is a concern for larger firms during underwriter selection, but less so for small

to mid-size companies.

Another critical difference exists between the value placed on underwriter reputation in small

and large firms, with high-prestige, large firms selecting underwriters almost solely based on

their reputation and existing, institutional investor clients. Small firms, like those represented

by AltX, may select low-prestige underwriters due to accessible fee structures.

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Under-pricing plays a weighted role in the IPO process, with a range of theories suggesting

that under-pricing has positive, negative and neutral consequences for the public firm shortly

after the IPO. The companies are generally priced lower, sometimes significantly lower, than

their first-day closing price and CFOs are generally very cognisant of the expected level of

under-pricing.

CFOs cite several reasons for the necessity of under-pricing (Kleeburg, 2005). Among them

was the need to compensate investors for their risk and, secondarily, the tendency of

underwriters to use under-pricing in order to gain the favour of their institutional clients. A

realistic set of guidelines as promoted in this dissertation would eliminate discrepancies in

share allocations and, consequently, improve liquidity in the JSE’s already limited level of

activity (Espinasse, 2011).

Signalling theory suggests that firms with solid future prospects send accessible signals to

the market when going public, such as owner retention of a considerable portion of the firm.

The signal may vary, but should be one that would not be replicable by a firm with poor future

prospects. In the absence of any signal, unreliable information may be used by investors

which results in poor selection of IPOs and volatile markets.

At the crux of signalling theory is the assumption that firms should strategically introduce

signals into the marketplace that will ensure positive reception of IPOs. Brau and Fawcett

(2006) cite that CFOs of large firms tend to use the signal of strong earnings history most

frequently, with the use of a highly reputable investment banker as the second most

frequently used signal. The assumption made by underwriters is that share prices are a

function of the price to earnings ratio and earnings per share and, if price to earnings ratio

represents investor sentiment (Gregoriou, 2006), then such P/E should remain stable if

higher earnings is expected. Thus, a promotion of expected earnings and suggested higher

future share price is used to justify a lower pre-IPO share price (Draho, 2004).

The lock-up period of AltX shares following the IPO listing is an integral signal to the market

that the share is secured (Espinasse, 2011). Long lock-up periods are viewed as positive

signals by investors, as the lock-up period precludes insiders from selling shares, both

reflecting and supporting investor confidence. Trading restrictions are all removed following

the lock-up period and the stock prices often declines permanently after this time (Brau and

Fawcett, 2006).

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Signals that are strategically avoided by CFOs include selling a large portion of the firm,

having a shorter than usual lock-up period and the selling of insider shares. The process

design is significantly informed by all of the aforementioned issues, with underwriting and

lock-up period being of paramount concern (Gregoriou, 2006).

Ultimately, the decision to remain private or to withdraw an IPO is generally grounded in a

desire to retain decision-making control. Unfavourable market or industry-specific conditions

can affect the choice to opt out or never enter the public domain and smaller firms are less

confident throughout the process than larger firms.

Regardless of size, firms that employ high-prestige underwriters exhibit greater confidence in

the IPO process and thus can determine their own prices (Kleeburg, 2005). High-technology

firms are less concerned with control and the history of managerial decision-making can

either reduce or enhance firm confidence. Specifically, Brau and Fawcett (2006: 399) cite that

“CFOs who attempted an IPO (either successfully or unsuccessfully) disagree with CFOs

who have not tried an IPO (not-tried CFOs) pertaining to motivations for going public,

underwriter selection criteria, reasons for under-pricing and negative IPO signals”. High-

technology firms were generally far more likely to go through with an IPO despite any other

trepidations, even when the firms were small in size.

Overall, Brau and Fawcett’s 2006 study highlights that signalling theory is used in practice by

CFOs, with wave theory receiving less credence. While CFOs did employ strategically

positive signals during the IPO process, concurrently shunning the negative signals, the

participants in the study did not acknowledge IPO waves as an importance influence on their

timing of decisions; the general stock climate was more important when strategizing the

introductory time period.

3.3.2 Under-pricing Theories

Under-pricing theories range considerably, with the strategic use of under-pricing receiving

both support and criticism in the financial management field (Draho, 2004). Essentially the

difference between the price of the IPO and the price of the stock on the close of the first

trading day, under-pricing exists whether it is deemed strategic or not.

Daily et al. (2003) cite that under-pricing occurs at an average of 16%, though the internet

bubble between 1999 and 2000 saw rates as high as 65%. A fundamental lack of

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consistency between under-pricing practice and theory has precluded any concrete

conclusions regarding why under-pricing occurs.

Brau and Fawcett (2006) cite that underwriters aim to exploit their superior market knowledge

for two key reasons: in order to minimise marketing efforts and ingratiate themselves with

their existing clients. Alternative theories highlight, however, that under-pricing is a result of

asymmetric information between potential investors and issuers, with investor uncertainty

regarding the IPO firm forcing prices to be lower than the unknown future market price.

Under-pricing may also stem from the rewarding of sophisticated investors for disclosing

valuation information during the book-building process. The role of asymmetric information

between informed and uninformed investors may raise the perceived risk of the firm, in turn

driving under-pricing by the need to compensate investors; underlying this assumption is also

the potential for under-pricing to protect the firm against future investor litigation.

Daily et al. (2003) performed a meta-analysis of under-pricing literature in order to provide a

comprehensive overview of under-pricing practice and theory. The authors contend that the

reasons a firm decides to go public, categorised as either a mechanism for assisting the

firms’ shareholders in diversification or managers with procuring funds for upcoming projects,

inform the role played by under-pricing. The need to raise capital is the dominant reason for

embarking on an IPO, with the pursuit of growth opportunities facilitated by the IPO process.

Initial shareholders may want to reduce under-pricing due to their isolation from the practice’s

value. Daily et al. (2003: 277) offer the following example:

“To illustrate, suppose a firm undertakes an IPO and agrees to sell one million shares

of the firm for $10/share (the offer price). At this offer price, the initial shareholders of

the firm (often firm founders and managers) would receive $10-million to invest in new

projects. Suppose, however, that the offer price at the opening of trading is $10/share

and the stock price closes on the first day of trading at $15/share (the closing price).

This would represent an under-pricing of 50% ([$15-$10]/$10). This level of under-

pricing, given the number of shares sold at the time of the IPO, results in the initial

shareholders leaving $5-million on the table. In other words, investors purchasing the

stock at the $10 offer price captured this rise in value, not the initial shareholders.

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Under-pricing is, however, viewed as entirely rational by the underwriters, as either a fairly or

under-priced stock will provide underwriters with a guaranteed payment. Over-priced stocks,

in short, are far more dangerous than under-priced stocks from the perspective of the

underwriter. The greater the over-pricing of stocks, the more shares are likely to not be sold;

this creates a more significant loss for the underwriter (Daily et al., 2003).

The marketing function of under-pricing theory has emerged during the late 1990s, slowly

gaining credence throughout the first decade of the new millennium. Under-pricing can cause

a cascading effect among potential and actual investors that increases demand for the new

issue. In turn, under-pricing brings more attention to the stock and increases the after-issue

trading volume. Brau and Fawcett (2006) contend that under-pricing may well fuel

questionable practices such as spinning and flipping, the former practice referring to the

enrichment of favoured investment bank clients and the latter committed by favoured

investors.

3.3.2.1 Prospect Theory and Under-pricing

Prospect theory suggests that underwriters are not overly concerned with under-pricing, thus

allowing it to exist (Loughran and Ritter, 2004). The assumption of the theory is that investors

make decisions based on changes in their wealth, with a genuine, behavioural influence of

IPO gains essentially causing under-pricing (Loughran and Ritter, 2004).

Prospect theory has been condemned by a range of scholars (Brau and Fawcett, 2003: 399;

Daily et al., 2003: 279), but advocates of the theory suggest that the behavioural element in

finance is far more integral to under-pricing than any strictly financial factor. Prospect theory

suggests that value should be assigned to gains and losses rather than assets due to

behavioural changes that fostered by these issues.

Loughran and Ritter (2004) cite a reference level exists from which the individual views

consequences as either positive or negative; these consequences need not be monetary in

nature. The reference level is similar to a baseline or a status quo, with the gains and losses

moving above and below this level, respectively.

Prospect theory explains how risk is perceived during the under-pricing process as well as

the impact under-pricing has on IPO sales. Specifically, the gains from under-priced stock

would be pleasurable for investors, but not to the same extent that losses would be painful,

even when the monetary amounts are the same.

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Ljungqvist and Wilhelm (2003) extend the behavioural finance theory to repetitive

investments and the selection of underwriters, assessing the overall applicability of prospect

theory to alternative IPO contexts. The authors suggest that firms are less likely to switch

underwriters if they were satisfied with the IPO’s initial performance and underwriters benefit

in general from behavioural biases among IPO officers. Specifically, underwriters are able to

charge higher fees for future transactions if their customers were previously satisfied

(Gregoriou, 2006).

Ljungqvist and Wilhelm’s (2003) critique of prospect theory is relevant in that it rejects one of

the core assumptions made by Loughran and Ritter (Loughran and Ritter, 2002: 52); that IPO

decision-makers are behaviourally uniform in their valuation of a firm. If IPO decision-makers

demonstrate preferences in future decisions, prospect theory is empirically testable and the

authors acknowledge that IPO firms are significantly more likely to switch underwriters if

dissatisfied with IPO performance.

However, if the decision-makers change, as they are likely to do, then prospect theory is not

applicable to firm decision-making. Specifically, firms that retained the same CEO after their

offering can be studied for prospect theory’s relevance, but most firms will change decision-

makers at some point after their seasoned equity offering (SEO). Additionally, the satisfaction

of investors has no bearing on the decision-makers’ choice to either stay with the same

underwriter or find a new one and the authors also contend that behavioural biases among

investors do not exist to the extent that Loughran and Ritter (2004) assumed.

Overall, prospect theory remains controversial with respect to its applicability to IPOs.

Loughran and Ritter (2002) focus primarily on investor decision-making, while Ljungqvist and

Wilhelm (2003) extend the theory to firms’ internal decision-making processes. In

synthesising the conclusions of the two studies, underwriters have incentive for SEOs to

perform well, while future offerings need not perform at the same level and investors suffering

an initial loss form mental barriers against future IPOs. Behavioural finance is a relevant area

of research, albeit subjective one and both studies contribute to this body of research by

highlighting the profoundly weighted role of investor, underwriter and internal firm decision-

maker choices on IPO performance.

3.3.2.2 Information Asymmetry Theories, Book-building and Under-pricing

Excessive under-pricing creates risk as well, however, as the underwriters’ average initial

returns will cause issuers to stop using the underwriter. The role of information asymmetry in

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determining an optimum level of under-pricing then exists. Both Brau and Fawcett (2006) and

Daily et al. (2003) cite that information asymmetry manifests with either issuers being more

informed than investors or vice versa.

Daily et al. (2003) theorises that IPO issuers are generally more informed than are investors,

with investors facing greater levels of uncertainty. Consequently, investors will submit their

purchase orders only at a lower price than the expected value. Theories based on

asymmetric information when the issuer is more informed than investors, cite that rational

investors will naturally fear any firm that does not signal their quality. Better quality firms will

sell shares at a lower price, leaving money on the table, in order to demonstrate that they are

stable enough to do so.

Ritter and Welch (2002) argue, however, that this signal may be less relevant than the

literature suggests, as a firm’s commitment to spend the extra money on a designated

marketing campaign or donating it to charity should, theoretically, have the same impact as

intentional under-pricing. If the investors are more significantly informed than the issuer,

information asymmetry presents a formidable problem to the issuer. The issuing firm is not

cognisant of the price the market is likely to bear and the demand for stock is unpredictable.

Most theories that attempt to frame this type of information asymmetry do so under the

assumption that all investors are equally informed. This may not be the case and buyers will

purchase shares only if they are priced below a commonly assessed price (Ritter and Welch,

2002).

In short, over-priced IPOs would never occur since issuers would have access to the same

knowledge as the common investor pool. Ritter and Welch (2002) argue that it is far more

likely that investors are not equally informed and fear either the Winner’s Curse or an

Informational Cascade.

The Winner’s Curse theory cites that investors will fear they only receive full allocations if

they belong to the most optimistic pool of investors. The investor would garner a total

allocation of IPOs if they were over-priced, rather than only a partial allocation of under-priced

issues. In essence, when a large number of investors desire the IPO due to under-pricing, the

issue will get rationed (Ritter and Welch, 2002).

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In the informational cascade, potential investors will seek to assess the level of interest had

by other investors; this can lead to asymmetric information within the investor pool and, if

investors are aware of this, they are likely to reject the IPO out of sheer uncertainty (Ritter

and Welch, 2002). Book-building theories are grounded in the practice which allows

underwriters to garner information from informed investors, setting a preliminary price range

and going on the road show to market the IPO. In turn, the underwriter can gauge investor

interest, setting the price higher in the stated range if interest is high and conversely lower in

response to minimal interest (Ritter and Welch, 2002).

The problem with empirically investigating the impact of book-building on IPO pricing is that

investors are cognisant that their interest will result in a higher price; therefore they have

incentive to show less interest unless they are offered something in return.

Underwriters will offer investors, as an incentive, greater IPO allocations and under-pricing if

they reveal their interest honestly. Book-building is evidenced by the effect of revisions made

to the offer price during the filing period. Ritter and Welch (2002) cite that underwriters will not

fully increase their prices even when demand is strong for a stated price due to allocation

concerns and the need for investor incentives.

Primary research shows that all theories related to asymmetric information suggest that the

asymmetry of information is directly and positively related to under-pricing. Under-pricing

disappears entirely in models connecting the two variables when asymmetric information

stands at zero and, by extension, the reduction of information asymmetry will increase IPO

prices (Ritter and Welch, 2002). This dissertation has taken cognizance of these variables in

determining a set of determinants to identify a realistic share price pre-IPO.

At the July 2010 AltX Directors Induction Programme (Appendix 1, No 7), Noah Greenhill

introduced the objective of the entrepreneurial training sessions by saying that “lack of

information asymmetry is often used to under-price an IPO at listing to avoid potential

litigation.”

Under the litigation-risk hypothesis, initial returns can be related to the probability of a lawsuit

along two dimensions (Drake and Vetsuypens, 1993). First, firms with higher litigation risk

should under-price their IPOs by a greater amount as insurance against litigation. This

implies that initial returns are an increasing function of litigation risk. Second, firms that buy

more insurance against litigation, i.e. under-price more, should be sued less often. This

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implies that litigation is a decreasing function of initial returns. Because the probability of

being sued is itself an endogenous variable that could depend on under-pricing, a

comparison of initial returns across sued and non-sued firms is problematic.

Primary research suggests, however, that under-pricing levels have no impact whatsoever on

whether a firm will be sued. Both Ritter and Welch (2002) and Daily et al. (2003) cite that

under-pricing is not a cost-effective way of avoiding lawsuits and nations that do not

experience lawsuits as frequently as the United States still have high levels of under-pricing;

this suggests that information asymmetry plays a significant, if not the most significant, role in

decisions to under-price IPOs. As such, this dissertation does not consider the litigation as an

important determinant in the IPO pricing process.

3.3.2.3 Signalling Theory and Underwriting

Signalling theory aligns closely with Daily et al.’s (2003) assumption that investors are less

informed than the issuers. The need to resolve information asymmetry problems is addressed

by the communication of certain variables that will signal the firm’s capability to market

stakeholders.

Investors assessment of future value ultimately impacts the share price they are willing to pay

for shares at listing, managers aim to reduce information asymmetry by communicating a

high, future price of stock. Daily et al. (2003) cite that less informed investors are targeted by

signalling more so than informed investors who would already be aware of the firm’s

potential.

While signalling theory plays a key role throughout the IPO process (Brau and Fawcett,

2006), it is particularly integral to the underwriting process. The central assertions of

signalling theory are that the signal or signals must be observable and known prior to the

IPO, with such a signal being either costly or difficult to replicate by a low-performing firm.

The signal might be retained equity, underwriter reputation, auditor reputation, risk factors,

firm size, firm longevity and the use of proceeds generated by the IPO (Daily et al., 2003).

Daily et al. (2003) concluded that a high level of retained equity would signal confidence to

investors, as would high levels of owner/manager equity. The first round of investors, given

these signals, would be willing to pay a higher offering price for the equity, reducing the

under-pricing range. Auditor reputation, however, was associated with higher levels of under-

pricing on average.

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An integral aspect of signalling theory is the distinction between high and low quality firms

and under-pricing may result from high-quality firms intentionally under-pricing IPOs in order

to reduce the potential for imitation by lower performing firms (Daily et al., 2003). Specifically,

a high performing firm may not need to maximize IPO returns as would a floundering

organisation, thus under-pricing the IPO would not be as viable of an option for a poor

performing firm or a small cap company, such as targeted by AltX investors; this, in turn,

signals to investors that the firm is of a high quality due to under-pricing.

3.3.3 Wave Theory and Under-pricing

IPO waves are apparent in the monthly volume and under-pricing of IPOs which co-vary over

time (Banerjee, Hansen and Hrnjic, 2009). High waves in which there are a high volume of

IPOs tend to concurrently be characterised by severe under-pricing, while low waves have

dormant volume and only mild under-pricing; the former environment is deemed a hot market,

while the latter is a conversely cold market.

While a relationship between IPO waves and under-pricing clearly exists, the causal direction

of this relationship is largely unknown and the consequent subject of much speculation.

Banerjee, Hansen and Hrnjic (2009) cite that hot markets may emerge from investor

irrationality, which causes low cost of capital which, in turn, creates incentives for firms to

issue overvalued shares. Alternatively, waves can be caused by rational market variations.

Banerjee, Hansen and Hrnjic (2009) cite that firms which possess first-mover advantage will

lead a hot market if their project to be funded by the IPO is a high-growth project; this is,

however, dependent upon the economy being in a good state.

Firms leading a hot market are more likely to have under-priced shares than those that are

followers in the market after it is already hot. Firms may, by extension, cause a high wave

and consequent hot market, by going public too early. Banerjee, Hansen and Hrnjic (2009)

cite that firms who go public early will need to significantly under-price stock due to the

greater risk involved, thereby fuelling the IPO wave. Banerjee, Hansen and Hrnjic (2009)

suggest that the signals sent by firms starting the wave in a hot market are critical, as under-

pricing shares is a signal not replicable by weak firms.

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In short, only strong firms that can send signals through under-pricing can effectively start a

hot market IPO wave. Firms that begin the wave tend to experience significantly higher

growth in sales than do firms that enter a hot market mid-wave, though there is little option for

smaller firms that cannot under-price shares to the necessary extent early on in a hot market.

Jovanovic and Rousseau (2003) applied Q-Theory, or the ratio of market value to

replacement value, in order to assess IPO performance. The authors highlight that not only is

IPO performance explainable via Q-Theory, but that IPOs uniquely respond to Q-Theory in a

way not applicable to other stocks. Market waves are then partially explained by Q-Theory,

but information asymmetry can significantly impact the value of Q, as can the difficult-to-

measure impact of intangible assets possessed by a company but not assessed by traditional

accounting.

The primary value of Jovanovic and Rousseau’s 2003 study to this dissertation is its

distinguishing of IPOs from all other types of stock, with general market waves and IPO-

specific waves inextricably bound to one another.

3.3.4 Choosing to Go Public

On global markets, IPOs raise an average $78-million per deal, but the risks associated with

going public are considerable (Ritter and Welch, 2002). The choice to go public is affected by

a range of considerations that Ritter and Welch (2002) argue are not only defined by the

need to generate quick capital.

Non-financial reasons, including publicity boosts and gains in legitimacy, play a weighted role

as well, though the public market process is complex enough that it may preclude the choice

to go public if only nonfinancial reasons are present.

3.4 INTERNAL VERSUS EXTERNAL FORCES

3.4.1 Life Cycle and Market-Timing Theories

Life cycle theories suggests that potential acquirers of firms will seek out only public firms and

that outside investors are less likely to be swayed than internal stakeholders in terms of price-

reduction (Ritter and Welch, 2002).

By extension, firms have an incentive to go public if they are looking to facilitate the

acquisition of the company for the highest value possible. Alternatively, Ritter and Welch

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(2002) assert that IPOs essentially disperse ownership, rather than remove control entirely

from the private owners and this has a range of industry-specific advantages. The cost of

going public, however, keeps newer, smaller firms from making the choice to move out of the

private realm.

Despite the advantages of going public, in short, new firms must wait until later in their life

cycles to go public.

First-mover advantage may allow firms to opt to go public earlier in their life cycles than if

similar firms are already being actively traded. High public prices attract market competition,

but public trading can also add significant value to the firm. The first-mover advantage of a

firm that is the primary organisation in its industry to go public holds far more benefits than

those who follow suit, as evidenced by the range of browser companies that chose to go

public during the late 1990s (Ritter and Welch, 2002: 12).

Unlike life cycle theories, market-timing theories assert that the choice to go public stems

from external forces and not the internal environment. Companies may choose to postpone

their initial issue if asymmetric information has caused severe under-pricing. Ritter and Welch

(2002:12) highlight “if a bear market places too low a value on the firm, given the knowledge

of entrepreneurs, then they will delay their IPOs until a bull market offers more favourable

pricing.” The information spill over that occurs during the peak of a wave, in a hot market,

may cause firms to choose to go public even when competition seems high. This is because

information asymmetry will tend to be lower.

Overall, Ritter and Welch (2002) assert that the internal environment of a firm has far more

influence over the choice to go public than market-timing in general, calling their theory a

semi-rational theory that affords little credence to asymmetric information. Specifically, Ritter

and Welch (2002) assert that firms’ owners sense the value of their organisation from an

internal perspective, acknowledging everyday functioning along with deep-rooted business

fundamentals and are generally less concerned with the public market.

The rapid shifts of value in publicly traded firms are not readily and immediately absorbed into

the sense of value held by owners; this does not mean that the public market has no

influence whatsoever over the choice to go public, but, rather, suggests that irrational public

sentiment that both sources and is sourced by information asymmetry affects the firm’s

choice with a lag.

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3.4.2 Problems with Evaluating Theories Regarding IPO Timing

Theories regarding the choice to go public, stemming from either an external or internal

perspective, have a deep-seated flaw that precludes concrete, empirical testing. Both Ritter

and Welch (2002) and Brau and Fawcett (2006) argue that the inability to observe and

explore the high number of firms that could go public - but choose not to do so - may discount

the bulk of empirical evidence supporting either life cycle or market-timing theories.

When IPO activity is high, the evidence suggests that underwriters are encouraging, both

directly and indirectly, more firms to go public (Ritter and Welch, 2002). Firms that choose to

remain private may do so in order to retain control, out of fear of competition or public

scrutiny, or for any other number of reasons linked to internal or external factors. A wide gap

in the literature exists with respect to the choice to remain private, even when the market is

conducive to going public.

3.5 SHARE ALLOCATION THEORIES

Theories related to share allocation and price have emerged only recently. They are an effort

to resolve problems related to share allocation methodologies (Espinasse, 2011). The

disproportionate allocation of shares to institutional investors by underwriters, for example,

has been condemned for a range of reasons, as it isolates individual investors and skews

share prices (Draho, 2004).

Share allocation is inextricably bound to information asymmetry. Information affects who

receives IPO allocations, how investors decide to request allocations, how allocations are

informed by other aspects of investor business and the level of preferential treatment given to

institutional investors. Information also determines the price attached to any particular IPO

(Ritter and Welch, 2002).

Three diverging theories of share allocation exist, all of which link information asymmetry to

under-pricing. From one perspective, underwriters will extract information from investors in

order to reduce average under-pricing and, in turn, increase the returns for issuers.

Alternatively, if underwriters have the ability to allocate future IPO shares to investors, the link

between information asymmetry and under-pricing is reduced. Finally, Ritter and Welch

(2002) highlight that an equilibrium exists between the degree of under-pricing and the level

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of information asymmetry, with a certain degree of under-pricing necessitated by the

disclosure of investor interest.

Loughran and Ritter (2004) argue that an inherent conflict of interest exists between

underwriters and investors which are grossly underestimated by share allocation theories. If

IPOs are under-priced on average, then investors are incentivised to garner as much

information as possible about an IPO in order to discern which IPO is under-priced the most.

Under-pricing will then be inadequate to compensate knowledgeable investors for their risk of

information disclosure. Additionally, a conflict of interest between issuers and underwriters

exists as well; as share allocation does not necessarily occur in the best interests of the firm

issuing shares. Underwriters have an incentive to leave money on the table and then allocate

shares to institutional clients.

Substantial evidence of share allocation’s utility for underwriters and lack thereof for issuers

exists, with the bulk of literature showing that underwriters use share allocation in order to

cultivate institutional investors.

The reason issuers remain content to effectively lose profits due to strategic share allocation

and under-pricing may be explained by the aforementioned prospect theory, as firms are

content to see their wealth increase and are less concerned by the difference between their

actual increase in wealth and potential increase in wealth, had share allocation and under-

pricing been less influential (Loughran and Ritter, 2004).

3.6 VALUATION AND WAVE THEORIES

3.6.1 The Link to Long-Run Performance

The most frequent explanation for how a firm is valued is the use of comparable firm

multiples. Accounting data utilised in this process, however, may be markedly unreliable as a

measure of valuation, particularly when firms are valued on the sole basis of growth options

and not historic financials. The use of comparable peer analysis with an over-emphasis on

growth options tends to lead to wildly over-priced IPOs, according to Ritter and Welch (2002).

When historic financials are used in conjunction with growth options during firm comparisons,

over-pricing is far less likely and long-run performance is more predictable. The years

following the offering of the IPO are markedly telling in terms of stock performance.

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Rational market theorists may argue that an IPO, once publicly traded, should not be treated

any differently than another sort of stock, with intrinsic value trumping any other IPO-specific

definition of value (Ritter and Welch, 2002). This would mean that post-IPO stock

performance should neither be predictable nor any way linked to the first-day performance.

Long-run performance theories afford attention to both raw data, or absolute performance

and performance with respect to a specific benchmark, or abnormal return. Ritter and Welch

(2002: 1802) cite that “when publicly traded firms similar in market capitalization and book-to-

market values are used as a benchmark, it becomes clear that the poor long-run performance

of firms “similar to IPO firms” extends beyond the IPO market. IPOs are strongly tilted

towards small growth firms and this has been the worst-performing style category of the last

several decades”.

However, discontinuity between investor expectations affects both the firm’s initial valuation

as well as its long-run performance. The heterogeneous expectations of investors impact the

long-run performance of a firm because only the most optimistic investors will buy the IPO.

When less optimistic investors begin to affect the stock’s value, the price will fall over time

(Ritter and Welch, 2002). Following a lock-up period, such as that set by AltX Listing

Schedule 21 (Appendix 1, No 4) the price is likely to fall when more public shares become

available. This is taken into account in this dissertation in determining a set of price

guidelines. Venture capitalists, in particular, will distribute shares to their partners when the

lock-up expires, which means firms backed primarily by venture capitalists will experience

lower performance immediately following the lock-up period than those not backed by venture

capitalists.

Wave theory offers an alternative explanation for long-run performance of IPOs, citing that

IPOs that are successful will cause subsequent IPOs, particularly those in the same industry,

to be successful as well. In consequence, the long-run performance of an IPO is affected by

its place in the wave, with that of firms coming earlier in the wave being less predictable than

the success of firms coming at the end of the wave (Ritter and Welch, 2002).

Wave theory disallows for attention to internal factors, however, which several theorists have

discounted as far too narrow of an explanation for long-run performance (Daily et al. 2003;

Loughran and Ritter, 2004).

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Overly optimistic accounting early in the firm’s life cycle may well inform long-term

underperformance. Because firms have incentive to frame themselves well when conducting

the IPO process and the market may not be able to identify negative signals of an overly

optimistic firm, the issuer may not perform well in the long-run.

In a recession or otherwise struggling economy, the long-run performance of internally

optimistic firms may be particularly poor (Ritter and Welch, 2002). IPOs that are priced high in

accordance with comparable peers but without sufficient attention to historic financials will

perform the worst in the long-run; these may show higher than normal returns on first-day

IPOs but experience a decline following the lock-up period. This is yet another determinant in

this dissertation.

Under-pricing seems to have no empirical link whatsoever to long-run performance,

particularly with respect to short-run under-pricing. Small cap IPOs, or those trading for less

than 100 cents per share, were not common prior to the 1990s (Ritter and Welch, 2002);

these often severely under-priced stocks will show high first-day returns, but perform very

poorly in the long run, as highlighted by the sample study of 63 AltX companies in the

designated timeframe. When under-pricing is relatively low or non-existent, the stock may

have a lower first-day return than under-priced stock but also have low long-run performance

(Ritter and Welch, 2002).

Bachmann (2004) presents an alternative theory of long-term underperformance, highlighting

that low performing IPOs can be partially explained by categorical divisions between

investors: “Outside investors are of one of two types: some investors know and understand

even the not directly observable economic incentives of the original shareholders, whereas all

other investors learn about the IPO market only from the publicly observable IPO market

data.” (Bachmann, 2004: 7).

If investors who depend on observable data participate predominantly in an IPO offering,

long-term underperformance of the stock is higher, as is under-pricing. Moreover, if market

participation of these investors is higher overall, with informed investors playing less of a role

in the collective IPO market, IPO waves are more apparent. Bachmann’s (2004) study

connects three variables frequent in IPO discourse, linking under-pricing, underperformance

and investor information to wave theory. Bachmann’s (2004) model is dependent upon

several assumptions, the most integral one of which is that investors are easily distinguished

from one another in terms of access to opportunities to which they have unique knowledge or

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those to which they have comparatively little knowledge. Additionally, the author contends

that nature creates investment opportunities in specific time intervals, with the sole purpose

of the IPO being to raise capital for investments.

Bachmann (2004) assumes that all funds raised from an IPO issue will be reinvested in the

firm and firms without access to physical investment opportunities will not go public. The

model acknowledges prospect theory, in part, by also assuming that investors will select the

IPO that will maximize their terminal wealth and an investor who had a poor experience with

an IPO is unlikely to invest in another for some time, contributing to the predictable market

waves. The crux of Bachmann’s (2004) model is that firms will strategically use under-pricing

to fill in information gaps, augmenting the information available to investors.

By extension, investors who participate in the market and rely only on publicly available data

essentially upset the market equilibrium and encourage under-pricing. Long-term

underperformance is caused by the ease at which under-pricing occurs in order to signal

profitability to investors: “Even a minor increase in the price at which firms can issue equity is

sufficient to alter the incentives of firms with lower quality investment opportunities.”

(Bachmann, 2004: 2-10).

The sudden increase in IPO activity that is accompanied by a “significant drop in the average

IPO quality leads to subsequent IPO underperformance” (Bachmann, 2004: 32). The

implication of Bachmann’s model is that under-pricing is a negative practice that is fuelled by

asymmetric information in conjunction with a firm’s overreliance on under-pricing as a positive

signal.

3.7 A SYNTHESISING THEORY

3.7.1 Under-pricing, Information Asymmetry, Wealth Prospects and IPO

Performance

Habib and Ljungqvist (2000) argue for further integration of IPO variables, citing specifically

that owners of firms wield considerable control over the level of under-pricing by which their

IPO will be affected. Benefits of reducing under-pricing for internal firm stakeholders depend

critically on the extent to which owners will participate in the offering.

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In returning to prospect theory, Habib and Ljungqvist (2000) highlight that owners effectively

trade-off under-pricing for promotion of their IPO, which the nature of this trade-off linked to

the minimisation of wealth losses. Habib and Ljungqvist (2000) also contend that global

under-pricing disparities are explainable through the amount of information asymmetry and

one other more fundamental reason (Habib and Ljungqvist, 2000). Chinese IPOs tend to be

under-priced by up to 42%, compared to the American average of 13% and the Malaysian

average of 6%, because of both a higher degree of information asymmetry as well as owners

who do not “care about under-pricing” (Habib and Ljungqvist, 2000: 3).

The extent to which owners are involved in their IPO offering is directly bound to the amount

of under-pricing they will experience, with their involvement linked to how much wealth they

stand to lose from the IPO. Owners who care more about their IPO due to potential wealth

losses will spend more resources on reducing under-pricing; the implication of this

assumption, aligned with prospect theory, is that owners who stand to lose wealth care more

about under-pricing than those who stand to gain the same amount of wealth. Losses,

according to the authors, are directly proportional to the number of shares sold and the level

of under-pricing is affected by the costs incurred by owners when promoting their issue.

Habib and Ljungqvist (2000) tested their theory on a sample of IPOs in the American market

between 1991 and 1995, citing that issuers will spend more on their IPO promotion if more

shares are being offered, thereby reducing under-pricing. Habib and Ljungqvist (2000) assert

further that issuers who stand to lose the most will select an underwriter with the specific aim

of under-pricing reduction.

Information asymmetry between investors means comparatively little to under-pricing when

prospect theory is applied to owner decision-making.

3.8 LITERATURE SYNTHESIS AND CONCLUSIONS

The dominant theories in IPO discourse are wave, signalling and prospect theories as they

relate specifically to pricing strategies (in particular under-pricing) and information

asymmetry.

The literature reviewed herein reflects several common themes within these theoretical

frameworks, with clear links existing between IPO under-pricing, information asymmetry and

IPO waves; the causal connections between these variables, however, are significantly

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contested in the literature. In consequence, the widest gaps in the literature exist with respect

to IPO variables, cause and effect.

Brau and Fawcett (2006) and Daily et al. (2003) assert that under-pricing is a signal

strategically used by firms to show investors that they are financially stable enough to under-

price their IPO, with IPO waves caused, in part, by financially stable firms entering the

market; this aligns with Ritter and Welch’s (2002) contention that under-pricing is significantly

greater at the start of an IPO wave. The same authors acknowledge that when under-pricing

is high, underwriters will encourage more firms to go public, thereby catalysing a wave. The

extent to which underwriters can influence firms choice to go public does not arise in any

other study, however and Ritter and Welch’s (2002) assertion that this variable exists is a

convincing one.

Underwriters have an incentive to under-price IPOs in order to cater to institutional investors

and underwriters may well be causing the IPO waves and movement toward hot markets.

Banerjee, Hansen and Hrnjic (2009) cite that under-pricing is clearly higher at the inception of

a hot market, with stable firms choosing to go public starting the wave.

An intimate link then exists between stable firms choosing to go public and underwriters’

encouragement of other firms to make the same decision. An IPO wave may well begin with

a financially stable firm choosing to go public in order to raise capital. The firm would use

under-pricing as a signal to investors that it was financially stable, as less stable firms could

not afford to under-price their IPO so significantly and seek out an underwriter who would

keep under-pricing as minimal as possible within their stated parameters.

Ritter and Welch (2002) and Brau and Fawcett (2006) both cite that firms will also use

underwriter reputation to signal investors, with under-pricing used as the more frequent

signal. Subsequently, the underwriter begins to encourage more firms, likely in the same

industry, to go public, causing both the IPO wave as well as prevalent under-pricing.

Signalling theory (Kleeburg, 2005), in practice, is very evident in the literature. Daily et al.

(2003) and Brau and Fawcett (2006) both show clear evidence that internal decision-makers

strategically use signals in their IPO decision-making. The use of under-pricing as a signal is

a common one, though decision-makers do make use of other signals as well.

Page | 52

Firms with a solid earnings history, Brau and Fawcett (2006) contend, are likely to rely less

on under-pricing than younger firms. The choice to go public is primarily affected by a need to

raise capital and under-pricing is thus not in the best interest of firms in a short-term

perspective (Ritter and Welch, 2002).

Banerjee, Hansen and Hrnjic (2009) highlight, however, that all literature discussing firm

choices to go public is compromised by an inability to assess firms’ decisions not to go public.

Long-run performance of IPOs is affected by the internal optimism of decision-makers, with

overly optimistic firms not performing as well as sceptical firms (Daily et al., 2003).

Behavioural finance highlights the role of wealth loss and gains in IPOs, with Habib and

Ljungqvist (2000), Loughran and Ritter (2002) and Bachmann (2004) all forging connections

between the prospect of gains or losses and IPO variables.

Habib and Ljungqvist (2000) suggest that the promise of losing wealth, as manifested in more

shares, significantly lowers under-pricing because the role played by internal decision-makers

is greater. When owners care less about the IPO’s price due to perceived insignificance in

loss, under-pricing is greater, according to the authors. Loughran and Ritter (2002) articulate

prospect theory with respect to investor decisions, citing that investors essentially feel losses

twice as much as they feel equal gains.

Consequently, under-pricing affects the long-run performance of an IPO due to the lowered

chance of loss; this aligns with Brau and Fawcett’s (2006) conclusions that firms will under-

price an IPO in order to avoid future liability, as IPOs that are not under-priced are

significantly more likely to garner legal ramifications.

Bachmann (2004) cites that under-pricing is strategically used to fill in the gaps left by

information asymmetry. The author’s assertion goes against the causal relationship asserted

by Ritter and Welch (2002) which cites that under-pricing encourages information asymmetry.

Ritter and Welch (2002) cite that their model shows that when information asymmetry

approaches zero, under-pricing disappears entirely.

The literature does not discuss the role played by information asymmetry in firm choice to go

public in that there is no contention that information symmetry or asymmetry is part of firm

strategy. Because information asymmetry is connected to under-pricing, it would be in a

firm’s interest to reduce information asymmetry as much as possible.

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Underwriters, conversely, appear to benefit from information asymmetry, as under-pricing is

connected to hot markets, reduced legal liability and higher long-run performance (Banerjee,

Hansen and Hrnjic, 2009: 10; Daily et al., 2003: 275). Bachmann’s (2004) study forges

connections between information asymmetry, under-pricing and market waves, arguing that a

significant portion of under-informed investors will cause under-pricing which is the most

frequent way to address investor risk when information is weak.

With the exception of Habib and Ljungqvist (2000), no studies discuss why under-pricing is

apparently a preferable means of addressing information asymmetry and investor risk. The

authors make a particularly convincing argument with respect to prospect theory, arguing that

owners who care less about potential loss will concurrently care less about under-pricing. If

this is true, then wealth loss may also affect information asymmetry, as the two variables are

so inextricably bound to one another in the literature. Owners not facing a significant loss

would be less likely to seek information symmetry, instead opting to fill in information gaps

with under-pricing. As underwriters have incentive to under-price within reason, they are

unlikely to discourage the practice and urge firms to provide more information to investors.

Specific sources of information asymmetry are also under-discussed in the literature, which is

glaring apparent given the predominance of the variable in all ten studies reviewed.

Information asymmetry in the marketplace, according to Bachmann (2004), can directly

contribute to both under-pricing as well as IPO waves.

Underwriters encourage firms to go public in hot markets, when under-pricing is at its highest,

which may counter the assumption that under-pricing is an effective signal to investors. Brau

and Fawcett (2006) surveyed internal firm stakeholders with respect to under-pricing as a

strategic signal, but underwriters were not a part of any participant pool in the ten studies

reviewed.

While the bulk of the studies were theoretical and not empirical, this is still significant given

the range of assertions made by the researchers regarding underwriter decision-making. If

information asymmetry is the core reason under-pricing exists, then the use of under-pricing

as a signal has far less utility. Mechanisms for boosting information symmetry, such as the

road show and prospectus, received little attention in the literature.

In synthesising the literature, market waves (Habib and Ljungqvist, 2000) seem to be caused

by signals when financially strong firms go public and under-price their IPO; internal

Page | 54

perceptions of this reasoning cite that investors are being compensated for their risk due to

information asymmetry.

The prospect of a loss is far more market-changing than the prospect of a gain and investors

will pursue under-priced stock not because of the promise of long-run performance but

because, fundamentally, they frame the promise of losing money to be less. Hot market

waves are fuelled by underwriters encouraging firms to go public when under-pricing is high,

which also means information asymmetry is higher during a hot market wave. The assertions

made by Bachmann (2004) and Habib and Ljungqvist (2000) are among the most significant

in the study, as they link the variables present in the remaining literature.

Specifically, the most fundamental question remaining after reviewing the ten studies is why

firms would not seek to reduce information asymmetry prior to under-pricing their IPO. The

positive connection between information asymmetry and under-pricing is present in seven of

the ten studies and Habib and Ljungqvist (2000) cite that internal decision-makers simply

care less about under-pricing if their promise of loss is perceived as minimal. The implication

made by the authors is that under-pricing is almost an afterthought for internal decision-

makers, accepted as a necessary evil of sorts that cannot be avoided and underwriters may

well be playing a significant role in strategically under-pricing IPOs to a far greater extent than

necessary.

3.9 CONCLUSION

The most significant gap in the literature is how, precisely, firms could reduce information

asymmetry and therefore also reduce under-pricing, as Brau and Fawcett’s (2006) survey of

356 CEOs did not show information symmetry to be a dominant concern.

While clear decision-making concerns for internal stakeholders and investors exist in the

literature, no such evidence exists for underwriters. The prospect of wealth loss plays a key

role how heavy-handed internal stakeholders are in the IPO process, with lower prospects of

loss fuelling use of under-pricing as a signal and, by extension, IPO waves.

The next chapter of this dissertation aims to explain the methodology of this analysis. The

chapter will include a description of the techniques used for finding the appropriate

information. More specifically, Chapter 4 focuses of the JSE and AltX, with a full and in-depth

analysis of the JSE’s Schedule 21 of the Listing Requirements.

Page | 55

CHAPTER 4: THE JSE AND ALTX

4.1 INTRODUCTION

The objectives of this chapter are to identify and analyse economic and market variables that

influence the pricing of IPOs before they list in South Africa, from a theoretical and practical

perspective. This is undertaken by first understanding the global arena in IPOs (Section 4.2)

and then honing this analysis down to the South African Exchanges (Section 4.3). Note that

the specific focus is on the 63 listed AltX-companies that make up this dissertation’s sample

database (Tables 4.1, 4.2, 4.6 and 4.7 and Appendices 3 and 4).

The 63 companies were assessed on the basis of share price movements (Table 4.2), since

their listing dates on the AltX, followed by an analysis of methods used to determine IPO

pricing (Section 4.5) in South Africa and this is compared to major and relevant JSE indices

(Table 4.5).

The above provides the foundation for an in-depth analysis of the AltX’s Listing

Requirements, as set out in Schedule 21 (Section 4.5.2.1.1). Analysis of Schedule 21 aims to

determine which sections of the Schedule relate to IPO pricing. Specific focus is on

understanding the role of the designated advisor (Section 4.5.2.3.2), with specific focus on

IPO pricing.

This aim of this section is also to assess AltX in relation to AIM, as it is essentially the

Exchange on which AltX was modelled (Section 4.5.3). This provides a basis to determine

the efficiency of AltX as an Exchange (Sections 4.6 and 4.7). This is thus used to determine

whether intrinsic and fair values can be applied to IPOs prior to listing on AltX (Section 4.8).

The last part of this chapter researches pricing determinants as a precursor to Chapter 5,

which deals with empirical analysis and interpretation of the efficacy of AltX as an Exchange.

4.2 IPO AND ECONOMICS: THEORETICAL AND ANALYTICAL ISSUES

In principle, the Stock Market is expected to accelerate economic growth by providing a boost

to domestic savings and increasing the quantity and the quality of investment (Singh, 1997).

The Stock Market is expected to encourage savings by providing individuals with an

Page | 56

additional financial instrument that may better meet their risk preferences and liquidity needs.

Better savings mobilization may increase the savings rate (Levine and Zervos, 1996).

Stock markets also provide an avenue for growing companies to raise capital at lower cost,

when compared to bank loans and the long-term effect of gearing on profits (About.com). In

addition, companies in countries with developed stock markets are less dependent on bank

financing, which can reduce the risk of a credit crunch. Stock markets, therefore, are able to

positively influence economic growth through encouraging savings amongst individuals and

providing avenues for firm financing. The Stock Market is supposed to ensure through the

takeover mechanism that past investments are also most efficiently used (Petros, 2007).

In principle, the stock market is expected to accelerate economic growth by providing a boost

to domestic savings and increasing the quantity and the quality of investment (Singh, 1997).

Theoretically, therefore the threat of hostile corporate events, like takeovers, should provide

management with an incentive to maximize firm value. The presumption is that, if

management does not maximize firm value, there may be shareholders who take advantage

of lower share prices to launch a bid to take control of the company’s share. The enxt step is

usually to replace management and reap the gains from the more efficient firm.

Thus, a free market in corporate control, by providing financial discipline, is expected to

provide the best guarantee of efficiency in the use of assets. Similarly, the ability to effect

changes in the management of listed companies is expected to ensure that managerial

resources are used efficiently (Yartey, 2008).

Efficient stock markets may also reduce the costs of information by generating and sending

out price-related information (Gu and Hit, 2001). Stock markets are efficient if prices

incorporate all available information and, consequently, reducing the costs of acquiring

information is expected to improve investment opportunities. Stock prices determined in

exchanges and other publicly available information may help investor make better investment

decisions and thereby ensure better allocation of funds among corporations and as a result a

higher rate of economic growth.

Stock Market liquidity is expected to reduce the downside risk and costs of investing in

projects that do not pay off for a long time. With a liquid market, the initial investors do not

lose access to their savings for the duration of the investment project because they can

easily, quickly and cheaply, sell their stake in the company (Yartey, 2008).

Page | 57

Thus, more liquid stock markets could ease investment in future, potentially more profitable

projects, thereby improving the allocation of capital and enhancing prospects for long-term

growth. It is important to point out, however, that, theory is ambiguous about the exact

impacts of greater Stock Market liquidity on economic growth. By reducing the need for

precautionary savings, increased Stock Market liquidity may have an adverse effect on the

rate of economic growth.

Critics of the Stock Market argue that, Stock Market prices do not accurately reflect the

underlying fundamentals when speculative bubbles emerge in the market (Yartey, 2008). In

such situations, prices on the Stock Market are not simply determined by discounting the

expected future cash flows, which according to the efficient market hypothesis should reflect

all currently available information about fundamentals.

Under this condition, the Stock Market develops its own speculative growth dynamics, which

may be guided by irrational behaviour. This irrationality is expected to adversely affect the

real sector of the economy as it is in danger of becoming the by-product of a casino. Critics

further argue that Stock Market liquidity may negatively influence corporate governance

because a very liquid Stock Market may encourage investor myopia.

Since investors are re to sell their shares, more liquid stock markets may weaken investors’

commitment and incentive to exert corporate control. In other words, instant Stock Market

liquidity may discourage investors from having long-term commitment to firms whose shares

they own and therefore create potential corporate governance problems with serious

ramifications for economic growth (Yartey, 2008).

Critics also point out that the actual operation of the pricing and takeover mechanism in well-

functioning stock markets lead to short-term and lower rates of long-term investment. It also

generates perverse incentives, rewarding managers for their success in financial engineering

rather than creating new wealth through organic growth (Singh, 1997). This is because prices

react very quickly to a variety of information influencing expectations on financial markets.

Therefore, prices on the Stock Market tend to be highly volatile and enable profits within short

periods. Moreover, because the Stock Market undervalues long-term investment, managers

are not encouraged to undertake long-term investments since their activities are judged by

the performance of a company’s financial assets, which may harm long run prospects of

Page | 58

companies (Binswanger, 1999). In addition, empirical evidence shows that the takeover

mechanism does not perform a disciplinary function and that competitive selection in the

market for corporate control takes place much more on the basis of size rather than

performance (Singh, 1971).

Therefore, a large inefficient firm has a higher chance of survival than a small relatively

efficient firm. These problems are further magnified in developing countries especially sub-

Saharan African economies with their weaker regulatory institutions and greater

macroeconomic volatility.

The higher degree of price volatility on stock markets in developing countries reduces the

efficiency of the price signals in allocating investment resources. These serious limitations of

the Stock Market have led many analysts to question the importance of the system in

promoting economic growth in African countries.

Previous literature examined by this dissertation (See Chapters 2 and 3) has focused

primarily on IPO under-pricing phenomenon (Ljungqvist, 2006; Ljungqvist and Wilhelm, 2003;

Purnanandam and Swaminathan, 2004; Ritter and Welch, 2002) as a performance gauge.

Daily (2005), however, argues that IPO offer pricing, which is a key factor in under-pricing

has remained relatively unexplored in literature.

Paleari and Vismara (2007) also agree that although valuation of IPO is a critical subject,

very little research has addressed this issue. Despite its importance, determinants of IPO

pricing have remained relatively unexplored in the AltX market (Section 4.5.2.2.5).

Most of previous studies of IPOs are based in developed markets such as the US and

Germany. It is therefore of value to study IPO pricing in developing markets such as AltX.

The following overview of the South African stockbroking environment is followed by an

analysis of the efficiency of the JSE and AltX within the global context. This is then followed

by an assessment of IPO pricing determinants.

Page | 59

4.3 SOUTH AFRICAN EXCHANGES

While the JSE is over a century old, it is only in the last 20 years that this South African

Exchange became globally competitive after amendments to the trading system and trading

procedures took place (Appendix 8).

AltX was launched in 2003, after the JSE and the Department of Trade and Industry (DTI)

developed the procedures for the listing of companies on this exchange, which targets small

to medium sized companies.

4.3.1 JSE and AltX

This aim of the research is to assess fair pricing practices for AltX IPOs. To achieve this,

research investigated determinants of IPO pricing for the AltX Exchange in South Africa and

was conducted within the global IPO environment.

The dissertation explores the extent to which investor sentiment, post-IPO ownership

retention, firm size, board prestige and age of the firm affect IPO pricing. The sample period

is between October 2003 (when AltX launched) and 15 November 2012.

Average under-pricing of 8.14% was observed in AltX IPOs for the period under study, but

some companies had Abnormal Initial Returns (AIR) of 44% (AC Towers), 59% (Alert), 139%

(Blue) and 46% (Wearne). AIR is defined as a continued and abnormal rise in a share price

after listing (Langmead, 1998).

TABLE 4.1: ALTX COMPANIES USED IN THE SAMPLE

NO COMPANY NAME SHORT NAME

1 Accentuate Limited AC Towers2 Africa Cellular Towers Limited Accent3 African Dawn Capital Limited Afdawn4 African Eagle Resources Plc Afeagle5 Ah-Vest Limited Ah-Vest6 Alert Steel Holdings Limited Alert7 Alliance Mining Corporation Limited Alliance8 Ansys Limited Ansys9 B&W Instrumentation & Electrical Ltd B&W10 Beige Holdings Limited Beige11 Bioscience Brands Limited Bioscience12 Blackstar Group Se Blackstar13 Blue Financial Services Limited Blue14 Brikor Limited Brickcor15 BSI Steel Limited BSI-Steel16 Chemical Specialities Limited Chemspec

Page | 60

NO COMPANY NAME SHORT NAME

17 Chrometco Limited Chrometco18 Diamondcorp Plc Diamondcp19 Erbacon Investment Holdings Limited Erbacon20 Finbond Group Limited Finbond21 Foneworx Holdings Limited Foneworx22 Gooderson Leisure Corporation Ltd Gooderson23 Hardware Warehouse Limited Hardware24 Huge Group Limited Huge25 Imbalie Beauty Limited Imbalie26 Interwaste Holdings Limited Interwaste27 IPSA Group Plc IPSA28 Iquad Group Limited Iquad29 ISA Holdings Limited ISA30 Kibo Mining Plc Kibo31 Lonrho Plc Lonrho32 M & S Holdings Limited MS Holding33 Moneyweb Holdings Limited Moneyweb34 Mas Plc MAS35 Mine Restoration Investments Ltd MINERESI36 Muvoni Technology Group Ltd Muvoni37 Nutritional Holdings Limited Nutrition38 Oasis Crescent Property Fund Oasis39 Onelogix Group Limited Onelogic40 Osiris Prop International Co Ltd Osiris41 Pinnacle Point Group Limited Pinpoint42 Poynting Holdings Limited Poynting43 PSV Holdings Limited PSV44 Quantum Property Group Limited Quantum45 Queensgate Hotels & Leisure Limited QPG46 Racec Group Limited Racec47 Rare Holdings Limited Rare48 RBA Holdings Limited RBA49 RGT Smart Market Intelligence Ltd RGT50 Rockcastle Global Real Est Co Ltd Rockcastl51 S A French Limited SA French52 Sable Holdings Limited SABLE53 Sherbourne Capital Limited Shercap54 Silverbridge Holdings Limited Silverb55 Stratcorp Limited Stratcorp56 Telemasters Holdings Limited Telemaster57 Total Client Services Limited TCS58 Ububele Holdings Limited Ububele59 Vunani Limited Vunani60 W G Wearne Limited Wearne61 William Tell Holdings Limited Willtell62 Workforce Holdings Limited Workforce63 Zaptronix Limited Zaptronix

Source: JSE, AltX and Business Consultants International, 2012

Page | 61

TABLE 4.2: ALTX COMPANIES: IPO PRICING

NO ALTXIPO SHARE

PRICE(CENTS)

HIGHAFTER

LISTING(Two

Weeks)(CENTS)

DATE%

CHANGE

1 AC Towers 120 173 22-07-07 44.172 Accent 94 94 13-11-08 0.003 Afdawn 5 5 06-01-04 0.004 Afeagle 225 244 10-09-07 8.445 Ah-Vest 50 50 29-12-03 0.006 Alert 135 215 12-04-07 59.267 Alliance 130 135 05-04-05 3.858 Ansys 143 171 11-06-07 19.589 B&W 185 215 12-07-07 16.22

10 Beige 12 13 08-10-03 8.3311 Bioscience 75 87 27-09-05 16.0012 Blackstar 953 1100 23-08-11 15.4213 Blue 125 299 19-10-06 139.2014 Brickcor 165 175 13-08-07 6.0615 BSI-Steel 96 102 25-10-07 6.2516 Chemspec 110 118 09-11-07 7.2717 Chrometco 129 125 22-08-05 -3.1018 Diamondcp 1550 1550 08-04-08 0.0019 Erbacon 290 270 13-12-07 -6.9020 Finbond 225 220 21-06-07 -2.2221 Foneworx 12 10 21-11-03 -16.6722 Gooderson 85 85 02-10-06 0.0023 Hardware 113 100 12-10-07 -11.5024 Huge 310 345 17-08-07 11.2925 Imbalie 61 68 05-09-07 11.4826 Interwaste 178 195 18-06-07 9.5527 IPSA 585 700 25-10-06 19.6628 Iquad 600 597 15-08-07 -0.5029 ISA 3 3 14-10-03 0.0030 Kibo 50 50 22-06-11 0.0031 Lonrho 125 126 21-11-03 0.8032 MS Holding 163 180 27-12-06 10.4333 Moneyweb 173 95 06-07-99 -45.0934 MAS 125 130 14-10-03 4.0035 MINERESI 19 26 20-07-12 36.8436 Muvoni 110 136 15-11-07 23.6437 Nutrition 150 140 12-12-06 -6.6738 Oasis 1030 1550 05-12-05 50.4939 Onelogic 8 8 15-10-03 0.0040 Osiris 13 13 17-09-12 0.0041 Pinpoint 110 75 24-02-06 -31.8242 Poynting 120 105 16-07-08 -12.5043 PSV 80 90 08-05-06 12.5044 Quantum 250 210 21-10-08 -16.0045 Qleisure 20 39 20-01-08 95.0046 Racec 149 190 24-10-07 27.5247 Rare 285 250 05-03-07 -12.2848 RBA 140 135 01-10-07 -3.5749 RGT 10 13 04-06-10 30.0050 Rockcastl 876 989 08-08-12 12.9051 SA French 156 150 15-11-07 -3.8552 Sable 520 545 04-12-03 4.8153 Shercap 58 49 19-12-06 -15.52

Page | 62

NO ALTXIPO SHARE

PRICE(CENTS)

HIGHAFTER

LISTING(Two

Weeks)(CENTS)

DATE%

CHANGE

54 Silverb 145 180 21-04-99 24.1455 Stratcorp 40 40 20-10-03 0.0056 Telemaster 260 298 27-03-07 14.6257 TCS 31 29 17-04-08 -6.4558 Ububele 200 150 17-11-09 -25.0059 Vunani 6250 5500 06-12-07 -12.0060 Wearne 171 250 07-03-06 46.2061 Willtell 429 500 19-07-07 16.5562 Workforce 140 148 27-11-06 5.7163 Zaptronix 3 4 16-09-03 33.33

Source: JSE, AltX and Business Consultants International, 2012

FIGURE 4.1: AVERAGE FIRST DAY RETURNS: USA IPOS

Source: SEC website

TABLE 4.3: USA IPOS

YEAR IPOSAVERAGE FIRST-DAY

RETURN

2003/4 67 12.3%2004/5 184 12.2%2005/6 168 10.1%2006/7 162 11.9%2007/8 162 13.8%2008/9 21 6.4%2009/10 43 10.6%2010/11 103 8.8%2011/12 82 13.2%

AVERAGE TOTAL 120 11.03

Source: SEC website: http://www.sec.gov

In comparison, the USA market during the same period saw the IPO price rise by an average

of 11.03% as set out in Table 4.2 and 4.3. Analysis of the data and public information in

Table 4.2 and 4.3 and Appendix 2 highlight that public information disclosed in prospectuses

in the US and AltX are not always mirrored in IPO offer prices. As such, rational theory

cannot explain the effect of investor sentiment in IPO market in AltX listings.

Page | 63

It can, however, be stated that share pricing information in AltX prospectuses (in relation to

US information) (Appendix 2) is poor. In Bensveniste and Spindt (1989) posit that issuers can

feign themselves to investors as having a higher reputation than they actually have. Derrien

(2005) agrees that pricing of IPOs is a daunting task due to obscurity of discovering an

appropriate comparable firm.

Documentation assessed during the past four years in the field of stockbroking, economics

and the IPO market highlights that researchers in developed countries have documented the

extent of under-pricing of IPOs, but have ignored or avoided identifying the main factors

involved in setting the IPO offer price.

Many researchers such as Cornelli (2004), Ibbotson (1975), Ljungqvist (2006) and

Purnanandan and Swaminathan (2004) have presented evidence that IPOs are generally

under-priced, which refers to the percentage difference between the offer price and the first

day closing price (Paleari and Vismara, 2007). This percentage difference can be difficult to

determine, because privately owned companies are entering into unexplored, volatile territory

when pricing IPOs (Chapter 2, Section 2.2).

Under-pricing is a loss to the issuing firm, because it is a loss of money that could be utilised

for profitable investment opportunities. This phenomenon contradicts one of the major

purposes for companies going public (SEC: listing booklet), which is to raise funds to support

expansion of the firm. In Chapter 3 (Section 3.2) it is stated that the level of funds raised by

the IPO must be measured as a fair and reasonable benefit to the shareholder.

This can only be achieved if IPOs provide the investing public with a series of documentation

citing how the IPO will generate capital and how this capital will be utilized. In Section 3.3.4 it

is also determined that the entrepreneur’s choice to go public is affected by a range of

considerations that are not only defined by the need to generate capital.

This amount of information should enable investors to determine a fair and realistic price for

the IPO, but under-pricing an IPO effectively contradicts efficient market hypothesis, which

postulates that share prices must fully reflect all publicly and privately available information.

As compared to developed markets the number of companies going public on the AltX is low.

For example, a study by Daily (2005) shows that more than 773 firms went public in the

United States between 1996 and 1997 and 992 listed since 2003. This compares to the total

Page | 64

amount of companies listed on AltX since its launch of 100, which occurred in August 2012

when Bermuda-based Osiris Properties International listed on AltX (AltX website).

Of these 100 companies, 21 have successfully transferred to the JSE's Main Board and 16

have delisted, leaving 63 companies currently listed on AltX; which forms the sample of this

dissertation. These are set out in Appendices 3 and 4 and Tables 4.1 and 4.2.

4.4 GLOBAL EXCHANGES: SMALL AND MEDIUM ENTERPRISE (SME)

The objective of SME exchanges is to provide a way for smaller companies to raise capital

(World Federation of Exchanges, 2011). These companies, due to their smaller sizes, cannot

raise capital from larger exchanges. The companies which would want to raise money from

SME exchanges would generally range from young, venture capital-backed start-ups to well-

established, mature organisations looking to expand.

These small and mid-sized firms usually cannot meet the stringent requirements that are

necessary for listing on bigger exchanges. SME exchanges are designed specifically for

these companies. These exchanges provide a way for the small companies to get listed and

also provide an alternative investment option for the investors, who can buy the equity of

smaller businesses.

There are numerous reasons why a small company would want to get itself listed on an SME

exchange. The reasons are essentially the similar to why any company would want to go

public. But, the priorities in the case of the small firms are different. For example, listing on an

Exchange creates a heightened public profile of a small company. This is very important for

most small companies getting listed on SME exchange, but not as important for a well-

established company getting listed on a major exchange.

According to the SEC booklet on SMEs (2012) some of the reasons why a small company

wants to get itself listed on an SME Exchange include:

• To provide access to capital for growth.

• To create a market for the company’s shares.

• To place an objective market value on company’s business.

• To encourage employee commitment by making share schemes more attractive.

• To increase the company’s ability to make acquisitions using quoted shares as currency.

• To create a heightened public profile.

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• To enhance status with customers and suppliers.

There are many SME exchanges around the world. Presently, India does not have such an

exchange. Examples of some of the popular SME exchanges around the world are:

• AIM London.

• NYSE Alternext.

• JSE Alternative Exchange South Africa.

• Market for Alternative Investment (MAI) Thailand.

• TSX Venture Exchange Canada.

• Mothers (Market of the high-growth and emerging stocks) Japan.

• Gems - Hong Kong.

• KSODAQ – Korea.

4.5 METHODS OF OBTAINING AN IPO: SOUTH AFRICA

In South Africa, there are three principle methods of obtaining a listing:

An introduction: This method can be used where the company does not need to raise

capital and has a sufficiently wide public spread of shareholdings. It is the quickest and

cheapest method of listing, as there is no offer to the public and minimum formalities are

required (Magliolo, 2004).

A private placing: This has proved to be the most common method of obtaining a listing.

In this instance, shares in the company are placed or offered to prospective shareholders

through private negotiation. Usually this will be done through a sponsor or a merchant

bank.

A public offer: A public offer can either be an offer for subscription or an offer for sale:

o Offer for subscription: the public are invited to subscribe for unissued shares

and the proceeds accrue to the company.

o Offer for sale: existing shareholders invite subscribers to purchase their shares

and therefore the proceeds accrue to the shareholders. This method requires

a prospectus that must be approved and registered with the Registrar of

Companies:

Page | 66

The public will have a certain period of time within which to submit their

applications and payment. It is up to the company to decide on the

basis of allocation if there is an over-subscription.

If the offer is over-subscribed, the company earns interest on the

payments received until the date of refund. This increase may be used

to offset the costs of the offer.

4.5.1 The JSE

TABLE 4.4: JSE MARKET CAPITALISATION

JSE MARKETCAPITALISATION

WEEKENDED

16-11-2012

WEEKENDED

18-11-2011

% CHANGEYEAR-ON-YEAR

Value in Rand Billion 7,955.80 6,848.61 16.17

Source: JSE website, 2010-2012

TABLE 4.5: INDICES PERFORMANCE: YEAR-ON-YEAR

INDEX NAME INDEX CLOSE INDEX CLOSE % CHANGEYEAR-ON-YEAR

HIGH VALUE LOW VALUE

15-11-2012 15-11-2011

All Share 36,818.76 31,812.66 15.74 37,553.99 36,756.10

Mid Cap 51,788.79 42,812.13 20.97 52,461.04 51,551.90

Small Cap 38,613.39 31,916.48 20.98 38,720.15 38,392.37

Top 40 32,612.45 28,431.41 14.71 33,336.60 32,571.66

Resource 10 47,801.64 52,919.35 -9.67 49,885.44 47,676.56

Industrial 25 38,017.87 28,220.05 34.72 38,804.26 37,993.51

Financial 15 10,305.28 7,933.71 29.89 10,396.93 10,201.35

Financial & Industrial 30 41,302.33 30,973.53 33.35 41,990.90 41,229.98

Gold Mining 2,283.81 3,099.96 -26.33 2,466.50 2,260.80

AltX 1,048.96 1,383.83 -24.20 1,077.75 1, 007.81

Source: JSE website, 2010-2012

THE Johannesburg Securities Exchange (JSE) is the 16th largest in the world and by far the

largest of Africa's 22 stock exchanges. Market capitalisation at the end of December 2003

stood at R4,029-billion, up from R1,160-billion five years earlier. The market cap in 2011 was

R6,848 billion. In 2003 the JSE had an estimated 472 listed companies. Today there are 406

listed JSE companies.

The JSE describes itself as the "engine room" of the South African economy, providing an

orderly market for dealing in securities. Its main function is to facilitate the raising of primary

capital by re-channelling cash resources into productive economic activity and building the

Page | 67

economy while enhancing job opportunities and wealth creation. The JSE also provides an

effective price determination facility and price risk management mechanism.

As per the outcome of the World Economic Forum's 2009/2010 Global Competitiveness

Review, the JSE was ranked as the sixth most sophisticated financial market globally and 2nd

in terms of regulation while South Africa was ranked 4th in the world as a venue through

which finance may be raised through the local Equity Market (JSE Equity market profile;

January 2012)

The JSE is privately owned and funded and governed by a Board of Directors (JSE Website).

Its activities are licensed and regulated by two Acts of Parliament, namely the Stock

Exchanges Control Act, 1 of 1985 (SECA), which governs the equities markets and the

Financial Markets Control Act, 55 of 1989 (FMCA), which governs the derivatives markets.

In keeping with international practice, the JSE also acts as regulator of its members and

ensures that markets operate in a transparent manner, ensuring investor protection. Similarly,

issuers of securities must comply with the JSE Listings Requirements, which aim to ensure

sufficient disclosure of all information relevant to investors.

The JSE's roles include regulating applications for listing and ensuring that listed companies

continue to meet their obligations. The JSE monitors applications for alterations to existing

listings and scrutinises company disclosures to the public. The JSE also provides a Stock

Exchange News Service (SENS) through which company news, including price-sensitive

information, is distributed to the market.

The JSE has been bold in restructuring in the light of increasingly tough global competition,

adopting new technologies and outsourcing aspects of its business (JSE website, 2010).

The key challenges the JSE faced were:

The worldwide consolidation of markets and infrastructure meant that emerging markets

were finding it more and more difficult to stay relevant.

The ageing JSE trading technology outgrew its capacity, unable to cope with the

increased number of deals that needed to be processed each day.

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A number of South Africa's biggest listed companies moved their primary listings to

London in the late nineties to be more attractive to international investors. This loss

caused concern in the South African market and resulted in decreased trade on the JSE.

The first major change occurred in November 1995, when the Stock Exchanges Control

Act changed the way in which stocks were traded in South Africa, opening the doors to

non-South Africans and allowing brokers to buy and sell stock for their own account

(where previously they could only act as agents for their clients).

New capital adequacy requirements, based on European Union requirements, require the

separation of clients' funds from those of brokers.

The traditional open outcry market - in which traders jostled for deals on a noisy trading

floor - has now disappeared, replaced by a less colourful, but faster, computer-driven

trading system (the Johannesburg equities trading (JET) screen-based system).

The JSE has been opened to corporate membership, resulting in a stampede by foreign

banks, who have bought out most of the major local broking firms, using these as

platforms for other financial services, such as corporate and government advisory work.

A Stock Exchange News Service (SENS) was launched in 1997 (Appendix 1, No 6),

offering real time prices. Listed companies are expected to disseminate any corporate

news or price-sensitive information on the service prior to using any other media outlet.

SENS aims to ensure early, equal and wide dissemination of any information that may

have an effect on prices and improves communication between listed companies and the

investing community.

The classification of listed companies was simplified in mid-1999, combining sectors that

were considered to be subject to similar economic and political pressures.

The introduction of an electronic settlement system (STRATE - Share Transactions

Totally Electronic) to replace the previous manual settlement of scrip.

Change of name to JSE Securities Exchange South Africa. It has since been renamed to

JSE Limited.

Page | 69

The introduction of an alternative exchange, called AltX, to entice black-owned

businesses to go public.

In 1999, the JSE hired the financial consulting firm Accenture, which had assisted with the

implementation of the electronic settlement system, STRATE, to broker a strategic

relationship between the JSE and the London Stock Exchange (LSE). The JSE's trading and

information systems were replaced with the LSE's Sequence and LMIL systems, branded

JSE SETS and InfoWiz respectively. The trading engine and information dissemination feed-

handler is hosted in London and connected remotely to the JSE (Joburg website, 2011:

http://www.joburg.org.za).

The JSE also aligned their equities trading model with that of Europe and reclassified their

instruments in line with the FTSE Global Classification system. This has led to the

introduction of the FTSE/JSE Africa Index Series that makes the South African Indices

comparable to similar indices worldwide. Implementation was completed in June 2002 and

opened by South African President Thabo Mbeki and British Deputy Prime Minister John

Prescott, who described the deal as an historic partnership. The investment community is

now served by one of the most reliable trading platforms worldwide (Joburg website, 2011).

Trade information of instruments listed on the JSE can now be disseminated by the LSE to

more than 104,000 trading terminals around the world, raising the profile of the JSE among

the international investor community.

4.5.2 The Alternative Exchange (AltX)

TABLE 4.6: ALTX MARKET CAPITALISATION

NO ALTXMARKET

CAP % OF TOTAL(Rand million)

1 AC Towers 66 0.4752 Accent 19 0.1373 Afdawn 59 0.4254 Afeagle 180 1.2965 Ah-Vest 20.4 0.1476 Alert 81.8 0.5897 Alliance 233 1.6788 Ansys 29 0.2099 B&W 140 1.008

10 Beige 114 0.82111 Bioscience 29.1 0.21012 Blackstar 902.9 6.50113 Blue 2,500.0 17.99914 Brickcor 38.7 0.279

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NO ALTXMARKET

CAP % OF TOTAL(Rand million)

15 BSI-Steel 331.1 2.38416 Chemspec 612.1 4.40717 Chrometco 42.5 0.30618 Diamondcp 216.6 1.55919 Erbacon 366 2.63520 Finbond 221.2 1.59321 Foneworx 251.6 1.81122 Gooderson 82.5 0.59423 Hardware 70.1 0.50524 Huge 126 0.90725 Imbalie 82.9 0.59726 Interwaste 214.1 1.54127 IPSA 33 0.23828 Iquad 98.2 0.70729 ISA 116 0.83530 Kibo 394.2 2.83831 Lonrho 1,800.00 12.96032 MS Holding 51 0.36733 Moneyweb 62.5 0.45034 MAS 505.5 3.63935 MINERESI 118 0.85036 Muvoni 22.2 0.16037 Nutrition 42 0.30238 Oasis 558.7 4.02339 Onelogic 400.7 2.88540 Osiris 8.9 0.06441 Pinpoint 83.1 0.59842 Poynting 128 0.92243 PSV 49.1 0.35444 Quantum 29 0.20945 QLesiure 18 0.13046 Racec 93 0.67047 Rare 143.1 1.03048 RBA 57.9 0.41749 RGT 48.6 0.35050 Rockcastl 1,150.00 8.28051 SA French 61.2 0.44152 Sable 211 1.51953 Shercap 18.2 0.13154 Silverb 27.8 0.20055 Stratcorp 21.6 0.15656 Telemaster 32 0.23057 TCS 15.6 0.11258 Ububele 78.5 0.56559 Vunani 200 1.44060 Wearne 33.2 0.23961 Willtell 11.3 0.08162 Workforce 120 0.86463 Zaptronix 7.6 0.055

TOTAL 13,889.3 100.00

Source: PDSNet, 2012

The Exchange launched in October 2003 as a nursery for the JSE Main Board, replacing the

failed Venture Capital and Development Capital Boards established as sub-sets of the main

board in the 1980s. It was intended to encourage entrepreneurship, especially among South

Africa's emerging black middle class (Gstraunthaler, 2010: 154).

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Beige Holdings Limited and Insurance Outsourcing Managers' Holding Limited were the first

companies to list, in January 2004.

AltX plays an "important macroeconomic role" in developing South Africa, according to Nicole

Cheyne, newly appointed AltX spokeswoman (interview; Economic Trends: I-Net Bridge; 25

June 2012 17:42)

John Burke, director of issuer services at the JSE (interview; Economic Trends: I-Net Bridge;

25 June 2012 17:42), said a dedicated AltX spokesperson had become necessary given the

growing importance of and interest in, the alternative exchange.

The board was created to help small- and medium-sized businesses raise capital for growth,

she said and attracted a "full spectrum" of investors, including those keen to add high-risk,

high-return assets to their portfolios.

AltX has a market cap of R13.9 billion, but only 7 companies make up 70% of the value of the

exchange.

TABLE 4.7: ALTX HIGH NET WORTH COMPANIES

NO. ALTXMARKET CAPITALISATION

(Rand Million)

1 Blue 21.950

2 Lonrho 15.804

3 Rockcastl 10.097

4 Blackstar 7.928

5 Chemspec 5.374

6 Oasis 4.905

7 MAS 4.438

TOTAL 70.5%

Source: PDSNet, 2012, Business Consultants International, 2012

4.5.2.1 AltX - A South African SME Stock Exchange

4.5.2.1.1 Analysis of Schedule 21 of the JSE’s Listing Requirements

Investors and entrepreneurs looked forward to the launch of AltX in October 2003; a

partnership between the JSE, DTI and Wits. This long-awaited alternative market had been

touted to investors and entrepreneurs alike for four years by the JSE.

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The aim was for AltX to form part of the JSE, but function as a parallel market for smaller

companies that needed to raise capital; or, for those entrepreneurs listed on the VCM or

DCM, who wished to move to AltX. The aim of the JSE was to promote listed AltX companies

to eventually move onto the Main Board; after being nurtured and promoted by a designated

advisor and research sponsor (See Section 4.2).

One question asked on numerous occasions was whether investing in AltX companies was

riskier than investing in JSE Main Board listed companies? Being an Stock Exchange

targeting SMEs must, by its nature, mean that there would be an element of higher risk. The

objective of AltX was to provide a high quality migratory platform to the Main Board.

The JSE has considered this risk factor with due care and, to minimize these risks, its listing

requirements include a compulsory Director’s Induction Programme (DIP) (see Section

4.5.2.2.9), the appointment of a Designated Advisor (DA) (see Section 4.5.2.2.6) and an AltX

Advisory Committee. These controls were implemented to lessen the risk associated with

SMEs.

Among the host of listing requirements to qualify for a listing on AltX, companies must have a

subscribed capital base of R2-million and a minimum of 100 public shareholders (Appendix 1,

No 2).

There are two distinct advantages for entrepreneurs and investors to list their companies on

AltX:

• These SMEs are expected to ultimately reach a stage where they comply with the criteria

for the Main Board and the JSE might transfer their listing to that board.

• Companies with higher net worth than share price that are listed on the DCM or VCM –

and that do not want to be transferred to AltX – would have to pay out minorities.

The JSE has indicated that over time (JSE website), it will clean up the Main, Development

Capital and Venture Capital Boards, with the last two eventually disappearing. In addition,

AltX will be marketed to investors by the JSE.

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4.5.2.1.2 Advantages for Companies Listing on AltX

Companies that list on AltX have a lower listing costs (Appendix 1), which include reduced

listing fees, reduced STRATE fees and a relaxation of the requirement to publish company

announcements in the media. The regulations governing corporate activity and the

requirement for circulars to shareholders and/or shareholder approvals have also been

relaxed.

Former AltX Head, Noah Greenhill (Magliolo, 2004: xiii): “AltX is forecast to become the

single most substantial source of corporate funding in South Africa. There are extensive

benefits to listing; from a financial company shareholder, director and employee points of

view”.

This does not mean that such companies will be less supported by the full range of JSE

services. They will have access to the same trading platform, market surveillance,

dissemination of company information through the Stock Exchange News Service (SENS),

settlement through STRATE - the JSE's electronic trading system - and compliance

supervision by the listings division of the JSE. So, investors have a security blanket.

It is well known that, with a few exceptions, the development capital and venture capital

boards of the JSE have been a dismal failure (Vanek, 2007). Not only did the bourse struggle

to attract quality companies and investors, it became the hunting ground for opportunists and

speculators. On the other hand, AltX is meant for the serious entrepreneur and investor and

there are distinct short- and long-term advantages of this form of capital raising.

Flotation on a public market is first and foremost an opportunity to raise funds immediately

and in the future. There are many reasons why a company might consider going public on

AltX:

• To provide access to capital for growth, giving a company the opportunity to further

development - both at the time of flotation and later, through further capital issues.

• To create a market for a company's shares, broadening the shareholder base and giving

existing shareholders the chance to exit. It is an investor’s Exit Strategy. Increased

liquidity is an attraction for shareholders, particularly in South Africa, where liquidity is a

continued problem (Fin24, 2010).

Page | 74

The process of taking a company through to listing will result (at some stage) in a company

valuation by the DA (See Section 4.5.2.2.6). Essentially, it places an objective market value

on a company's business:

• To encourage employee commitment by making share schemes, which are an attractive

incentive for employees' long-term motivation.

• To increase the company's ability to make acquisitions, using quoted shares as a means

of raising funds.

• To create a heightened company profile, stemming from increased media coverage that

aim to maintain liquidity in a company's shares. This improved profile will benefit

shareholders, clients, staff and directors.

• To enhance the company’s status with customers and suppliers, who are reassured by

the regulations involved in the company's listing on AltX. It also acts as a conduit to

attracting new investors and investment.

The process of market research, due diligence and the development of a business plan

forces entrepreneurs to adopt a more professional attitude to financial and news reporting.

This improves information dissemination both internally and externally.

4.5.2.2 Listing Requirements

This section assesses the AltX listings requirements as set out by Schedule 21 of the JSE

Securities Exchange (South Africa) (JSE website). In drafting these requirements, former

head of AltX, Greenhill recognized that the decision to invest in the shares of AltX companies

would be affected by confidence (Magliolo, 2004). As such, confidence would be influenced

by a company’s willingness to abide by market rules and the ease with which investors could

buy and sell their shares.

Therefore, it can be concluded that the key to the success of the market is transparency and

liquidity (Wuyts, 2007). For this reason, there is an emphasis on the appointment of

Designated Advisors to assist entrepreneurs with understanding AltX Listing requirements

(Section 4.5.2.2). Furthermore, there is a critical need for the entrepreneur to understand that

AltX companies must have a programme for on-going marketing to shareholders; through

media coverage and analytical reports to the investment community.

This continuous relationship and communication with shareholders and the public should

enhance liquidity levels. Therefore, the main focus of the AltX Section 21 is to include

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requirements that achieve these aims, namely the appointment of a Designated Advisor and

the compulsory directors’ induction programme.

However, as highlighted by the regulations set out hereunder, no actual legislation exists to

determine a fair pre-IPO share price.

Comments by former AltX head, Greenhill, at the AltX Directors’ Induction Programme in

2010 highlight this factor: “Listing your company on AltX is a contract between you (the

entrepreneur), the Designated Advisor and the JSE. You must therefore fulfil these rules to

determine at what price you will list, at what date and how you intend to run your company”.

In addition, no profit history is required for a listing on AltX and a share capital has been

limited to R2-million. Listing and annual JSE fees have been significantly reduced, but there

is a greater level of emphasis towards higher qualified expertise, transparency and corporate

governance.

The following sections follow the Section 21 Listing Requirements. This section contains the

requirements that must be satisfied by issuers wishing to apply for, or which have a listing on,

the AltX. The main heading sections of the AltX’s Listing Requirements Schedule 21 are set

out in Table 4.8.

TABLE 4.8: SECTION 21 OF THE JSE LISTING REQUIREMENTS

SCHEDULE 21 SECTIONS CONTENT

21.1 General

21.2 to 21.4 Conditions for Listing

21.5 Publication

21.6 Corporate Governance

21.7 Public Shareholders

21.8 Issues for Cash

21.9 Pre-Listing Statements

21.10 Financial Information

21.11 Transactions

21.12 Related Party Transactions

21.13 to 21.35 Designated Advisor ("DA")

21.36 to 21.39 Documents to be submitted and published

21.40 Fees

Source: JSE Listing Requirements

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4.5.2.2.1 Section 21.1: General

The section starts off with a general comment that, while AltX concentrates on a new listing

requirements section (namely 21), both entrepreneur and investor must comply with ALL the

JSE Securities Listings Requirements, i.e. Sections 1 to 21. To complicate matters, there are

exceptions, which are discussed below.

4.5.2.2.2 Sections 21.2 To 21.4: Conditions for Listing

These three sections concentrate on the suitability of an entrepreneur being granted a listing

on AltX.

4.5.2.2.3 Section 21.2 (a): A Market for SMEs

AltX is a market for SMEs, but not every company that is in a growth phase will be granted a

listing. For instance, SMEs that meet the criteria for listing on the Main Board or any other

sector will not necessarily be granted a listing on AltX. The JSE reserves the right to request

that these entrepreneurs reroute their applications to other sectors of the JSE.

4.5.2.2.4 Section 21.2 (b): Timing Issues

When the entrepreneurs’ AltX listed company reaches the stage where they comply with the

JSE Main Board criteria, the Exchange may require that the company transfers their listing to

the Main Board.

4.5.2.2.5 Section 21.3: Listing Requirements

In addition to listing requirements set out by the JSE Listing Requirements, entrepreneurs

wishing to apply for a listing on AltX must comply (and after the listing has been granted, on a

continuing basis) with the following requirements; as set out under the following sections.

4.5.2.2.6 Section 21.3 (a): Appoint a Designated Advisor (DA)

A DA must be appointed and the terms of the appointment must be in accordance with

Paragraph 21.13, which sets out the terms and conditions for DAs.

4.5.2.2.7 Section 21.3 (b): Share Capital Requirements

Applicants must have a share capital of at least R2 million, which includes reserves, but

excludes minority interests. Revaluations of assets and intangible assets must be supported

by a valuation undertaken by an independent professional expert, who is acceptable to the

JSE. In addition, it has to have been prepared within the last six months.

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4.5.2.2.8 Section 21.3 (c): Public Interest in AltX Companies

The public must hold a minimum of 10% of each class of equity securities and there must be

at least 100 public shareholders.

4.5.2.2.9 Section 21.3 (d): Director Education

The directors of an AltX company must complete the AltX Directors Induction Programme

(DIP) or must make arrangements to the satisfaction of the JSE to complete it.

4.5.2.2.10 Section 21.3 (e): Appointment of a Financial Expert

The entrepreneur seeking an AltX listing for his company must appoint an executive financial

director and the DA must be satisfied that the financial director has the appropriate expertise

and experience to fulfil the role. In addition, the DA must submit confirmation of such

appointment in writing to the JSE.

4.5.2.2.11 Section 21.3 (f): Financial Forecasts

The entrepreneur must produce a profit forecast for the remainder of the financial year during

which it will list and one full financial year thereafter.

4.5.2.2.12 Section 21.3 (g): Directors’ Shareholding

The applicant’s auditors or attorneys must hold in trust 50% of the shareholding of each

director and, if the DA holds shares, 50% of these as well. This has to be done from the date

of listing and a certificate to that effect must be lodged with the JSE by the auditors or

attorneys. These securities, whether new or existing, are to be held in trust until the

publication of the audited results for the periods outlined in Section 21.3 (f). Once the results

have been announced, the 50% may be released and the balance one year thereafter. These

securities may only be released after notifying the JSE.

In fact, studies (Zachary, 2009) indicate that there is no direct evidence that placing a lockup

on shares to prevent directors from offloading shares, has a positive influence on share

prices. The study examined a sample of 5,559 lockup expirations and evaluated whether

investors holding these securities, during the five-day period surrounding the expiration of the

lockup period, experienced abnormally negative buy and hold abnormal returns.

4.5.2.2.13 Section 21.3 (h): Non-executive Directors

At least 25% of the directors must be non-executive.

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4.5.2.2.14 Section 21.4: Warning Statements on Documents

The front cover of all documents, including announcements, circulars and annual reports,

issued or published by the applicant must contain an appropriate warning in bold. This

warning relate to the following:

Risks of investing in an AltX company, particularly the company involved.

The JSE does not guarantee the viability or success of the applicant.

The importance of the DA. If the company fails to retain a DA, it faces suspension within

the specified time and subsequent termination without the prospect of an appropriate

offer.

4.5.2.2.15 Section 21.5: Publication

Corporate announcements must be published on the following sites:

Stock Exchange News Service (SENS).

The company’s web site (where one exists).

The AltX website.

This is only a minimum and the JSE would encourage voluntary publication in the media.

4.5.2.2.16 Section 21.6: Corporate Governance

All the provisions of the Listings Requirements relating to corporate governance are

applicable with the exception of paragraphs 3.84 (c) and (d) of the King Code on Corporate

Governance. Effectively, the exclusion of Section 3.84 (c) means the entrepreneur does not

have to state in his annual report that he complies with King II. And, the exclusion of Section

3.84 (d) means that setting up a host of committees can now be avoided. However, an audit

committee must be appointed to fulfil the role as set out in the King Code.

This committee must comprise the non-executive directors and the DA as a minimum. The

audit committee may not include any of the executive directors.

4.5.2.2.17 Section 3.84 (c)

This states that entrepreneurs must be in compliance with the King Code of Corporate

Governance and must, therefore, disclose such compliance in their annual reports.

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4.5.2.2.18 Section 3.84 (d)

This states that entrepreneurs must, in compliance with the King Code, appoint an audit

committee and remuneration committee and if required, given the nature of their business

and composition of their board, a risk committee and nomination committee. The composition

of such committees, a brief description of their mandates, the number of meetings held and

other relevant information must be disclosed in the annual report.

4.5.2.2.19 Section 21.7: Public Shareholders

AltX provisions state that any shareholding that is held beneficially, whether directly or

indirectly, by the DA will not be regarded as being public.

4.5.2.2.20 Section 21.8: Issues for Cash

Entrepreneurs must comply with all the provisions of the Listings Requirements relating to

general share issues for cash with the following exceptions:

• The percentage of shares for cash may not exceed 50% of the issue.

• To issue 50% of the shares for cash, an approval is required by 75% of all

shareholders. This approval can be represented by proxy at the general meeting, but

must exclude the DA, controlling shareholders and associates.

4.5.2.2.21 Section 21.9: Pre-Listing Statements

Issuers must comply with all the provisions of Section 6 of the Listings Requirements, which

sets out the legal requirements of pre-listing statements. This includes requirements for pre-

listing statements, responsibility of directors and formal approval.

The exception for AltX is in the amount of new shares that can be issued within a three month

period. Under the Listing Requirements, a new issue of shares that would increase the share

issued capital is limited to 30%. This is paragraph 6.19(g).

Under AltX, this percentage is 50%.

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4.5.2.2.22 Section 21.10: Financial Information

All the provisions of section 8 of the Listings Requirements are applicable to AltX companies.

This Section outlines rules for financial statements, including income statement, balance

sheet, statement of changes in equity, cash flow statement, accounting policies and financial

notes.

The exception is found in Paragraph 8.4, which states that three years of historic financial

information is required. AltX companies only need to submit one year of financial information.

4.5.2.2.23 Section 21.11: Transactions

Entrepreneurs must comply with all the provisions of Section 9 of the Listings Requirements

when undertaking a transaction as a listed company. This section of the Listings

Requirements deals with transactions in relation to acquisitions and disposals by a listed

company. It describes how these are categorized, what the requirements are for

announcements and circulars and whether shareholder approval is required for such

transactions.

Before Section 9 is explained, mention of “percentages” under this section needs to be

explained. These ratios are the figures, expressed as a percentage, that result from each of

the following:

Market capitalization: The transaction being considered divided by the aggregate market

value of all the equity securities of the listed company.

Dilution: The number of securities issued by a listed company as consideration for an

acquisition compared with those in issue prior to the transaction.

Transactions to be settled in part cash and part shares: The category size for such a

transaction is to be calculated by first assessing the cash to market capitalization

percentage and then adding this percentage to the dilution percentage.

In circumstances where either of the above calculations produces an anomalous result, or

where the calculations are inappropriate to the sphere of activity of the listed company, the

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JSE Committee may disregard the calculation and may substitute other relevant indicators of

size.

Where all or part of the transaction is in the form of securities to be listed, the “transaction”

means the aggregate market value of those securities based on the ruling price of these

securities. The calculation must be done at the time when the transaction is announced.

The transaction consideration is the amount paid to the vendors, but the JSE Committee may

require the inclusion of further amounts. For instance, where the purchaser agrees to

discharge any liabilities, whether actual or contingent, of the vendors as part of the terms of

the transaction. If the consideration is deferred or may be payable in the future, the

consideration is the maximum possible total consideration payable under the agreement. If

the total consideration is not subject to any maximum the transaction will normally be treated

as Category 1, notwithstanding the category into which it otherwise falls.

TABLE 4.9: ALTX SCHEDULES 9.3 TO 9.5

SECTION REQUIREMENT

9.3 Any listed company considering a transaction must, at an early stage, consider the transaction

categories.

9.4 A transaction is categorized by assessing its size relative to that of the listed company

proposing to make it and the listed holding company of such listed company, if applicable.

9.5 The different categories of transactions are:

Section 9.5 a: Category 4. A transaction where either of the percentage ratios are less than

10, but more than 5.

Section 9.5 b: Category 3. A transaction where any percentage ratio is 10 or more but each

is less than 20.

Section 9.5 c: Category 2. A transaction where any percentage ratio is 20 or more, but each

is less than 30.

Section 9.5 d: Category 1. A transaction where any percentage ratio is 30 or more.

Section 9.5 e: Reverse take-over. Any transaction, or series of transactions, involving an

acquisition by a listed company of a business, an unlisted company or assets that would result

in a fundamental change in the business or in a de jure change in board or voting control (in

terms of the SRP) of the listed company, except in the circumstances outlined

In paragraph 9.11.

Source: JSE Securities Exchange (South Africa) Listing Requirements, 2002

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Notwithstanding the provisions of Paragraph 9.5, an AltX transaction will be categorized as:

A Category 1 transaction where any percentage ratio is 50% or more.

A Category 3 transaction where the percentage ratio is less than 50%.

4.5.2.2.24 Section 21.12: Related Party Transactions

Entrepreneurs must comply with the provisions of Section 10 of the Listings Requirements

with some exceptions. Therefore, it is important to describe what this section entails before

setting out the exceptions.

4.5.2.2.25 Section 10 of the JSE Listings Requirements

This provides certain safeguards against those shareholders, directors and other persons

related to a listed company taking advantage of their position within the company.

Transactions with parties related to a listed company are known as related party transactions.

Reference should also be made to the Listings Requirements regarding transactions set out

in Section 9 of the Listing Requirements. Where any transaction is proposed between a listed

company (or any of its subsidiaries) and a related party, a circular to shareholders and the

approval of the shareholders of the listed company in a general meeting will normally be

required.

Any corporate finance-related issue is detailed in a circular to shareholders. This is done in

connection with a related party transaction and must provide sufficient information to enable

any recipient of the circular to evaluate the effects of the transaction on the listed company.

4.5.2.3 Other Important Issues

The following issues are important to note, but are not related to pre-IPO pricing.

All related party transactions must be announced, irrespective of the size of the

transaction.

The fair and reasonable statement in respect of transactions that are greater than 10%,

but less than 50% may be given by the DA. In such a case, the DA may not be a party to

the transaction and he may also not have any other vested interest in the transaction

other than being a shareholder.

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4.5.2.3.1 Sections 21.13 to 21.39: Designated Advisors

AltX has created the role of the Designated Advisor to help entrepreneurs through the fairly

complex process of listing. The DA is expected to play a key role in ensuring companies

comply with the listing requirements. This should provide investors with a level of confidence

and reassurance that their investments are based on transparency and solid corporate

governance.

The main role of a DA is to competently, professionally and impartially advise an

entrepreneur who wishes to list his company on:

All his responsibilities during the application process.

All his responsibilities after the listing process have been completed.

The DA must ensure the following:

The company’s full compliance with the applicable JSE and AltX Listings Requirements.

Submission of all relevant documentation, as stated in the Listings Requirements.

Suitability of listing a company on AltX.

Pre-listing statements have been accurately completed to meet Listings Requirements.

Directors have requisite expertise and experience to run a listed company and that these

directors can prepare and publish all corporate and financial information.

Directors complete the Directors Induction Programme within two months of their

appointment.

That they attend all company board meetings in an advisory capacity.

4.5.2.3.2 List of DA Functions

This section deals with the crux of the IPO pricing dilemma in South Africa, with specific

reference to AltX. It is the duty of the DA to guide the entrepreneur to a successful listing and

to ensure that the pre-IPO share price is fair to both entrepreneur and investor. In view of

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information set out in Table 4.2 it can be argued that gthis does not appear to have

happened.

The following duties must be undertaken by DAs for companies listed on AltX, which is

important to understand and acts as a checklist for DAs when an initial consultation is made

with the entrepreneur.

Monitoring of directors, role of financial director, shares held in trust, share dealings of

directors within open/closed periods:

SENS approvals/publications.

Cautionary announcements.

Monitoring of share prices. This is only place in Schedule 21 that a company’s share

price is mentioned. Note that it only establishes that the DA must monitor the share

price.

Review and publication of results on SENS, AltX and company’s web site.

Annual report including resolutions for AGM (at office) must be submitted to AltX in

electronic format.

Corporate Governance reviews.

Preparation for and attendance of audit committee meetings.

Announcement of all related party transaction matters announced.

Maintaining on-going contact with client on changes/updates to Listings

Requirements.

Regular review of trading performance and financial condition/position; monitoring

management accounts.

Preparation for and attendance of board meetings in advisory capacity.

Attendance of forums with/on behalf of clients.

Annual listings compliance review for JSE.

Quarterly meetings to address business conditions and strategy; and sundry

discussions.

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4.5.2.4 Responsibility of DAs

4.5.2.4.1 Section 21.17

The DA's role is of particular importance to the successful operation of AltX, since it is the

expectation of the JSE that each issuer must, with the guidance and assistance of the DA,

comply with and discharge its responsibilities under the Listings Requirements. In this regard,

the DA is expected to be the entrepreneur’s advisor in all matters pertaining to the listing.

4.5.2.4.2 Section 21.18

The DA must ensure at all times that their conduct or judgement does not impair the integrity

and reputation of AltX.

4.5.2.4.3 Section 21.19

The DA must immediately inform the JSE in writing, if the entrepreneur does not comply with

the applicable regulation as set out in Section 21.20 (f) – set out in the following text.

4.5.2.4.4 Section 21.20

The DA must, prior to listing, confirm in writing to the JSE that the following have been

completed:

Section 21.20 (a): All the documents required by the Listings Requirements have been

submitted.

Section 21.20 (b): It considers the new applicant suitable for listing on AltX.

Section 21.20 (c): The new applicant complies with all the conditions for listing set out in

the Listings Requirements.

Section 21.20 (d): The pre-listing statement is in compliance with the Listings

Requirements and that the following has been undertaken:

The information contained in the pre-listing statement is accurate and complete in all material

respects and is not false or misleading. There are no omissions that would make any pre-

listing statement false or misleading.

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Statements of fact and opinion expressed by the directors in the pre-listing statement have

been arrived at after due and careful consideration on the part of the directors and are

founded on bases and assumptions that are fair and reasonable.

The directors of the new applicant have made sufficient enquiries so as to enable them to

give the confirmations set out in the "responsibility statement" contained in the pre-listing

statement.

Section 21.20 (e): There are no matters other than those disclosed in the pre-listing

statement or otherwise in writing to the JSE which should have been disclosed to the JSE

in considering the application for listing of the relevant securities.

Section 21.20 (f): The DA has explained to the directors the nature of their responsibilities

under the Listings Requirements, the Companies Act, the SRP Code and GAAP. In

addition, the DA must be completely satisfied that:

The directors have the requisite expertise and experience:

The directors understand the nature of those responsibilities and can be expected to

honour their obligations under the Listings Requirements and other applicable

regulations.

The directors can be expected to prepare and publish all information necessary for an

informed market to take place in the applicant issuer's securities.

The information supplied on the Directors' declarations has been verified and confirmed

as true.

4.5.2.4.5 Section 21.21

The DA must take all reasonable steps to brief all new appointees to the company’s board of

directors as to the nature of their responsibilities under all AltX and JSE Listings

Requirements. The DA must also ensure that the directors (current and future) have

completed the DIP prior to listing within two months of appointment.

4.5.2.4.6 Section 21.22

All future changes to listing requirements must be conveyed to the directors.

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4.5.2.4.7 Section 21.23

The DA must assess and review all company publications, relating to financial information,

corporate announcements and other documentation. The aim is to ensuring that the directors

understand the importance of accurately disclosing all material information to shareholders

and the market.

4.5.2.4.8 Section 21.24

The DA must regularly review the issuer's actual trading performance and financial condition

to ensure that appropriate disclosure is made at all times.

4.5.2.4.9 Section 21.25

The DA, or one of its approved executives, must attend all board meetings in an advisory

capacity to ensure that all Listings Requirements and applicable regulations are complied

with.

4.5.2.4.10 Section 21.26

The DA must provide the JSE with confirmation that all of its approved executives have

attended at least four of the six annual DA forums hosted by AltX.

4.5.3 The Alternative Investment Market (AIM)

Noah Greenhill stated, at the 2005 launch of A Guide to AltX (Magliolo, 2004). “AltX was

fashioned on the highly successful AIM exchange…”

Given the level of success that the London Stock Exchange (LSE) has had with its small to

medium-sized company exchange, called The Alternative Investment Market (AIM for short),

it is appropriate to briefly outline its history and objectives (AIM website,

www.londonstockexchange.com). After all, AltX has been designed to adopt AIM’s best

practices. In addition, South African entrepreneurs are not limited to listing on AltX. AIM might

be the global alternative for raising capital that some entrepreneurs have been looking for.

AIM is the LSE’s market for smaller, growing companies from all over the world, enabling

businesses to access the capital and liquidity of the London markets (AIM website:

www.londonstockexchange.com). It is also the largest European growth market by

capitalization and has more companies than all of the other growth markets in Europe put

together (AIM website: www.londonstockexchange.com).

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According to online Wikipedia (Wikipedia database) AIM has also emerged as the most

international European growth market, with more overseas companies, than any other

market. It is also the fastest growing market. Since it was created in 1995, over 1,200

companies have used AIM as a vehicle for growth and more than £9-billion (US$14-billion)

has been raised on the market.

In addition, AIM continues to experience increased interest from overseas companies,

advisors and investors. In response to this demand, in May 2003, AIM introduced an

expedited admissions procedure for companies with existing quotations on other major

markets known as “AIM Designated Markets”.

Companies that have been listed for at least 18 months on the main boards of AIM

Designated Markets are exempt from the formal obligation to produce an AIM admission

document, although they may be legally be required to produce such documents in

connection with certain types of fundraising or may choose to for marketing purposes.

4.5.3.1 Suited for SMEs

As one of the range of markets that the LSE has developed to meet the needs of companies

and investors, AIM is tailored to suit growing businesses. Its rules have been designed to

reflect these companies’ unique requirements. At the same time, AIM provides a central

focus for investors who understand growing companies and who want to invest in their

potential.

AIM’s flexibility means it is attractive to a wide range of dynamic companies, from young and

venture capital-backed businesses to established family concerns. Similarly, AIM companies

cover all business sectors, ranging from mining companies, real estate, mobile commerce,

leisure, entertainment and hotels, general retailers and include companies at all stages of

their life cycle.

Whatever their area of business, all AIM companies enjoy the benefits of being quoted on the

LSE – including exposure to London’s liquidity, the deepest pool of global capital in the world,

respected regulatory standards and unrivalled international expertise.

There are no specific suitability criteria for companies to qualify for AIM. However, under the

AIM rules, all companies must produce an admission document making certain disclosures

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about such matters as their directors' backgrounds, their promoters, business activities and

financial position.

4.5.3.2 Nomads and Brokers

Importantly, all AIM companies are required to have a nominated advisor; popularly known as

a nomad from the register of such advisors published by the LSE (AIM database). Similarly,

AltX has the Designated Advisor (Appendix 1, No 5). This nominated advisor is responsible,

among other duties, for warranting to the Exchange that a particular company is appropriate

for AIM. This is an important quality control for AIM and a very serious responsibility for the

nominated adviser.

The entrepreneur will also need a retail stock broker to sell his shares into the market. This is

a stockbroking firm that is a member of the LSE or AltX and can be Nomad or Designated

Advisor, but not all listing brokers are registered to trade stocks. The broker will work with the

nominated advisor in respect of any fund raisings. There is no reason why the broker cannot

be part of the same organisation as the nominated advisor. The stipulation is that there will

need to be procedures in place to avoid any conflict of interest. The broker will play an

important role in bringing buyers and sellers of the company’s shares together and making a

success of the flotation and trading in the aftermarket.

Once admitted to AIM, a company has certain on-going disclosure requirements and needs

to retain a nominated advisor at all times (AIM Database). Ordinarily, once a company has

been on AIM for two years it will have the opportunity to seek admittance to the main market

by using a special expedited procedure.

AIM companies are not bound by the full Listing Rules of the UK Listing Authority. In South

Africa, AltX companies also enjoy more limited disclosure regulations when compared to

Main Board listings (Appendix 1). Additionally AIM listed securities are treated as unquoted

for taxation purposes, providing various potential tax benefits.

To reiterate, to list on AIM, the following has to be undertaken:

After research, due diligence and the drafting of a business plan, assessed the advantages

and responsibilities involved in listing on AIM. If the company is right for AIM, then the

entrepreneur will need to:

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Appoint a nominated advisor.

Appoint a broker.

Make a pre-application announcement to the market about the company.

Produce an admission document. It is possible that certain overseas companies may be

able to obtain an exemption from this requirement.

Submit a declaration confirming that the company will adhere to the AIM rules and a

separate declaration by the nominated advisor that the company is appropriate for AIM.

4.5.3.3 Movement to the Main Board

AIM may be and has been, used as a stepping-stone for companies whose shares eventually

are traded on the Official List. More than 85 companies have progressed from AIM to the

main market. In addition over 90 smaller companies on the Official List have transferred to

AIM as it better suits their requirements. Procedures and practices relating to AIM have

developed since its inception and are now embodied within the AIM Rules for companies,

issued by the London Stock Exchange (AIM Website: www.londonstockexchange.com).

AltX companies are also expected to move to the Main Board after a period of time, which

has yet to be stipulated.

4.5.3.4 Eligibility of Companies Applying to AIM

AIM imposes no formal restrictions on the type of business or on the industry sector in which

the company operates. The market is open to companies from all sectors, incorporated in any

country worldwide. The company should hold discussions with its corporate advisors when

deciding whether an AIM flotation is a suitable way forward. The application process is

tailored to encompass companies at all stages of their life cycle – from start-up enterprises to

businesses with years of trading experience (AIM website: www.londonstockexchange.com).

The main requirement is that the company is “appropriate” for the market, a view taken by the

company’s appointed Nomad. The requirements for admission to AIM are straightforward.

No minimum trading record is required as is generally the case with admission to the LSE.

There is no minimum requirement as to the percentage of shares that must be placed into

hands of the public.

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Companies that apply for their shares to be admitted to AIM must comply with relevant

legislation and regulations, i.e. requirements of the Public Offers of Securities Regulations

1995 “POS Regulations”.

The London Stock Exchange has issued the AIM Rules for companies, which must be

adhered to.

4.6 DETERMINING FINANCIAL MARKET EFFICIENCIES

4.6.1 Impact on Price Determination

The efficient market theory states that “prices of securities in financial markets fully reflect all

available information.” (Mishkin, 1997, 3). Thus market efficiency can be defined as the

degree to which any new information is very quickly reflected accurately in the share prices.

This theory gives rise to the phenomenon of an ‘Efficient market Hypothesis’ which states

that all relevant information is fully and immediately reflected in a security’s market price,

thereby assuming that an investor will obtain a fair and reasonable rate of return.

Chapter 2 (Section 2.4.1.3) outlines that it cannot be assumed that an investor will obtain the

fair rate of return, because greater demand for the stock directly increases the IPO’s share

price before it is even listed. Consequently, underwriters often fix the price of the IPO pre-

listing.

In other words, an investor should not expect to earn an abnormal return through either the

use of technical triggers to determine entry and exit prices or via fundamental analysis, which

includes investigation of the company in relation to economic, business and macro-

environmental variables. This hypothesis implies that if new information is revealed about a

firm it will be incorporated into the share price rapidly and rationally, with respect to the

direction of the share price movement and the size of that movement.

Stock Market efficiency only means that investors base the IPO price on available

information.

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4.6.1.1 Types of Market Efficiency

To understand the concept clearly, market efficiency can be synthesized, according to Bruce

Chadwick (Seminar 2010, Investment Strategy, International Development and Productivity

Techniques) into:

Operational Efficiency: referring to the cost to buyers and sellers of transactions in a

security exchange.

Allocation Efficiency: helping in the process of allocating society’s resources between

competing real investments.

Pricing Efficiency: enabling investor to expect to earn merely a risk-adjusted return from

an investment as prices move instantaneously and in an unbiased manner to any news.

It is ‘pricing efficiency’ that is the focus of this paper, i.e. determining whether AltX is an

efficient market and one in which shareholders benefit from a fair and reasonable price for

their investments in listed entities.

4.6.1.1.1 Need for Market Efficiency

The Stock Market should be efficient for if the following takes place:

The proper pricing of securities at listing and, therefore, vigorous trading of such

securities would be based on demand and supply variables rather than inadequate

pricing methods.

The proper allocation of financial resources based on the operating efficiency.

4.6.1.1.2 Levels of Market Efficiency

Economists have defined different levels of efficiency according to the type of information,

which is reflected in prices. Three levels of market efficiency can be identified which are as

follows:

Weak-Form Efficiency: where the share prices fully reflect all information which were

revealed by past price movements of the shares. This form of efficiency will not do any

good to the investor as the future cannot be predicted on the basis of the historic price

data.

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Semi-Strong Form Efficiency: where the share prices fully reflect all the relevant

information which are publicly available like earnings and dividend announcements, rights

issues, technological breakthrough, resignation of directors etc. along with the past price

movements of the shares.

Strong-Form Efficiency: where all relevant information including those privately held is

reflected in the price. In this form of efficiency ‘Insider Trading’ plays a vital role, in which

a few privileged individuals like director or other senior executive of a company who is in

possession of a valuable information (positive or negative) about the company and uses it

to take a personal profit by trading in the company’s shares.

4.6.1.2 Efficient Stock Market Trading

An 'efficient' market is defined as a market where there are large numbers of rational, profit-

maximizes actively competing, with each trying to predict future market values of individual

securities and where important current information is almost freely available to all

participants. In an efficient market, competition among the many intelligent participants leads

to a situation where, at any point in time, actual prices of individual securities already reflect

the effects of information based both on events that have already occurred and on events

which, as of now, the market expects to take place in the future.

In other words, “in an efficient market at any point in time the actual price of a security will be

a good estimate of its intrinsic value.”(Fama, 1965: 34).

As stated above, the Efficient Market Hypothesis states that at any given point of time, the

prices of securities in the Stock Market fully reflect all available information. The Efficient

Market Hypothesis implies that the while individuals buy and sell securities on the assumption

that the worth of the securities are more or less than the price the market offers.

But if markets are efficient and current prices fully reflect all information, then buying and

selling of securities in an attempt to outperform the market will effectively be a game of

chance rather than skill. This is so because there are various other factors which have a

direct or indirect influence on the stock prices and which affect the movements of the prices

upwards or downwards depending on their positive or negative impact on the buying or

selling moods of the investors.

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There is another theory known as ‘Random Walk Theory’ which advocates that the stock

price movements will not follow any patterns or trends. The theory also asserts that the past

price movements cannot be used as a basis to predict the future price movements (Fama,

1965: 55).

With more and more numbers of intelligent investors and traders entering the stock markets

for transacting on various over valued and undervalued securities, the market tends to

become more efficient to take the faster dissemination of information flowing from all

directions and from all these people dealing in the securities.

The efficiency of the Stock Market operation has its own reflections on the trading in

securities both from the angle of the investor and the company whose shares are being

traded. As it is implied that the public information cannot be used to earn abnormal returns,

the average investor should decide on a particular portfolio with the minimum cost of trading

and base his decision on a host of information which are timely and valuable to make the

otherwise efficient market to his advantage.

Entrepreneurs should be encouraged by investor pressure, accounting bodies, government

ruling and Stock Market regulations to provide as much information as possible to enable the

Stock Market to react sharply and accurately to ensure a proper pricing. As far as the

companies are concerned the market efficiency will be greatly affected by the company either

manipulating or withholding of information and which consequently will reflect on the prices of

their securities.

The Stock Market anomalies unearthed by researchers are in contrast to the efficient market

hypothesis. The search for anomalies is effectively the search for systems or patterns that

can be used to outperform passive and/or buy-and-hold strategies.

One additional point to be noted is that numerous anomalies that have been documented

have subsequently either disappeared from the market or they have been proved to be

impossible to exploit because of the transaction costs.

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4.6.1.3 Stock Market Anomalies

Despite the existence of strong evidences to advocate the efficiency of the stock markets

there are also theories that have documented long-term anomalies in the Stock Market which

seem to act against the efficient market hypothesis. However the following points with respect

to such anomalies need to be taken into consideration:

The investors while trying to exploit the anomalies to earn higher returns should keep in

mind that although the anomalies existed historically, there is no guarantee that they will

persist in the future.

Even if they persist the transaction and hidden costs may prevent the out-performance in

the future.

Investors should also consider the tax effects in their taxable portfolios when evaluating

stock strategies on the basis of using anomalies.

The following Section of the dissertation presents the findings and analysis of various

information gathered from the available literature and incorporated in this dissertation.

4.6.1.4 Theoretical Deductions to Determine Market Efficiencies

From the review of the available literature on the Stock Market operations, efficient market

hypothesis and the Stock Market anomalies the following points emerge as findings from this

dissertation.

Similarly, if a market is really efficient no information or analysis can be expected to

outperform the market (Wikipedia, 2012).

The efficient market hypothesis takes three forms, depending on the availability of past and

present information on prices and other issues concerning the prices of stocks being dealt

with in the stock market. These are:

Weak.

Semi-strong.

Strong.

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Technical Anomalies offer some help to the analysts to predict the stock price movements

more or less approximately. However the transaction costs may hamper any advantage of

such technical analysis.

There are several Stock Market anomalies based on factors internal to the company as well

as external which have a tendency to create Stock Market vibrations resulting in positive or

negative movements of stock prices.

The Stock Market anomalies although short lived operate against the efficient market

hypothesis and try to find patterns or systems that can be used to outperform passive and/or

buy and hold strategies on the stock price movements.

The paradox of efficient market is that if every investor believes that the market is efficient

and would react on its own on the stock prices, no analysis of the prices would be made by

the investors before risking their money (Fama, 1965). In fact, stock markets operate on the

strength of the participants who do not believe the market is efficient and they can manipulate

the prices by their actions (Wikipedia).

While the advocates for efficient market hypothesis believe that it is not possible to beat the

market by the actions of the individuals or firms some people believe that stocks can be

divided into categories based in risk factors and corresponding higher and lower expected

returns.

From the findings of the analysis it emerges that:

Stock markets are neither perfectly efficient nor completely inefficient, but there is a level

at which markets can be considered inefficient (Chapter 6). It appears from the results of

the various studies that the markets are efficient to a certain extent in reacting to the

information.

It may happen that in markets with substantial impairments of efficiency more

knowledgeable investors will take an upper hand and try to outperform those investors

who do not have enough knowledge or information on the stocks.

In an efficient market the primary responsibility for stockbrokers, portfolio managers and

traders will be not to try to beat the market with the available information; but to decide on

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strategic portfolio structures by taking factors into account, namely age, tax and risk

aversion of the client.

Hence there will be no opportunity for investment managers to analyse the underlying

information which may affect the Stock Market and make their investment decisions. This is

so because they are given a set of values and attributes to consider the investments rather

than the efficiency factors of the stock market.

It may be argued that due to inefficiency of the market some out performance of the market

can be exhibited by one or more participants (Ray, 1995). However, with this it is not

possible to generalize the situation. The performance of such participants has to be analysed

on the basis of the ratio of such out performances to the number of participants. This may not

really be possible due to the complexities involved in such a process.

It may also happen that strong performers in a certain period may turn out to be under

performers in the subsequent periods. This point strongly supports the efficient market

hypothesis theory as it has been found that there is little or no correlation between strong

performers from one period to another.

While deciding on the categories of the stock on the basis of the risk factors, some believe

that ‘value’ stocks are riskier than ‘growth’ stocks and therefore are entitled to claim higher

expected returns.

4.7 ALTX SHARE PRICE VERSUS EARNINGS EFFICIENCIES

Entrepreneurs have a legal obligation to inform both shareholders and investors about the

state of health of a firm (Appendix 1, No 13). Earnings announcements provide a method that

can be utilised by the market to assess the wealth and profitability of a firm. The purpose of

this section of the dissertation was to investigate whether there are any significant returns

relating to public cautionary announcements of earnings.

The part of this dissertation focused on all 76 companies listed on the AltX - that announced

annual earnings between 1 January and 31 December 2009. Julia Maluleka of JSE Business

Development division (The JSE Alternative, 2010), is on record as stating: “We had 76

companies listed on the market at the end of 2009 as compared to 77 in 2008. Total market

capitalisation declined from R18.3-billion in 2008 to R11.9-billion as at 31 December 2009.”

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This period was chosen as AltX reached its peak in 2008 and rapid decline in 2009 (Figure

4.2).

FIGURE 4.2: ALTX INDEX

Source: PDSNet, Business Consultants International database, 2012

Empirical evidence demonstrates that there is substantial negative share price reaction to

earnings announcements on AltX, which displays weak market efficiency (Figure 4.2).

The study concluded that, during a recessionary period, shareholders’ wealth is eroded on

AltX; however, the weak form of market efficiency provides an opportunity for entrepreneurs

and investors to exploit the market for profits when the market is performing well. In Chapter

5, Sections 5.2 and 5.2.2 analysis highlights that AltX capital value declined during the period

2008 and 2009, when the market reached its height before falling by 83.9% (Figure 4.2).

Efficient Market Hypothesis theory has stimulated a new dimension of studies in behavioural

finance in the last three decades. More importantly, it has emerged as the “cornerstone of

modern-day finance theory, dominating the mainstream of finance research” (Hussin, Ahmed

and Ying, 2010: 36). Fama, Fisher, Jensen and Roll (1969) argued that there are three forms

of market efficiency, namely, the weak form, the semi-strong form and the strong form.

Accordingly, many empirical studies have been conducted to test the validity of the market

efficiency concept. One of the ways of testing this concept has been the observation of Stock

Market reaction to corporate announcements (Spenser-Young, 2010; AltX Directors’

Induction Program).

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If the announcement conveys vital information, then it is assumed that such information will

be reflected by stock price movements (Hussin et al., 2010) as soon as the information is

publicly released to the market. Earnings, per se, are an interesting phenomenon to observe,

because they carry inside information about the company’s future prospects (Aharony and

Swary, 1980).

The literature argues that earnings announcements are one of the important signalling

devices used by managers to transmit information to the public about the firm’s future

prospects (Lonie, Abeyratna, Power and Sinclair, 1996). Earnings announcements are thus

one of the critical components of testing market efficiency. Management further uses

earnings information to inform both shareholders and investors about the state of health of a

firm. In other words, earnings announcements provide a yardstick that can be utilised by the

market to assess the wealth and profitability of a firm.

If the market is efficient, then any new information released is instantaneously reflected in the

share price. Therefore, as earnings are publicly announced, the share price should

immediately reflect this announcement and therefore deny investors any above-average risk-

adjusted profits.

4.7.1 The Global Experience

Earnings studies in France by Gajewski and Quéré (2001) found that there is a critical market

movement to half-year and annual earnings announcements. The authors also conclude that

the reaction to annual earnings is stronger than the reaction observed for half-year earnings;

however, they argue that the amount and depth of information set out in annual results is only

one factor explaining share movement, stating that traders and investors also look at how the

company is managing their earnings.

This is normally calculated by using a Discounted Cash flow. This is in line with the

arguments advanced by Putman, Griffin and Kilgore (2008) and Chai and Tung (2002).

Gajewski and Quéré (2001) conclude that in France, greater attention and sensitivity are

based on annual earnings and that this disparity is therefore a strong incentive for

management to announce bad news strategically in half-year earnings rather than in annual

earnings.

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Louhichi (2008), conversely, highlight the following regarding intraday trading on the Euronext

Paris stock market:

Investors react positively to good news.

Investors react negatively to bad news.

Investors and traders take less than 15 minutes to take advantage of abnormal returns.

Earnings tend to take longer before converging back to equilibrium following bad

announcements and price reversal takes about 30 minutes following bad

announcements.

Earnings release is accompanied by a rise in volume, which lags the price adjustment

back to equilibrium.

Chan, Faff and Ramsay (2005) provide Australian evidence concerning earnings

announcements. They focused on the size effect of earnings and found that larger firms

respond significantly more positively to earnings than do micro-capitalisation, small and

medium-sized firms and this finding corresponds with that of Christensen, Smith and Stuerke

(2004). They attribute this positive market response to the fact that larger firms could be

releasing additional information following the annual earnings announcement. They further

note that investors appear to regard earnings accompanied by dividends to be of higher

quality.

Cheon, Christensen and Bamber (2001) in America conducted a study comparing the

traditional New York Stock Exchange (NYSE) and over-the-counter NASDAQ. They found

that NASDAQ firms’ earnings announcements significantly exceed the abnormal returns

associated with NYSE firms’ earnings announcements and attribute this to:

Differences between NYSE and NASDAQ firms’ pre-disclosure information environment.

Differences between NYSE and NASDAQ firms’ expected earnings growth.

Differences in investor sensitivity to growth opportunities in NYSE and NASDAQ firms.

This is different to the Australian finding that larger firms respond significantly more positively

(Chan, Faff and Ramsay, 2005). Kong and Taghavi (2006) provide a Chinese perspective

and indicate that the abnormal returns increase markedly (through an overreaction) four days

before the announcement and decrease (through rectification) four to six days after the

announcement.

This finding was consistent in both the Shanghai and Shenzhen markets.

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In India, Das, Pattanayak and Pathak (2008) conducted a study separating ‘good’ and ‘bad’

announcements.

The authors found no evidence of significant abnormal returns for either of the groups. The

study was also not able to establish that the share price drift was positively affected in the

case of good announcements, or negatively affected by bad announcements. However, it

should be noted that this study focused only on larger firms: there is conjecture that large

firms receive greater attention from market participants and that fundamental information is

thus rapidly incorporated into prices, leaving no space for superior returns.

In Greece, Dasilas, Lyroudi and Ginoglou (2008) posit that there is positive market reaction to

joint earnings and dividend announcement. However, it should be noted that this result is

based on a very small sample of 24 announcements. Due to the small sample size, caution

should be exercised with regard to statistical inference. Again, dividends clearly confound the

market reaction to earnings announcements.

The British study by Lonie et al. (1996) is similar to the Greek study (Dasilas, Lyroudi and

Ginoglou, 2008) in the sense that both earnings and dividends announcements were

observed; however, the sample was further subdivided into whether earnings and/or

dividends increased or declined.

It was found that companies with a combination of bad announcements had the largest

negative abnormal returns. Sponholtz (2008), in her study in a small Danish stock market,

presented the following evidence related to earnings announcements:

“Abnormal volatility in the days surrounding earnings announcements, which persists several

days after the announcement; however, there was no quantification of the duration of this

volatility. The slow adjustment of prices following announcements, indicating market

inefficiency in this market.”

4.8 FINDING INTRINSIC VALUE: IPOS

Most IPOs are young and thus it is difficult to forecast their future cash flow. Moreover, most

global IPOs (Appendix 2) do not have any historical data and their value rely on their future

growth. Consequently, valuing IPOs is difficult compared to valuing brick and mortar firms.

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Valuing IPOs is widely implemented by the use of financial information through regression

analysis and through comparable firm multiples.

Regression analysis incorporates firm and market information. The regression model can be

used to predict value of IPOs (Falta and Willett, 2012). Comparable firm P/E multiples rely on

finding comparable firms that match IPOs (Reiner, 2009). The most widely used multiples

include market-to-book, price-to-sales, enterprise value-to-sales and enterprise value to-

operating cash flow ratios, where enterprise value is defined as the market value of equity

plus the book value of debt, minus cash. The use of forecasted financial information and

growth of cash flow can improve the accuracy of IPO valuation.

Valuing an early-stage company or IPO is difficult, because much of the company’s current

value depends on expected future revenues from products not yet sold. Valuing an IPO in a

emerging industry is even more difficult since there is no historical information for comparison

(Falta, M et al.). When the first companies in a new industry go public, underwriters have little

guidance beyond traditional valuation methods employed in other industries, though they

may have a vague sense of uneasiness about unfamiliar territory.

Market participants are not limited to the information used by the underwriters. Moreover,

incentives may induce underwriters to set offer prices below their best estimates of the value.

For either reason or both, IPOs generally experience sizeable first-day returns.

The mechanics of going public in the United States, Securities and Exchange Commission

(SEC) clearance is needed to sell securities to the public (SEC Listing Booklet). The

regulations are based upon the Securities Act of 1933, but in practice much case law and

professional judgment applies.

The SEC is explicitly concerned with full disclosure of material information and does not

attempt to determine whether a security is fairly priced or not. Many state securities

regulators in the past attempted to ascertain whether a security is fairly priced (the “blue sky”

laws) before allowing investors to purchase an issue, but the National Securities Markets

Improvement Act of 1996 has given blanket approval for all IPOs that list on the American

Stock Exchange (Amex), New York Stock Exchange (NYSE), or the National Market System

(NMS) of Nasdaq.

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In preparation for going public, companies must supply audited financial statements

(Appendix 2). The level of detail that is required depends upon the size of the company, the

amount of money being raised and the age of the company.

The required disclosures are contained in SEC Regulations S-K or S-B (covering the

necessary descriptions of the company’s business) and Regulation S-X (covering the

necessary financial statements) (SEC Listing Booklet). For large offerings, Registration on

Form S-1 is required, but Form SB-2 can be used by companies with less than $25-million in

revenues. Form SB-2 registrations allow the use of financial statements prepared in

accordance with generally accepted accounting principles, whereas Form S-1 registrations

require that certain details specified in Regulation S-X be followed. The smallest offerings,

raising less than $5 million, may register under Regulation A, which has the least stringent

disclosure requirements.

Disclosure requirements differ for certain industries (such as banking) that are subject to

other regulations and for other industries with a history of abuses (such as oil and gas and

mining stocks).

In going public, an issuing firm will typically sell 20-40% of its stock to the public. The issuer

will hire investment bankers to assist in pricing the offering and marketing the stock. In

cooperation with outside counsel, the investment banker will also conduct a due diligence

investigation of the firm, write the prospectus and file the necessary documents with the SEC.

For young companies, most or all of the shares being sold are typically newly-issued (primary

shares), with the proceeds going to the company. With older companies going public, it is

common that many of the shares being sold come from existing stockholders (secondary

shares).

4.8.1 Valuing IPOs

In principal, valuing IPOs is no different from valuing other stocks. The common approaches

of discounted cash flow (DCF) analysis and comparable firms analysis can be used. In

practice, because many IPOs are of young growth firms in high technology industries,

historical accounting information is of limited use in projecting future profits or cash flows.

Thus, a preliminary valuation may rely heavily on how the market is valuing comparable

firms, which is the preferred method of determining IPO pricing by Designated Advisors

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(Section 6.5). In some cases, publicly-traded firms in similar sectors are easily compared. In

other cases, it may be difficult to find listed companies with the same product range. For

instance, in listing a restaurant-type firm, do you compare this company to a food retailer or a

fast food franchiser? The final valuation of the firm being listed typically occurs at a pricing

meeting the morning a firm is expected to receive SEC or AltX committee clearance to go

ahead with the listing. Because the IPO market is especially sensitive to changes in market

conditions and because it takes at least several months to complete the process of going

public, going public is a high-stress event for entrepreneurs.

Numerous cases have occurred where a firm was expecting to raise tens of millions of

dollars, only to withdraw the deal at the last moment due to factors outside of its control.

Because most companies prefer an offer price of between $10.00 and $20.00 per share in

the US (SEC Listing Booklet), firms frequently conduct a stock split or reverse stock split to

get into the target price range over time. On the AltX, the average price for the sample 63

companies listed (Appendix 3) is 304 cents a share. The highest price was 6250 cents and

the lowest was 3 cents a share (Appendix 3).

Stocks with a price below $5.00 per share are subject to the provisions of the Securities

Enforcement Remedies and Penny Stock Reform Act of 1990, aimed at reducing fraud and

abuse in the penny stock market. No such rules pertain to listing shares on AltX (Schedule

21).

Pricing of new IPOs is a critical decision. Koop and Li (2001) identified three roles played by

valuation including its significance in corporate control transactions; the need for firms going

public to value their stocks; and its significance in determining capital structure of the firm.

Mispricing of securities leads to problem of uncertainties in the capital market. Where one

party to a transaction has quality information more than the other party, a problem leads to a

situation where quality assets are driven out of the market, because the owners of quality

assets are not willing to sell at lower price demanded by buyers (Akerlof, 1970). Buyers will

seek risk premium to compensate them for taking risk.

An immediate question raised by the difference between the offer price and the first-day

market price is whether issuers or the Stock Market is pricing offerings in line with a firm’s

fundamentals. The most common method for valuing firms going public is the use of

comparable firm multiples. But unfortunately, accounting data are in many cases too

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unreliable a measure of valuation to facilitate powerful tests, especially because many firms

going public are being valued on the basis of their growth options, not their historical

financials.

As a result, the power of tests to explain pricing relative to some “true fundamental value” is

too low to make much headway in testing whether IPO pricing or after-market valuation better

reflects the IPOs’ fundamental valuations unless the sample is large. Kim and Ritter (1999)

find only a modest ability to explain the pricing of IPOs using accounting multiples, even

when using earnings forecasts.

Purnanandam and Swaminathan (2004) construct a measure of intrinsic value based on

industry-matched Price/Sales and Price/Ebitda from comparable publicly traded firms

(“comps”) for a sample of over 2,000 IPOs from 1980-1997. They find that, when offer prices

are used, IPO firms are priced about 50% above comparable peers, which is an enormous

difference. They also find that this initial over-pricing with respect to peer comparable

companies helps predict long-run underperformance.

Although it is difficult to come up with accurate valuation measures for IPOs, this literature is

promising. The next step may involve the use of earnings forecasts with more detailed

corporate information to enhance the power of these tests.

Typically, IPO prices are determined in stages along the IPO process. The filing price range

is determined first by the investment bankers and is contained in the prospectus, which

consists of the financing information of the issuing company. During the period from the filing

of the prospectus to the final offer date, called “the waiting period,” the managers of the

issuing companies, analysts and investment bankers are usually on the a show to meet with

investors and to get an assessment of the demand to be able to set the offer price. If the

demand is higher than expected, the final offer price is set higher; if the demand is lower than

expected, the final offer price is adjusted downward.

Since issuing shares are allocated mainly to the most influential or institutional investors, the

offer price reflects the information possessed by the most informed investors (Chemmanur,

He and Hu, 2007). However, the closing price on the IPO day reflects private information

from small or retail investors, who rarely receive an allocation of issuing shares. The IPO

process involves three players: firms, investment bankers and investors, all of which have

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very different goals. There are several reasons for the short-run first-day return of IPOs and

their relative importance differs across countries and mechanisms.

In the finance literature, IPOs have been found on average to have large first-day returns (the

percentage difference between the first-day closing price and the offer price) of between 10%

and 15% (See Section 2.3).

This phenomenon is referred to as IPO under-pricing. Evidence of large first-day returns can

be found in Logue (1973), Ibbotson (1975), and Ibbotson, Sindelar and Ritter (1995).

Ibbotson and Ritter (1995) also provided an intensive survey and review of IPO literatures.

Overall, the first-day return phenomenon is explained by asymmetric information and adverse

selection that forces the issuer to set the price below the fundamental value. To induce the

uninformed investor to participate in an IPO, the issuer has to set the offer price below the

intrinsic value. In contrast, to induce institutional investors, the issuer has to set a high offer

price.

Nevertheless, after issuing, the price will move back to the intrinsic value, leading to the

under-pricing or over-pricing of the offer price. If the market is efficient, the first-day closing

price will reflect the IPO’s intrinsic value. Several researchers used this idea to explain the

first day return phenomenon. Rock (1986) and Beatty and Ritter (1986) developed the

winner’s curse theory and explain that IPO first-day return occurs from the information

asymmetry between investors. Baron and Holmstrom (1980) and Baron (1982) explained that

the IPO first-day return can occur from the information asymmetry between issuers and

investment bankers.

If investment bankers take advantage of their superior knowledge of market conditions to

under-price offerings, which permits them to expend less marketing effort and to ingratiate

themselves with buy-side clients, IPOs will be under-priced.

Another explanation by Benveniste and Spindt (1989) is that information asymmetry between

investment bankers and investors leads to IPO first-day return. Investment bankers, who use

book-building, may under-price IPOs to induce regular investors to reveal information during

the pre-selling period, which then can be used to assist in pricing the issue. Moreover, Allen

and Faulhaber (1989), Grinblatt and Hwang (1988) and Welch (1989) developed the

signalling theory to explain this phenomenon.

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This theory hypothesizes that under-priced IPOs leave investors with a good taste, allowing

the firms and insiders to sell future offerings at a higher price than would otherwise be the

case. Chemmanur (1993) showed that publicity is generated by a high first-day return. This

publicity could generate additional investor interest and brand awareness.

Tinic (1988) and Hughes and Thakor (1992) explained that the frequency and severity of

future class action lawsuits can be reduced by first-day return because only investors who

lose money are entitled to damages. Welch (1992) illustrated that it can be explained when

potential investors pay attention not only to their own information about a new issue but also

to (1) whether other investors are purchasing, (2) bandwagon effects and (3) informational

cascades that may develop. Booth and Chua (1996) explained this phenomenon by

ownership dispersion.

Mauer and Senbet (1992) explained that this phenomenon is from the incompleteness of

market. Another theory of underwriter price support, proffered by Rudd (1993), is based on

the distribution of first-day return. He finds that there is an unobserved left tail or left-skewed

distribution of first-day return distribution and attributes this to the support of underwriters.

Along other lines, Aggarwal and Rivoli (1990) and Shiller (1990) argued that this

phenomenon can be explained by fad or investor’s optimism. Similarly, Teoh, Welch and

Wong (1998) supported this argument by showing that investor over-optimism is based on

accounting manipulation by the issuers.

In contrast, Rajan and Servaes (1997) evaluated analyst earnings forecasts of IPO firms and

find that investors are really overly optimistic about the long-term growth prospects of IPOs,

inducing an upward bias in analyst earnings forecasts. Overall, there are two anomalies that

support this theory, namely, hot issue markets and long-run underperformance of IPO

issuers. Hot issue markets are the periods during which both IPO volumes and first-day

returns are abnormally high.

The long-run underperformance of an IPO is supported mostly by the findings of Ritter

(1991), which suggests that IPO-issuing companies underperformed by 5.6% per year

compared to non-issuing firms.

Due to the Internet bubble of 1999 and early 2000, the most puzzling aspect of the first-day

return phenomenon is that, in some circumstances, issuers do not object to a severe first-day

return. Loughran and Ritter (2002) explained this phenomenon by using prospect theory

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developed by Kahneman and Tversky (1979): investors focus on changes in their wealth

rather than on the level of their wealth. Loughran and Ritter note that most of the money left

on the table is by a minority of firms for which the offer price was revised upwards during the

book-building process.

For these issuing firms, the executives see their personal wealth increase relative to the mid

filing price, even as they agree to leave money on the table. Loughran and Ritter (2002)

argued that the issuing firm’s managers bargain less hard for a higher offer price in this

circumstance than they otherwise would do, thus offer prices do not adjust fully to market

movements during the book-building period. Furthermore, they illustrate why underwriters

prefer to under-price IPOs rather than to charge higher gross spreads. This happens because

issuers pay less attention to the opportunity costs of first-day returns than to the direct costs

of gross spreads.

In contrast to previous findings about first-day returns, Purnanandam and Swaminathan

(2004) using comparable firm multiples found that IPOs from 1980 to 1997 were overvalued

and not undervalued by about 50% from their fair value. They rationalized this argument

using behavioural theories based on investor overconfidence.

According to Daniel, Hirshleifer and Subrahmanyam (1998) and to DeLong, Shleifer,

Summers and Waldmann (1990), stock prices initially reflect an overreaction to new

information. Daniel, Hirshleifer and Subrahmanyam explained that this is due to positive

feedback trading, while DeLong et al. suggested that this is due to investor overconfidence.

This overconfidence about the future success of IPOs leads underwriters and issuers to over-

price initial offerings.

4.8.2 Estimation of Intrinsic IPO Value

The overwhelming extant evidence on short-run under-pricing and long-term under-

performance suggests that the observed IPO offer value is a biased estimate of intrinsic IPO

value; the offer value equals IPO offer price multiplied by the shares outstanding at the close

on the offer date, as reported by the Center for Research in Security Prices (CRSP).

Institutional investors, market makers and other large traders are posited to form unbiased

estimates based on superior information and/or superior valuation capabilities of intrinsic

value.

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Valuation discrepancies between observed offer value and estimated intrinsic value are then

likely to trigger flipping activity, which is defined as a proxy for institutional informed trading.

In general, underwriters apply two methods to estimate intrinsic IPO value (Kim and Ritter,

1999; Pukthuanthong-Le and Varaiya, 2007).

First is the comparable firm approach that is frequently used by investment bankers to price

IPOs (Varaiya, Bergmark and Taylor, 1997; Kim and Ritter, 1999) and in academic studies

(Carter and Van Auken, 1990; Alford, 1992).

The comparable firm method uses information about firms comparable to the IPO firm as a

benchmark for setting the IPO offering price and offering value. Kim and Ritter (1999) used

the comparable firm method, together with accounting information to value IPOs. They

reported that valuation accuracy can be improved by using forecasted data and data from

comparable companies identified in their study by a research boutique specializing in IPO

pricing. In a recent paper, Purnanandam and Swaminathan (2004) used comparable firm

multiples and report that from 1980 to 1997, IPOs are not undervalued, but are significantly

overvalued by about 50% compared to their industry peers.

The second valuation method, which is employed, is more common in academic studies,

could be called the regression method. It is based on Beatty, Riffe and Thompson (2000) who

examined whether firm-specific accounting information can explain variations in IPO offering

values for a sample of IPOs from 1993 to 1998.

They find that historical accounting information primarily determines where the IPO price is

established. Bartov, Mohanram and Seethamraju (2002) and Johnston and Madura (2002)

applied a similar method to explain the variation in IPO offering values and initial returns of

Internet and non-Internet firm IPOs from January 1996 to June 1999, confirming the results of

Beatty, Riffe and Thomson (2000).

4.8.3 Comparable Firm Method to Estimating Intrinsic Value

4.8.3.1 Choosing Matching Firms

According to Pukthuanthong-Le (2007), each IPO firm in a sample should have a matching

comparable firm, which should be selected from among currently listed firms that should be

from the same sector and listing year. In addition, these should have the same characteristics

as the IPO. For example, Pukthuanthong-Le and Varaiya (2007) selected matching firms

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within the same industry and used sales and sales divided by gross costs as the main criteria

for selection.

Pukthuanthong-Le (2007) stated that, since the majority of IPOs have little or no history, they

tend to have income statement losses. He stated that, therefore, to include observations with

negative EBITDA (earnings before interest expense, tax, depreciation and amortization),

matching the peer comparable companies based on sales divided by gross costs, defined as

sales minus EBITDA is appropriate. The theory is that firms within similar industries are likely

to have comparable operating risks, profitability and growth opportunities. Under such

analytical conditions, the “Sales” figure is used to refer to the company’s size and sales

divided by gross costs can be used as a proxy for differences in profitability across firms.

The profit margin is an accounting measure designed to assess the financial health of a

business firm or industry and thus is an appropriate measure to compare IPOs within similar

industries. In general, the profit margin is defined as the ratio of profit earned to total sales

receipts (or costs) over some defined period. The profit margin also provides an indication of

efficiency in that it captures the amount of surplus generated per unit of the product or service

sold. Consequently, since sales as a percentage of gross costs measures operating

profitability, it is a more stable measure of profitability than sales divided by net costs, which

equals sales minus earnings and thus affected by interest expense.

However, matching firms based on historic turnover growth is not widely implemented in

foreign bourses as most IPOs do not have turnover statistics available for two prior fiscal

years (Appendix 2). Pukthuanthong-Le and Varaiya’s (2007: 42) matching method is similar

to that of Kim and Ritter (1999), who argued for controlling the differences in both growth and

profitability. Kim and Ritter’s method is a balance between matching only on industry and

sales and trying to match on too many financial variables.

According to Purnanandam and Swaminathan (2004), the IPO should have information on

Sales (data item 12 in Compustat) and EBITDA (earnings before interest, taxes, depreciation

and amortization) to enable pertinent IPO comparison. To reduce the number of comparable

firms for analysis, Purnanandam and Swaminathan suggest that investors start by eliminating

IPOs older than three years, ignore real estate investment trusts, closed-end funds, American

Depositary Receipts (ADRs), financial firms and firms with share prices less than $5 a share.

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Purnanandam and Swaminathan (2007) state that, to obtain a matching firm for the IPO

pricing analysis, an investor should first classify all remaining firms into industries based on

their Standard Industrial Classification (SIC) codes obtained from Securities Data Corporation

(SDC) at the time the company went public. These firms should be grouped into 48 industries

using the updated industry specifications from Kenneth French’s web site, which are

groupings of various 4-digit SIC codes and then the IPO firm is assigned into its industry

group.

Another way to reduce the number of firms for analysis is to eliminate companies that have

revenues not matching between 70% and 130% of the IPOs revenue. From this final set, an

investor can select the match as the one whose sales divided by gross cost is closest to that

of the IPO firm.

Purnanandam and Swaminathan (2007) method of calculating comparable firm multiples for

each sample IPO and then obtaining an offer price is as follows:

A

Key:

S = any key value driver selected to derive intrinsic value

Match = different companies estimated to Match the company being analysed. It can be

either sales or earnings and has to be measured in prior fiscal year.

o For internet companies, S can be number of page “hits” or views.

o For biotech or technology firms, S can be number of patents.

P = market price multiplied by the US-based Centre for Research in Securities’ Pricing

(CRSP) shares outstanding value for the matching firm. This market price is for the

trading day before the IPO date.

Kim and Ritter (1999) demonstrated that using forecasts does reduce valuation inaccuracies.

As such, S can denote earnings’ forecasts. The comparable firm approach assumes that:

is an estimate of the IPO firm’s intrinsic value multiples.

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PIPO is offer price (Offer PriceIPO) multiplied by CRSP shares outstanding at the end of the

offering date including the new primary shares. Thus, to get the offer price of the IPO, Offer

PriceIPO, divide PIPO by CRSP shares outstanding.

Purnanandam and Swaminathan (2007) believe that these two multiples can be used to

calculate a fair and relevant pre-IPO share price even if the IPO has either negative earnings

or negative EBITDA. However, the problem is that earnings forecasts to earnings multiples is

not available for every firm and price to book value multiples is not widely used because book

values tend to be low for IPO firms before going public. Moreover Liu, Nissim and Thomas

(1999) found that book value multiples are a poor measure of valuation, but they assert that

earnings and cash flow multiples are more accurate.

Liu, Nissim and Thomas (1999) thus calculate the offering value multiples for the IPO firms as

follows:

B

C

D

E

F

Key:

PIPO = the offer value, which is Offer PriceIPO, offering price multiplied by the shares

outstanding at the close on the offer date, as reported by CRSP.

Sales prior = annual sales before the IPO

Net costs = sales less earnings

Gross costs = sales minus EBITDA.

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All prior accounting data is for the current fiscal year and before the issue and forecasted

data is obtained from the available databases.

For the matching firm, Pmatch is market price of a matching firm multiplying by CRSP shares

outstanding. This market price is its stock price from CRSP on the day prior to the offering

date of IPO firm and all accounting data are for the fiscal year prior to the offering date.

4.8.3.2 Empirical Evidence

Purnanandam and Swaminathan (2004) and Pukthuanthong-Le and Varaiya (2007) showed

the offer price of IPO based on sales, sales/net costs and sales/gross costs, current year

forecasted earnings and next year forecasted earnings comparable methods are overvalued.

Kim and Ritter (1999: 409–437) used several valuation metrics and conclude that using

forecasted earnings is the best comparable method. Thus, an investor should calculate IPO

offer value using next year’s earnings forecast in order to take growth into account. This may

be impossible due to the limited availability of earnings forecast data. Purnanandam and

Swaminathan (2004) noted that analyst earnings forecasts are available only several months

after the IPO date and are therefore affected by information that is not available to investors

at the time of IPO.

Note that this problem is more severe due to the fact that analysts have incentives to issue

excessively optimistic recommendations for IPOs (Michaely and Womack, 1999). Rajan and

Servaes (1997) show that IPOs with high analyst growth expectations underperform IPOs

with low analyst growth expectations in the long run.

This suggests that IPOs with high analyst growth forecasts tend to be overvalued; thus,

matching on growth may bias the results toward overvaluation and reduce power of the test.

Given the concerns with using forecast earnings data, an investor should calculate IPO offer

value by sales divided by gross costs, where sales and gross costs are from the fiscal year

prior to IPO.

It is important to use prior fiscal year data since investors, institutions and other block traders

use information obtained from the pre-IPO phase. Pukthuanthong-Le and Varaiya (2007)

computed the ratio of IPO offer value with the offer value of comparable firms based on sales

divided by gross costs and the value is 1.36, suggesting significant overvaluation. Zheng

(2007) offered some reasons Purnanandam and Swaminathan (2004) and Pukthuanthong-Le

and Varaiya (2007) found that IPOs are over-priced. As such, if IPOs are generally over-

priced, then AltX follows a similar pattern, as set out in this dissertation. The distinction is that

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AltX has been compared to AIM and TSX and was found to be ineffectual as an overall

market (Chapter 6).

First, most IPO firms raise a lot of capital and increase sales, EBITDA and earnings

substantially after going public. These two studies used accounting number before the IPO to

compute comparable ratios. On the other hand, the matching firms do not raise capital and

have the same increase in future financial performance as the IPO. As a consequence, the

price of an IPO firms is much higher than the price of its matching firm because the IPO is

expected to grow at a much higher rate than its matching firm.

To solve this problem, Zheng (2007) suggested rescaling prices of IPO firms and matching

firms. Purnanandam and Swaminathan (2004) and Pukthuanthong-Le and Varaiya (2007)

found the IPO prices are overstated because they do not adjust cash holdings and leverage.

Zheng (2007) suggested an investor exclude the new primary shares because these new

equity raised in the IPO will bring higher sales and the total value of the IPO firm reflecting

the expected increase in cash flows.

The matching firm will not have the same increase in cash flows because it has not raised

any new capital. As a result, both studies found the overvaluation of IPO firm compared to its

matching firm. In addition, Zheng adjusted for cash holding and leverage when an investor

computes comparable firm method. Furthermore, he suggested matching firms have the

same growth as IPOs because the value of these IPO firms depends on their future growth.

The reason Purnanandam and Swaminathan (2004) and Pukthuanthong-Le and Varaiya

(2007) found IPOs are overvalued because their matching firms do not have the same growth

as their IPOs. To summarize, Zheng (2007) argued that overvaluation of IPO from

Purnanandam and Swaminathan (2004) and Pukthuanthong-Le and Varaiya (2007) is

caused by biases from new primary shares, cash holdings and capital structure.

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Purnanandam, therefore, suggested adapting equations (B) to (F) to the following:

G

H

I

J

Where PIPO is offer price (Offer PriceIPO) multiplying by CRSP shares outstanding at the end

of the offering date excluding the new primary shares. To get the offer price of the IPO, Offer

PriceIPO, an investor has to divide PIPO by CRSP shares outstanding excluded the new

primary shares. In addition, he selected matching firms based on industry, sales and ex post

consensus analyst growth forecasts to capture the effect of expected growth on valuation.

Analyst growth forecast of earnings per share are collect from the IBES analyst forecast

database and the average of growth forecasts in year after the IPO is used as the ex post

consensus analyst growth forecast. The drawback of this methodology is the analyst forecast

data is not available for every firm.

K

4.9 DETERMINANTS OF IPO PRICING

4.9.1 Investor Sentiment

A widely used measure of investor sentiment is the performance of Stock Market index prior

to the offering. Baker and Wurgler (2007) observe that investor sentiment is a belief about

future cash flows and investment risks that is not justified by the facts at hand. Behavioural

finance literature shows that investor sentiment results from noise trader sentiment where

noise traders suffer a sequence of psychological biases such that their trading behaviour

cannot be explained by rational expectation theory (Barberis, Huang and Thaler, 2006).

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Behavioural biases have become popular for explaining asset pricing that are inconsistent

with a rational decision-making framework (Cornelli, 2004). According to Brown and Cliff

(2005) excessive optimism drives asset values above fundamental.

Ljungqvist (2006) argues that investors are willing to pay premium in excess of their rational

belief if sentiment is biased towards newly issued stocks. Ljngqvist, Nanda and Singh (2003)

also agree that investor sentiment affects the pricing of IPO, but posit that since noise traders

are wealth constrained, the issuer must price IPO below the price noise traders are ready to

pay to induce informed investors.

According to Baker and Wurgler (2007), stocks of low capitalised, younger and growing firms

are prone to investor sentiment because they are harder to arbitrage and are difficult to value,

thus increasing chances of improper valuation.

4.9.2 Post-IPO Ownership Retention

Post-IPO ownership retention may play a role in valuation process of IPO. Ofek and

Richardson (2001) show a positive relationship between IPO values and post-IPO ownership

retention using a downward sloping demand curves for IPO shares.

Thus, a higher retention level means that fewer shares will be available for trading and hence

IPO prices will increase. According to McBain and Krause (1989) higher valuations are

experienced by firms whose pre-IPO shareholders maintain relatively larger ownership

positions following the offer. Consistent with Ritter (1984), Bhagat and Rangan (2004)

document a positive relation between IPO valuation and post-IPO ownership retention.

Habib and Lungqvist (2001) posit that where owners sell fewer shares at the time of IPO,

they are likely to be more tolerant to under-pricing (and hence higher offer price) because the

benefit of costly monitoring is minimal. Bhagat and Rangan (2004) extending the work of

Leland and Pyle (1977) argue that the entrepreneur taking the firm public retains shares only

when he is optimistic regarding future cash flows of the firm. The signalling model of Leland

and Pyle (1977) implies that greater ownership retention enhances IPO values.

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4.9.3 Firm Size

Extant research shows that firm size has a significant impact on IPO pricing. Ritter (1984)

argue that larger firms are easier to value because of ease of forecasting cash flows. The

under-pricing phenomenon in IPO literature which has been widely debated on in extant

research is to a great extent hinged on information asymmetry among investors.

According to Rock (1986), to lure relatively uninformed investors, investment bankers under-

price IPOs to cushion against potential losses experienced by uniformed investors due to

Winner's curse. Ann and Chan (2008) posit that greater uncertainty of the firm's value

encourage investors to demand for lower IPO price as an incentive for risk.

Teker and Ekit (2003) posit that a firm with larger amount of total assets experience less

uncertainty regarding its perpetuity and hence commanding less under-pricing and hence

higher offer price. According to Dalton (2003), the size of the IPO firm has important

implication for pricing as it is an important determinant of stability of the firm.

4.9.4 Board Prestige

Following the bankruptcy of Enron in 2001, the effectiveness of board of directors has

become a debatable issue. According to Gillan and Martin (2007) the bankruptcy of Enron

was as a result of failure by the firm's board to understand risks associated with the firm's

strategy coupled with conflicts of interests to execute their role as monitors.

According to Daily (2005) outside board member is a prestigious assignment. Certo (2001)

argue that IPO firm gains legitimacy through prestigious board of directors. According to

Dalton (2003) directors holding additional board positions possess exposure benefits. Korn

and Baum (1999) argue that directors’ association with other companies via board service

enhance the prestige of the IPO firm.

According to Certo (2003) prestigious board is a signal of effective control and enhances the

value of the firm going public. Davis and Mizruchi (1999) argue that board prestige is an

important signal to potential investors. Jensen (1993) posits that board of directors play a

crucial role in internal control systems of the firm.

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Effective control has the effect of enhancing value of the firm and hence higher offer price.

Daily (2005) argues that where an IPO firm possess prestigious board, the underwriter is

likely to offer a narrow offer price band and a higher offer price.

4.9.5 Age of the Firm

IPO firms are subject to uncertainties regarding quality of the firm because of missing track

record and lack of public scrutiny. In order to compensate investors for value uncertainty,

investment bankers discount IPO offer prices (Beatty and Ritter, 1986; Rock, 1986).

According to Carter (1998), older firms have longer operating histories and face less

uncertainty. This observation was also echoed by Ritter (1998) who argues that younger

firms have shorter operating history and are subject to great deal of uncertainty.

According to Daily (2005), because of greater uncertainties surrounding the prospects of

younger firms, underwriters apply greater offer price spread and lower offer prices as

compared to older firms with larger operating history. According to Kim and Ritter (1999) it is

difficult to forecast future cash flows of younger firms due to missing track records. Ritter

(1984) observes older firms are subject to less uncertainty and because under-pricing is

compensation to uncertainty, investment bankers attach higher value to IPOs of older firms.

4.9.6 Theoretical Underpinning

Rock (1986) argues that investors in the capital market possess differing levels of quality

information, given the missing track record of the firm. Because of information unevenness,

extant research has relied on signalling theory for investigating determinants of IPO firm

performance (Certo, 2001). Signalling theory postulates that IPO firm managers strive to

reveal the firm’s value to outsiders through favourable information so as to maximize the

share price (Certo, 2001).

Firms reveal their value through prospectus to show their potential and growth opportunities.

This study was guided by signalling theory, complemented by the resource based theory of

the firm. The resource based theory of the firm postulates that a firm nurtures resources to

differentiate itself from its competitors. This theory complements the signalling theory (Daily,

2005). IPO firms during the book-building process strive to induce institutional investors and

investment banks that it merits investing in its shares.

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4.10 CONCLUSION

Since the year 1960 the efficient market hypothesis founded by Eugene Fama (1960) has

been dominating the financial theory, which states that stock prices fully reflect the most

complete and best information available has posted an obstacle for active investors to find

ways to beat the market. It has all along been emphasized that if the market is efficient the

investors have to play with a simple rule that they cannot beat the index of stock prices.

However, in contrast to the theory of efficient market hypothesis a behavioural finance theory

has recently been evolved which challenges the foundation of the efficient market hypothesis.

This dissertation, however, advocates that if markets are efficient and current prices fully

reflect all information, then investors will not be adversely affected by buying shares that are

not properly priced prior to the IPO. Under a market where an IPO is priced at the discretion

of the issuer, buying and selling of securities in an attempt to outperform the market

effectively becomes a game of chance rather than skill.

All markets are efficient to a certain extent some more so than others. This dissertation,

however, concentrates on the AltX. Therefore, if a market is inefficient and prices are

incorrectly made at listing, then trading activity in the Stock Market cannot be predetermined

to react in a certain way simply because a company has positive or negative results. Prices in

an inefficient market cannot be expected to react in a logical and analytical manner.

Stock Market Anomalies do play an important role in enabling the players to beat the market

by exploiting the various anomalies to the maximum extent. However the investors should

consider the possible effects of the transaction costs while trying to exploit the anomalies of

the market. Hence the anomalies also have a limitation in their operation on the Stock Market

efficiency.

Based on the study conducted under this dissertation the following general recommendations

can be made for the benefit of the investors.

Any investment decision in an efficient market should be based on an intelligent analysis of

the past and historical data about the relative stock prices and a study of the performance of

the company over a period in respect of its profitability and intrinsic value addition, dividend

yield and other usual key financial indicators.

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According to Arthur Keown and John Pinkerton (1981), under such a system, shares will

move between being under-priced and over the intrinsic value. However, the norm is for the

stock to always tend back towards fair value.

While making investment decisions the value and growth aspects of investing need to be

taken into account by the investment managers to ensure that the investments represent the

optimal ones in the available securities. This reflects on the efficiency of the investment

manager in discharging his responsibilities.

This chapter reviewed the methodologies that can be used to determine the intrinsic value of

an IPO offering. Since IPOs’ share price values depend on future growth, a valuation method

needs to incorporate at least two years of forecast (Appendix 1, No 10). Procedures can be

described for implementing comparable firm method and regression analysis and provided

suggestions for improving valuation accuracy.

In Chapter 5 empirical testing includes an assessment of AltX-listed companies’ financials

and an analysis of AltX relative to AIM and TSX.

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CHAPTER 5: EMPIRICAL ANALYSIS AND INTERPRETATION

5.1 INTRODUCTION

With the establishment of the AltX JSE Exchange in 2003, the opportunity was created for

smaller firms to get access to investment capital. This incentive should create new

opportunities and foster growth in firms that previously did not have access to public funds via

the JSE. Of note is the fact that AltX companies do not need a profit history (Appendix 1, No

1).

The establishment of this Exchange also provided the opportunity for investors to invest in

small high growth companies which sometimes provide spectacular returns. The firms listed

on the AltX could have provided exceptional returns in the South African market. In March

2007 the price earnings ratio on the AltX Exchange was 1.4 times that of the JSE Main

Exchange (Dercksen, 2009). However, by November 2012, only 63 companies remain out of

the 100 listed on that Exchange (Chapter 4, Section 4.3.1).

The goal of all investors is to maximize return while minimizing risk. In general it is accepted

that a higher level of risk requires a higher level of return. This is intuitive to most investors

and economists.

There is one tool that allows an investor to maintain a level of expected returns while

decreasing the associated risk. That tool is a portfolio of investments (Brigham and Erhardt,

2005:163). To enable portfolio managers to compile and structure portfolios a prerequisite is

the existence of a relevant asset pricing model that relates risk to the expected return of an

asset. The high growth characteristics of the companies listed on AltX should make their

shares very attractive for high growth portfolios. There is however problems that prevents

these shares from being readily included in portfolios.

One such a problem was highlighted in a study by Van Heerden (2004:39) namely that the

CAPM and associated Beta cannot be used as a measure of market related risk for small to

medium sized companies or venture companies. In similar markets, the constraints that led to

problems were found to be low volumes and low frequency of trade as well as long periods

without dividend returns (Iqbal and Brooks, 2007:75).

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5.1.1 Main Goal

The main goal of this chapter is to assess the efficiency of AltX as a market for newly listed

companies and then to test a sample of AltX listed companies to assess investment viability

in relation to the IPO share price and closing price at the end of the sample period.

Essentially, an analysis is conducted to test the fairness of AltX companies’ pre-IPO share

prices.

The study can be broken down into the following sub objectives:

The first objective is to assess AltX share performance relative to these companies’

financial results following the sector reaching a peak in 2008 and the subsequent bear

market of 2009.

A second objective is to evaluate AltX performance relative to three global Junior Boards

to test whether declining shares was a global phenomenon or specific to AltX.

Thirdly, it is important to conduct a sector analysis to determine whether the fall in share

prices was sector specific or a general AltX trend.

5.1.2 Research Methodology

Empirical research is undertaken using a sample of 63 AltX companies, during a period of 24

months, from 2008 to end-2009.

5.2 TESTING ALTX SHARE PRICING EFFICIENCIES

5.2.1 Share Performance versus Financial Results

Sample period: 2008 to 2009

It can be noted from Figure 4.2 that the AltX index was in a ‘bear market’ for the whole of

2009, with the market losing almost 80%. It can also be noted that the worst performance

was in the first and last quarters and that the index stabilised somewhat in the middle of the

year.

It can further be observed that over the entire 16-day event window, the mean return was

-3.12% and the median return was -2.18%. Most of the returns in the event window were in

the range of -2.9% and -2%, which is also where the median lies.

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These results are shown in Table 5.1.

TABLE 5.1: STATISTICAL MEASURE OF THE AAR

STATISTICALMEASURE

VALUE

Mean -3.12%

Median -2.18%

Skewness -1.463

Kurtosis 0.84

Mode -2.9% to -2%

Table 5.1 presents the results of the share price response to earnings announcements for the

event window (a 16-day event window).

As observed, average abnormal returns for each of the 16 event days were negative.

However, not all the results were statistically significant; days t-10, t-8, t-7, t-3 and t+5 were

statistically significant at the 5% significance level (-2.72%, -3.02%, -3.45%, -3.53% and

-4.53% respectively).

Similarly, the results of days t-5 and t+2 were statistically significant at the 1% significance

level (-6.22 and -6.85 respectively).

TABLE 5.2: 16-DAY EVENT PERIOD RESULTS AND STATISTICAL ANALYSIS

EVENT DAY

AAR AART-STATISTICS

(2-TAILED)

CAAR CAART-STATISTICS

(2-TAILED)

SD

t-10 -2.72% -2.3179 -2.72% - 0.40 0.069

t-9 -1.67% -1.2170 -4.40% - 0.78 0.080

t-8 -3.02% -2.4967 -7.42% - 1.82 0.071

t-7 -3.45% -2.3402 -10.86% - 2.53 0.086

t-6 -1.30% -0.9212 -12.17% - 3.30 0.082

t-5 -6.22% -2.7367 -18.38% - 3.40 0.132

t-4 -2.43% -1.3793 -20.81% - 5.36 0.103

t-3 -3.53% -2.1097 -24.34% - 7.06 0.098

t-2 -2.90% -1.1575 -27.24% - 5.60 0.146

t.-1 -0.98% -0.4941 -28.22% - 7.75 0.115

t-0 -1.69% -0.9451 -29.90% - 9.52 0.104

t+1 -3.94% -1.3716 -33.84% - 7.01 0.167

t+2 -6.85% -2.9247 -40.69% - 10.75 0.136

t+3 -2.19% -1.4878 -42.88% - 18.66 0.086

t+4 -2.53% -1.5651 -45.41% -18.69 0.094

t+5 -4.53% -2.3137 -49.94% -17.49 0.114

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Figure 5.1 presents a graphical representation of these results.

FIGURE 5.1: 16-DAY EVENT PERIOD RESULTS AND STATISTICAL ANALYSIS

Table 5.1 and Figure 5.2 also present the cumulative average abnormal return results for the

entire 16-day event window. Interestingly, the results of only days t-10 (-0.4) and t-9 (-0.78)

were not statistically significant; and t-8 (-1.82) and t-7 (-2.53) were significant at the 10% and

5% levels respectively.

From day t-6 until day t+5, the results were statistically significant at the 1% level of

significance. It can also be noted that the sample showed an average cumulative loss of

49.9% during the entire event period.

FIGURE 5.2: CAAR

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Table 5.3 shows the results for a five-day event window, from day t-2 to t+2. The share price

reaction for both average abnormal returns and the cumulative average abnormal returns for

day t+5, (-6.85%: -2.925 and -16.34%: -2.678) were the only statistically significant results.

TABLE 5.3: FIVE DAY EVENT RESULTS AND ANALYSIS

Eventday

AARAAR

t-statistics(2-tailed)

CAARCAR

t-statistics(2-tailed)

SD

t-2 -2.90% -1.158 -2.90% -0.199 0.146t-1 -0.98% -0.494 -3.87% -0.476 0.115t-0 -1.69% -0.945 -5.56% -0.924 0.104t+1 -3.94% -1.372 -9.50% -1.135 0.167t+2 -6.85% -2.925 -16.34% -2.678 0.136

Having observed that the performance of AltX during 2009 was poor on average and that this

study suggests that the earnings announcements observed here were bad news, then these

study findings coincide with those of Lonie et al. (1996), Louhichi (2008), Lakhal (2008) and

Gajewski and Quéré (2001), in that earnings announcements of bad news gave rise to

negative share price reaction.

However, these findings differ fundamentally from those of:

Kong and Taghavi (2006), in that they found that annual earnings announcements led to

positive share price reaction. No dividends announcements were included. Similar findings

were reported by Sponholtz (2008).

Chan, Lin and Strong (2009), in that positive reactions were observed; however, dividends

were also included in this study. The same applies to Das et al. (2008).

Das, Pattanayak and Pathak (2008), who found neither positive nor negative reactions to

earnings announcements, irrespective of the quality of news announced.

This analysis was undertaken to achieve the following objectives:

• To investigate whether there are any significant abnormal returns (whether positive or

negative) related to the public announcement of earnings for AltX companies within

the 2008 and 2009 period.

• To establish whether the efficient capital market hypothesis applies to AltX.

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• To achieve these objectives, it was hypothesised that that cumulative average

abnormal returns (CAAR) due to earnings announcements are not significantly

different from zero.

It has been proved in this chapter that the null hypothesis is invalid.

Therefore, in line with the findings, the null hypothesis is rejected in favour of the alternate

hypothesis. Empirical evidence demonstrates that there is substantial negative share price

reaction to earnings announcements on AltX. It can be argued that, under conditions of

positive economic growth, AltX share prices would not have fallen by as much. Yet, the

analysis observed that both 16-day and five-day event periods lead to significant cumulative

loss of 49.9% and 16.3% respectively.

The study concludes that, for the sample chosen, it was proved that earnings

announcements during a recessionary period result in negative share price reaction

subsequently, share market erosion of the selected sample.

The analysis was also intended to contribute to the existing literature on earnings

announcements by analysing the information content of earnings announcements in a small

South African stock market. It was also intended to shed light on whether the small AltX

market is efficient.

No price recovery was observed in this study. It can therefore be argued that market

efficiency, at least in its strong form, is not observed in the AltX stock exchange.

The AltX thus shows weak market efficiency.

5.2.1.1 Implications and Recommendations

This analysis suggests that AltX has poor capital market efficiency, as supported by the

significant negative abnormal returns after earnings announcements in the above sample

study. The findings are useful to researchers, practitioners and investors with an interest in

the strategic decision-making of firms listed and to be listed on the AltX.

It is observed that once returns are on a down-slide, they do not seem to recover quickly and

invested capital can be eroded. In this study alone, share price as a proxy for shareholder

value led to up to 50% loss of value and the results were found to be very significant.

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It is concluded that, as AltX has weak market efficiency and companies that are over-priced

(incorrectly priced) at listing will see weakening share price performance despite the potential

of improved results (Figure 5.3).

5.2.2 AltX versus Foreign Junior Boards

The question now remains: Did the AltX do worse than its foreign counterparts? Using the

same sample period (2008 to 2009), AltX was compared to the Toronto-based TSX Venture

Exchange (TSXV) and the UK’s Alternative Investment Market (AIM). More comprehensive

statistics are set out in Appendix 5 (AIM), 6 (TSXV) and 7 (foreign exchange rates).

Bekithemba Sibanda, currently a researcher for the JSE‘s Business Development Division

confirmed in January 2010 (The JSE Alternative, 1) that these markets were set up to be

complementary to those exchanges’ different Main Boards i.e. AltX (Johannesburg Stock

Exchange), AIM (London Stock Exchange) and TSXV (Toronto Stock Exchange).

TABLE 5.4: ALTX VERSUS TSXV AND AIM

EQUITY MARKETCOMPARISON

AIM TSXV ALTX

2008 2009%

Change2008 2009

%Change

2008 2009%

Change

Number of companies listed 1,550 1,293 -16.58 2,443 2,375 -2.78 76 77 1.32

Market Value (R’bn) 570.85 741.50 29.90 141.19 305.64 116.46 18.30 11.9 -34.97

Average market cap (R’m) 368.24 573.36 55.70 57.797 128.691 122.66 240.79 154.55 -35.82

New listings 13 61 369.23 233 107 -54.08 1 4 300.00

Delistings 150 103 -31.33 38 68 78.95 1 3 200.00

Established 1995 2001 2003

Sources: stock exchanges of Toronto, AIM and AltX

These have been heralded for providing a platform for small-to-medium sized companies to

raise capital. Sibanda (The JSE Alternative, 2010) states that, over the years, these junior

boards have largely become a favoured avenue for entrepreneurs intending to grow their

companies.

The emergence of these markets provides two distinct marketplaces, namely the main

market and a junior board with its own risk profile, characteristics and specific opportunities.

Their distinct regulations, while allowing the admission of over-hyped companies, are robust

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enough to carve out highly speculative businesses which could grossly undermine the profile,

credibility and reputation of these markets (Sibanda, 2010, 4).

As such, close analysis of the three junior boards indicates that, while AltX woes (as set out

in the previous section) are not unique to the South African market, AltX has been much

more buoyant relative to the other junior boards. For example, since inception, only 5.8% (of

which 3.5% was due to mergers) of all AltX listings have delisted which is “an impressive

record for a market segment that specialises in upcoming and ultimately riskier companies”

(Sibanda, 2010, 11).

In the period under review, AltX had four new listings, but three delistings. This is according

to Julia Maluleka, analyst for the JSE Business Development unit (The JSE Alternative,

2010). As such, Maluleka suggests that it is more pertinent to view the top 15 stocks on the

AltX to get a better understanding of how the sector performed during this timeframe

(Maluleka, 2010, 11). In fact, the use of the AltX 15 Index highlights a sector that has

seriously underperformed the other junior boards. After opening 2008 at a level off 2066, the

AltX 15 Index fell by 83.9% to close at 332 in December 2009 as highlighted in Figure 5.3.

The index was weighed down by transfers to the JSE’s Main Board (Sibanda, 2010, 11).

FIGURE 5.3: ALTX 15 INDEX

Source: JSE website and PDSNet, 2012

Twenty two companies reported positive share performance, during this period, while 52

declined. The top performing stock, in terms of share price growth, was African Eagle

Resources, a dual listed mining company which grew by 148%, followed by 1Time an

aviation company which grew by 75%.

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TABLE 5.5: COMPARING INDICES

Bourse Indices 2008 2009 % Change

AltX 15 Index 2,066.00 332.00 -83.9

AltX Index 4,470.00 1,055.00 -76.4

Aim All Share Index 1,052.50 654.17 -37.8

Aim 50 Index 5,257.00 2,670.57 -49.1

TSXV Index 12,998.20 11,746.10 -9.6

Source: Google Finance

Table 5.5 shows that AltX Indices were the worst performing among the test sample bourses,

with the TSXV falling by 9.6%, while the AIM All Share by 37% and the AIM 50 Index by 49%.

From a market valuation perspective, taken as market capitalisation and valued in Rand

(average foreign exchange rates are set out in Appendix 7), Table 5.4 shows that AIM saw its

value rise by 29.9% to R741 billion), the TSXV by 116% to R305 billion, while AltX saw its

value fall by 34.9% to R11.9 billion.

5.2.3 Sector Analysis

The junior boards not only vary in size (market capitalisation), but also in the overall

composition of the companies listed. For instance, the Toronto Stock Exchange in Canada

has more companies listed on the TSX Venture market than on TSX main board with 2,250

companies on the TSXV compared to 1,503 companies listed on the TSX.

AIM is by far the largest junior board by market capitalisation, followed by TSXV. However,

on close analysis, the average market capitalisation of a company listed on the AltX is higher

than that of its counterpart on TSXV as shown in Table 5.4.

Furthermore, the charts below indicate that the AIM and the AltX are well diversified as

companies are spread across a variety of sectors. On the other hand 49% of companies

listed on the TSXV are primarily in the mining sector which largely constitute exploration

companies with limited alternative sources of finance, due to the fact that they do not

generate any revenue.

Financials constitute the largest number of stocks listed on the AIM whereas the AltX has a

high concentration of industrials, predominantly construction and materials stocks.

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5.2.3.1 TSXV Companies By Sector

FIGURE 5.4: TSXV SECTOR BREAKDOWN

Source: Bloomberg database, 2012

An interesting sector on the TSXV is the capital pool of companies (CPC) which constitutes

about 11% of companies listed. A CPC programme is a corporate finance vehicle commonly

known as a cash shell, which permits an IPO in listing a newly created company that has no

assets, other than cash and has not commenced commercial operations. This forms 11% of

the TSXV as shown in Figure 5.4.

The CPC then uses the proceeds to identify and evaluate assets or businesses which when

acquired qualifies it for a senior listing (tier 1 or tier 2) on the exchange. Failure to complete a

qualifying transaction within 24 months from the date of listing would result in suspension or

delisting of the CPC. The major advantage of the CPC is that it provides businesses with an

opportunity to obtain financing earlier in its development while also providing a springboard to

a more senior listing.

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5.2.3.2 AIM By Sector

FIGURE 5.5: AIM SECTOR BREAKDOWN

Source: Bloomberg database, 2012

In 2008, a total of 258 companies delisted from AIM (nine of which were transfers to the main

market). Delistings increased year on year by 15.2%, while new listings over the same period

declined by 60% to 114 companies. In comparison, the TSXV delisting rate declined by

28.5% to 128 companies while the listing rate was down by 14.7% to 233 companies.

There were five new listings on AltX in 2008, compared to 37 in 2007. Since inception, five

companies have delisted from AltX, of which three were as a result of mergers with other

listed entities. Six companies have also been transferred from the AltX onto the main board.

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5.2.3.3 AltX By Sector

FIGURE 5.6: ALTX SECTOR BREAKDOWN

Source: Bloomberg database, 2012

From Figure 5.7 it is evident that 2008 was a challenging year especially for growth markets

as the global economic turmoil led to falling share prices and dwindling fundraising

opportunities. On average 2008 was characterized by declining market capitalisation across

all markets.

According to the 2008 annual report issued by the World Federation of Exchanges (2008),

the market capitalisation for TSXV declined by 76.1% to US$14.1-billion and AIM was also

down 71.8 % to US$54.7bn. The market capitalisation of the AltX also deflated 59.7% to

US$1.8-billion during the same period.

Similarly, as at the end of calendar financial year 2008, the TSXV index had declined by

72.5% year on year, while the AIM index was down by 62.4% and interestingly the AltX only

lost 51.4%. Given its large exposure to the natural resources sector, the TSVX was

understandably affected by the global downturn with commodity prices declining by a

reported 68%.

Ironically, year to end-July 2008, the AltX continued with its downward trend, losing 36.5%

while the AIM and the TSXV indices gained 37% and 48% respectively on the back of

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improved trading volumes and average prices. Essentially, AltX was trading sideways, while

both AIM and TSXV bottomed out in December 2008. Evidently, the rather weak investor

sentiment in SA was lagging the global recovery of small cap stocks.

FIGURE 5.7: THE MARKET INDICES REBASED TO 100 AT 1 JULY 2008

Source: Stock Exchanges’ websites: AltX, AIM and TSXV

The challenge in 2009 by most growth oriented exchanges was to adapt to prevailing market

conditions, while not deviating from the objective of fostering early stage growth stocks. New

capital raised through secondary public offerings in 2008 dropped by 70% to US$5.8-billion

on the AIM and by 53% to US$4.9-billion for the TSXV. Surprisingly, secondary additional

fundraising on the AltX grew by 38% to US$347.6-millon.

5.3 CONCLUSION

It undertaking to launch a new Stock Exchange in South Africa, the JSE promised

entrepreneurs that the exchange would be suited to small cap companies and that Listing

Regulations would be easier than listing on the JSE Main Board (Appendix 1). However, the

lure of listing on an Exchange meant than many entrepreneurs omitted to assess the

Designated Advisors’ role in determining a fair and relevant share price.

The conclusion to the research was that only 7% of the 63 companies analysed in this

dissertation had succeeded to achieve a listing that is financially beneficial in terms of

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operating as a listed entity. As such, dissertation set out to prove that companies listed on

AltX were inefficiently priced at the pre-IPO stage and, therefore, AltX in its current form

needs to be re-engineered to establish fair and relevant share prices pre-IPO.

In testing for the efficiency level of AltX pricing, a variety of methods were used during the

research phase of this dissertation, but two main analytical methods are set out in this

dissertation. The first was to assess how share prices responded to earnings announcements

for the sample period. As observed, average abnormal returns for each of the 16 event days

were negative.

The share price analysis of the sample 63 companies confirmed the poor performance, as

highlighted by a 83% drop in share prices.

The question that followed was whether this poor performance was specific to AltX or

whether this was specific to other Stock Exchanges that were focused on small caps. To

achieve this, a comparison was undertaken between AltX and AIM and TSX.

To assess the three Boards, market valuation was based on market capitalisation and valued

in Rand. The analysis highlighted that, while AIM and TSX had increasing values (29.9% and

116% respectively, AltX saw its value fall by 34.9%.

Consequently, this chapter set out to prove that pricing method are a problem in South Africa,

which led to an investigation of the efficiency of AltX as a Stock Market. Chapter 6 set out this

dissertation’s analysis to prove market efficiency.

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CHAPTER 6: ALTX COMPANIES ARE OVERVALUED AT IPO

LISTING

6.1 INTRODUCTION

This chapter investigated reasons for the over-valuation theory and related these theories to

the JSE’s AltX. The aim was to assess whether AltX has a different approach to valuing

stocks pre-IPO and then to determine the validity of such methods.

An in-depth analysis followed, using the sample database of the 63 listed-AltX companies to

assess share price performance, with specific focus on the numerous sectors that the 63

companies make up (Table 6.1).

The aim is to assess these AltX sectors not only as an isolated division of the JSE, but to

investigate P/E multiples in relation to the All Share and Small Cap Indices. As such, the

investigation started with an historic overview and honed in to mathematical elements to

determine whether pricing strategies for the sample database was fair, relevant. This chapter

also aims to investigate whether there is a bias in pricing strategies for AltX and ultimately

determine whether this Stock Exchange is efficient.

6.2 THE OVER-VALUATION HYPOTHESIS

Myers and Majluf (1984) hypothesised that a firm conducts an equity offer when management

(based on their inside information) believe that equity is overvalued. At a certain point in time,

management becomes aware of additional information regarding the expected profitability of

future projects and the growth of the company. However, this information is not known to the

market until some future date.

Thus, it becomes profitable to issue equity if additional information would result in a

downward revision of the firm’s market value. Rational investors are aware of the fact that the

issuing firm’s equity might be overvalued on average and the stock price reacts negatively to

the announcement of the offer. Nevertheless, investors wait for confirmation of this

information that is known only to the management at time of announcement.

As the information is subsequently filtered through the market, the SEO firm underperforms in

the long run. Myers and Majluf (1984: 187) suggested that firms should use internal reserves

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or earnings retention to finance projects. If unavailable, bank debt or bond issue should be

undertaken rather than an equity offer, which in some cases would reveal too much

information to the market and competitors, leading to a reduction in the firm’s value.

Koop and Li (2001) found that both IPOs and SEOs are more likely to occur during the hot

issue periods, when investors are optimistic about equity issuing firms, providing support for

the overvaluation hypothesis. Additionally, Loughran and Ritter (1995), Lee (1997) and

Spiess and Affleck-Graves (1995) provided support for the overvaluation hypothesis, with

evidence that post-SEO underperformance of issuing firms is observable for up to five years

after the offer announcement.

6.3 ALTX – STAGGERING FALL ACROSS ALL SECTORS

This section assesses the performance of AltX companies within the defined sample dates

(Chapter 4, Section 4.3.1) with a specific focus on different business un its, as set out in

Table 6.1.

TABLE 6.1: ALTX SECTORS

NOSHORTNAME

INDEXSTOCK

SECTOR

1 AC Towers NO IT2 Accent YES Building materials and fixtures3 Afdawn YES Consumer finance4 Afeagle NO Mineral exploration and development company5 Ah-Vest YES Food products6 Alert NO Prime steel, building materials, plumbing and hardware products7 Alliance NO Design, development, manufacturing, installation for mining industry.8 Ansys YES Electronic equipment9 B&W YES Heavy construction10 Beige YES Personal products11 Bioscience YES Food products12 Blackstar NO Investment holding company13 Blue YES Consumer finance14 Brickcor YES Building materials and fixtures15 BSI-Steel YES Iron and steel16 Chemspec YES Building materials and fixtures17 Chrometco YES General mining18 Diamondcp NO Emerging diamond producer19 Erbacon YES Heavy construction20 Finbond YES Mortgage finance21 Foneworx YES Telecommunications equipment22 Gooderson YES Hotels23 Hardware YES Home improvement retailers24 Huge YES Telecommunications equipment25 Imbalie YES Personal products26 Interwaste YES Waste and disposal services27 IPSA YES Conventional electricity28 Iquad YES Business support services29 ISA YES Computer services

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NOSHORTNAME

INDEXSTOCK

SECTOR

30 Kibo NOMineral exploration and mining projects principally located inTanzania

31 Lonrho YES Diamonds and gemstones32 MAS YES Real estate holding and development33 MINERESI YES Industrial machinery34 Moneyweb YES Publishing

35 MS Holding NOProvider of personnel, primarily to the chemical and petro-chemicalplants,

36 Muvoni NO Investment holding company

37 Nutrition NOManufacture of high-protein fortified nutritional food products andsupplements

38 Oasis YES Retail Reits39 Onelogic YES Business support services40 Osiris NO Property company41 Pinpoint NO Property development, company42 Poynting YES Telecommunications equipment43 PSV YES Industrial machinery

44 QPG NODiversified property company with a vision to build a largeinvestment portfolio in all sectors of property.

45 QueensGate NO Hotels46 Racec YES Heavy construction47 Rare YES Industrial suppliers

48 RBA NOMarket leader in supplying fully-bonded quality homes on a turnkeybasis

49 RGT NO Collator of motor industry stat50 Rockcastl YES Real estate holding and development51 SA French YES Industrial suppliers52 SABLE YES Real estate holding and development53 Shercap NO Investment holding company54 Silverb YES Software55 Stratcorp YES Investment services56 TCS YES Computer services57 Telemaster NO Premier developer of Business Communication Strategies58 Ububele YES Food products59 Vunani YES Investment services60 Wearne YES Building materials and fixtures

61 Willtell NOProduces chipboard from wood waste, adds value by applyingmelamine surfaces.

62 Workforce NO Staff outsourcing, recruitment and specialist staffing.63 Zaptronix YES Electronic equipment

Sources: AltX database, 2012

A look at the AltX Index graph (Figure 6.1) provides clear conclusion that the sector has been

in a downward spiral since it reached a peak in 2008. However, it is imperative to assess

individual company share price performance, before it can be concluded whether influences

are on specific companies or overall industries.

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FIGURE 6.1: ALTX PRICE GRAPH

Source: PDSNet, Business Consultants International, 2012

6.3.1 Historic Background: Performance Outline

Johan Holtzhausen (The JSE Alternative, April 2011), managing director of PSG Capital,

believes that the fall in AltX prices between the peak reached in 2007 (Figure 6.1) to the

current (2012) low price, was “due to the fact that worldwide financial markets were in a

turmoil over the last two and a half years, but AltX still has a role to play.”

Peter Todd, (The JSE Alternative, 2012) CEO of AltX-listed Osiris Properties International

agrees with Holtzhausen, stating, at the company’s official listing on 12 August 2012, that the

decision to choose AltX as their secondary listing Exchange was not difficult.

Todd (2012) stated that the company aimed to “opportunistically acquire good quality

undervalued property assets predominantly in the UK and Europe and to offer investors a

high yielding, property investment.” Osiris has its primary listing on the Bermuda Stock

Exchange.

The listing of Osiris was the 100th AltX listing since the Exchange launched in October 2003.

Nicole Cheyne (The JSE Alternative, 2012), AltX spokesperson explains: “21 of these 100

companies have successfully transferred to the Main Board, 16 have delisted and there are

currently 63 companies listed on AltX. More than R1,25-billion has been raised via this

market. This year, there have been three new listings.”

Other market commentators have argued it has taken two to three years for the share prices

of recently listed companies to fall to levels that represent more realistic value. Cheyne is one

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such person, saying that “The JSE is extremely supportive of AltX and, while there has been

a dip in listings across Main Board and AltX, there is on-going interest in terms of listing on

AltX, but the listing cycle is protracted.”

However, most AltX counters have dropped below initial IPO offers.

For instance, of the currently listed 63 AltX companies (See Appendix 3), only 12 companies

have share prices higher than at listing.

The share prices of Dialogue, Afbrick, Brikor, Finbond, Vunani, Workforce, SA French and

WG Wearne share prices all fell sharply. Greenhill (2011) said at a presentation to institutions

in Cape Town that it was clear many AltX members remained positive about prospects and

reassured their respective businesses were sound.

Marc Hasenfuss (2009) pointed out that major companies such as Spur Corporation, Nu-

World, Medi-Clinic, Investec, Grindrod, Italtile, Sasfin and Bowler Metcalf survived the late

1980s listings boom. Similarly, the late 1990s listing boom saw small market capitalisation

companies shares get suspended. Yet, some notable small capitalisation companies

prospered during this volatile trading period, such as Digicore, UCS, Brimstone, AdvTech,

Peregrine, Adapt IT, AME, SecureData, Pinnacle Technology, Compu-Clearing, Datacentrix,

Afgri and Adcorp.

In 2002 Brimstone - now trading at 1000c on the JSE - was trading at between 28c and

58c/share, Pinnacle - now at 1710c - traded between 2c to 8c/share in 2002. Digicore - now

255c - was trading between 5c and 20c/share in 2005, while private education specialist

AdvTech - now 590c - was trading as low as 28c/share in 2003.

However, not all small capitalisation stocks were correctly priced and ultimately most have

been suspended from AltX. These include Whetstone, JEM Technology, Essential

Beverages, Maxtec, Cycad, Central Information Holdings, O'Hagan's, Nimbus, MMW Tech,

Afribrand, Sweets from Heaven and Nextvest.

Coronation Fund Managers small cap expert Alistair Lea (Business Day, 2005) said that the

reality for ordinary investors is that amid the prevailing market gloom and steady flow of

negative trading updates it is difficult to invest in companies that are inherently poorly priced

at its IPO.

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Lea (The JSE Alternative, 2009) added that, while the JSE's mid-cap stocks - heavily

weighted in retail shares - have enjoyed a remarkably strong run on the back of a lower

interest rate environment, that stronger performance has been replicated on a less

impressive scale by the JSE's small caps.

By contrast, says Lea (The JSE Alternative, 2009), the performance of AltX listings and

fledgling stocks has been nothing short of abysmal. "My sense is that there isn't much

opportunity left in the mid and small cap stocks. If there's opportunity it is in the JSE's

fledgling companies and the AltX." (The JSE Alternative, 2010).

Any more significant declines in AltX share prices, particularly among new listings will have a

negative effect on investor sentiment, as indicated by the P/E Ratio of AltX when compared

to the JSE Small Capitalisation Index. David Gardner (Motely Fool) is of the opinion that

negative investor sentiment (as expressed by P/E Ratios) reinforces the common belief that

newer listings will not able to deliver on the potential share price increases – as suggested in

their prospectuses or pre-listing statements – due to in the changed economic environment.

Internet based investment advisor, Motley Fool co-founder Gardner, defines the P/E as an

Investor Sentiment indicator. The P/E will move as the share prices and earnings change. As

the P/E goes up, it shows that current investor sentiment is that the company is worth more,

its future prospects are bright and sellers are only giving up their stock at higher prices. A

dropping P/E is an indication that the company is out of favour with investors.

An assessment of the P/E ratios of the JSE Small Capitalisation Index and AltX for the period

October 2003 (launch of AltX) and November 15, 2012, graphically indicates investor

sentiment for the two Indices, as set out in Figures 6.2 and 6.3.

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FIGURE 6.2: ALTX INDEX P/E RATIO

Sources: PDSNet, Share Friend Pro and Business Consultants Database, 2012

FIGURE 6.3: JSE SMALL CAPITALISATION INDEX P/E RATIO

Sources: PDSNet, Share Friend Pro and Business Consultants Database, 2012

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FIGURE 6.4: THE JSE ALL SHARE P/E RATIO

Sources: PDSNet, Share Friend Pro and Business Consultants Database, 2012

Figures 6.2 and 6.3 highlight that AltX sentiment is far worse than that of the JSE Small

Capitalisation Index. While the average for AltX is 5.8 times with a current ratio of -12.24

times, the average P/E ratio for the Small Capitalisation Index is 14.15 times and a current

ratio of 12.95 times.

In terms of relative value, Stanlib small cap expert Shaun Stockigt (Financial Mail, 2011) says

that such multiples for small cap companies are fundamentally low, but he still believes there

remains significant risk in selecting AltX companies.

Consequently, it is probably best to accumulate a portfolio of value shares rather than opting

for one or two winners.

AltX experts and continues to show that many AltX companies continue to trade at a discount

of over 80% to Mechantec’s estimate of the 1-year forward P/E of the FINDI and it is

anticipated that share prices will recover quickly for those AltX companies that display stable

or improving prospects.

While investor confidence and strong price recovery has occurred in 2012 with large and

small cap stocks, a general increase in the share prices of AltX stocks is still lagging

significantly. While the JSE All Share Index increased by 38% and the JSE Small Cap index

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increased by 29% since their recent lows in March 2009, the JSE AltX index has conversely

decreased by 45%.

6.4 ALTX IS NOT AN EFFICIENT MARKET

The following analysis is to be undertaken to investigate whether the share price decline

during the sample period was significantly abnormal or not relative to public earnings

announcements.

To achieve these objectives, it was hypothesised that that cumulative average abnormal

returns (CAAR) due to earnings announcements are not significantly different from zero. It

has been proved in this study that the null hypothesis is invalid. Therefore, in line with the

findings, the null hypothesis is rejected in favour of the alternate hypothesis. Empirical

evidence demonstrates that there is substantial negative share price reaction to earnings

announcements on AltX.

After considering the results of statistical tests on share prices after earnings announcements

during 2008 and 2009, it can be concluded that the evidence supports the assumption that

AltX is not an efficient market. As such, it is important to assess whether alternative methods

of establishing a pre-IPO share price is available around the globe.

For nearly over a decade US academics have debated the economic process that underlies

the pricing of ordinary shares (Gilbertson and Roux, 1977). The controversy revolves around

the so-called 'efficient market hypothesis' which states that the market prices of securities at

any time 'fully reflect' all available information.

The validity or otherwise of this hypothesis is of great practical significance. For example, it

implies that the study of trends and patterns in past price behaviour will not allow one to

predict the future performance of a given share. Consequently the activities of technical

analysts are of no value to investors at the initial stages of a new company listing. It further

implies that fundamental analysis — i.e. the acquisition and analysis of company financial

statements, directors' reports, earnings and dividend records also cannot be expected to

allow superior investment performance (Gilbertson et al, 1997).

Given the importance of these two categories of analysis in the traditional approach to

determining fair and reasonable share prices, the depth of the controversy becomes evident

in two studies investigated by this dissertation.

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This situation is not unlike that which existed in the early stages of American research (Roux

and Gilbertson unpublished report) and it is important to note that additional variables

influence share prices as there is evidence that the share prices listed on the JSE exhibit

even more pronounced leptokurtic (Appendix 11) properties than do the NYSE shares

reported on by Fama.

Therefore, it can be concluded that, whereas the small correlation coefficients are consistent

with the Efficiency Model Hypothesis, they do not prove its validity. Conversely, the observed

deviations from independence do not justify rejection of the hypothesis. Therefore,

generalised conclusions shall be avoided until the evidence is reviewed from other tests.

6.5 IPO PRICING

This section investigates how well valuation theory regarding P/E multiples, as advocated by

academia, is aligned with the multiples that leading financial analysts and corporate

financiers apply in practice (Nel, 2009). Although multiples are used extensively in practice as

an equity valuation method, no study has yet compared the preferences of investment

practitioners for certain multiples, with the multiples that theory advocates.

The research results reveal (Nel, 2010: 930 – 941) that, although theory and investment

practitioners favour the price earnings ratio and agree on the suitability of earnings and sales

as value drivers; they disagree significantly with regard to other multiples and value drivers.

Researchers, on the other hand, specify different approaches to valuations. Hendrikse and

Hendrikse (2004:123), for example, distinguish between the cost approach, the income

approach and the market approach, while Damodaran (2002:11) distinguishes between

discounted cash flow (DCF) valuations, relative valuations and contingent claim valuations.

Similarly, leading financial analysts and corporate financiers, who will be referred to as

“investment practitioners” in this dissertation, tend to focus on the DCF approach in practice

(PriceWaterhouseCoopers, 2008:13). Proponents of the DCF method attempt to estimate the

intrinsic value of an asset by focusing on the asset’s fundamentals (Damodaran, 2007:5).

Opponents to the DCF approach, however, point out that the focus of DCF models is on the

discounting of forecasted future cash flows, the estimation of which can be unreliable

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(Kamstra, 2003:49). The DCF approach can also be rather cumbersome and rests on a

range of sensitive assumptions (Lie and Lie, 2002:1).

Consequently, although multiples are generally regarded as appropriate secondary models,

they are used extensively in practice, usually as a plausibility check to more sophisticated

equity valuation methods (Bhojraj and Lee, 2002:407). This was confirmed by Designated

Advisors Arcay Moela in 2010 during the listing of RGT Smart (Moela, 2010).

According the Nel (2010), valuations that are based on multiples assume that the actual

value (V) of a company’s (j) shares at a given point in time (t) is equal to the product of a

specific multiple ( ) and a specific value driver ( ) at that specific point in time, so that

Much research has been devoted to determining which multiples and value driver categories,

such as earnings, are superior to others (Liu, Nissim and Thomas, 2001:153; Liu, Nissim and

Thomas, 2002:23; Abukari and McConomy, 2000:22; Cheng and McNamara, 2000:367;

Volker and Richter, 2003:216). Researchers such as Baker and Ruback (1999:19) focused

on which specific value drivers, between earnings before interest, tax, depreciation and

amortisation (EBITDA) and earnings before interest and tax (EBIT), for example, are more

accurate in terms of equity valuation.

If there is one number that people look at than more any other it is the P/E Ratio (Little,, K.,

2012)). The P/E is one of those numbers that investors throw around with great authority as if

it told the whole story. The P/E looks at the relationship between the stock price and the

company’s earnings. The P/E is the most popular metric of stock analysis, although it is far

from the only one you should consider.

AltX Designated Advisors tend to use comparative peer analysis to determine a fair P/E ratio

and then link the value driver to Earnings per Share (EPS). Brian Rainier, head of

Merchantec Capital Research stated in an interview in 2011 that the “fairest method of

determining a share price prior to listing is to use discount to comparable peer P/E analysis

as a new companies have no history.”

Rainier, (The JSE Alternative, 2009), stated it as follows:

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“Many AltX companies continue to trade at a discount of over 80% to our estimate of the 1-

year forward P/E of the FINDI and we anticipate that share prices will recover quickly for

those AltX companies that display stable or improving prospects.

However, the literature review undertaken for this dissertation revealed no evidence of a

study that compared theorists’ preferences with regard to the use of P/E multiples, with that

of investment practitioners. This dissertation investigates theories’ consensus among

chartered accountants regarding the use of multiples and whether the general concern

regarding a gap between theory and practice (Triantis, 2005:8; Ralston, 2003:1; Bernstein,

2008) is warranted.

The convergence of theory and investment practitioners on mainstream valuation practices is

a common phenomenon in developed markets (Bruner, Conroy, Estrada, Kritzman and Li,

2002:319). Although Bruner et al. (2002:319) emphasised the need for such convergence in

emerging markets, no research has yet been conducted on this topic in South Africa.

A valuation methodology field survey (PricewaterhouseCoopers, 2008), which was conducted

among leading financial analysts and corporate financiers in 2008, provides a valuable

benchmark for best practice for investment practitioners, while affording academia an insight

as to which equity valuation methods are applied most frequently in practice. However, no

such research has yet been conducted among academia.

Equity valuation methods based on multiples typically have broad dispersions (Fernández,

2001:2), which explains why they are not generally regarded as the most accurate equity

valuation methods (Courteau, Kao, O’Keefe and Richardson, 2003:24). Consequently

researchers generally regard multiples with the lowest dispersion as the most reliable

multiples (Pratt, 2006:4). Although multiples are not suitable primary equity valuation

methods, they are used extensively in practice, usually to anchor more comprehensive

valuation methods such as the free cash flow model (Liu, Nissim and Thomas, 2002:1).

Despite the fact that more sophisticated models may offer more suitable equity valuation

methods, they tend to be based on various assumptions and are rather cumbersome, which

is why analysts often revert to multiples. Consequently analysts’ reports and investment

bankers’ opinions are ubiquitous with multiples (Schreiner, 2007:1).

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Even analysts who are stern supporters of more comprehensive equity valuation methods

revert to multiples to check their equity values for plausibility (Bhojraj and Lee, 2002:407).

Best practice in terms of corporate valuation policy in emerging markets such as South

Africa, is a topic of great international interest (Bruner et al., 2002:319). A valuation

methodology survey conducted by PwC in 2008 among 25 leading financial analysts and

corporate financiers confirmed that investment practitioners have a preference for the DCF

approach when valuing equity.

According to the PwC survey results (6th edition, 2012), the P/E ratio is the most frequently

used multiple in practice, closely followed by the MVIC/EBITDA and MVIC/EBIT ratios,

respectively. MVIC equals market capitalisation plus preference shares plus interest - bearing

debt.

6.6 BIAS IN IPO PRICING

This section examines the IPO pricing process to analyse an apparent biases in the pricing of

new IPO share prices. While some of this dissertation’s findings provide added support for

one or more of the existing theories of IPO pricing, others cannot be explained with these

theories (Lowry and Schwert, 2001).

The analysis starts with the firm’s revelation of the expected range of offer prices, which is

announced at the time the offer is filed after book-building or the auction has taken place

(Appendix 2). The share price is then amended in the prospectus. Lowry et al found that

there are significant biases in these expected offer prices. Specifically, the price update,

defined as the percentage difference between the midpoint of this file range and the final

offer price, is predictably related to publicly known firm- and offer-specific characteristics.

Apparently, companies and their investment bankers do not incorporate all available

information when setting this price range.

While significant relations between the characteristics of the variables that make up the share

price, such as EPS and P/E ratios and the initial return after the first day’s trading have been

interpreted as supportive of information asymmetry theory, but it is difficult to similarly explain

the predictability of the price update (Lowry et al, 2001).

An investigation is then undertaken on how information, that becomes available during the

book-building period, is incorporated into the offer price. Lowry et al states that results show

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that companies and appointed underwriters update the offer price in response to recent

market returns. However, this adjustment process does not seem to be directly related to the

date on which the initial price range is first revealed. Underwriters appear to consider the past

three months of market returns when they update the offer price, irrespective of when the

initial price range was first revealed.

This finding provides additional evidence that all available information is not incorporated into

the initial price range. Lowry et al also found that the response of the final offer price to

information is asymmetric, with negative information being more fully incorporated than

positive information.

This is consistent Lowry and Schwert (Lowry and Schwert; 2001: 4-5) biases in IPO Pricing

with investment bankers trying to avoid losses on over-priced issues, but sharing the gains on

under-priced issues. Finally, the predictability of initial returns shows that underwriters only

partially incorporate private information that is learned during the filing period into the final

offer price, while public information is fully incorporated. This finding is consistent with

Benveniste and Spindt’s (1989: 343-362) partial updating theory.

In summary, results show that the IPO pricing process is a complicated function of many

factors, depending of which preferred method is used, as set out in Appendix 2. Some of the

dynamics between P/E multiples, EPS and other variables can be explained under the

information asymmetry theory or the partial updating theory, but some trading patterns need

further analysis, as set out in Section 6.5.1.

6.6.1 Value Drivers

Multiples are used to value an asset by using a comparable asset price/ratio as a benchmark

with regard to a common variable such as earnings or sales, known as value drivers.

Research on multiples tends to focus on these value drivers, which is earnings, cash flows,

book value and sales. Most researchers come to the conclusion that earnings-based

multiples, such as P/E ratios, are superior to their counterparts (Nel, 2010).

Liu, Nissim and Thomas (2001:153), for example, indicated that earnings-based multiples

perform more accurate valuations than those based on cash flows. In an extended study by

Liu et al. (2002:23), it focused on which value drivers performed the best among earnings,

cash flows, dividends and revenue, to approximate stock prices in ten countries, including

South Africa. Their research results indicated that earnings-based multiples performed the

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best valuations, while cash flow - and dividend-based multiples produced average results.

Sales-based multiples performed the worst.

Earnings also outperform book value as a value driver when using multiples to value equity

(Abukari, Jog and McConomy, 2000:22). Research conducted by Cheng and McNamara

(2000:367) and Volker and Richter (2003:216) also confirmed the superiority of earnings -

based multiples.

Further research focused on which earnings–based value drivers are superior. Baker and

Ruback (1999:19) found that sector-adjusted EBITDA outperformed EBIT and revenue. Lie

and Lie (2002:53) found EBITDA to be a more accurate value driver than EBIT and that

forward-looking multiples outperformed historical multiples.

Kim and Ritter (1999:430) concluded that two–year earnings per share (EPS) forecasts

are more accurate than one-year forecasts, while one-year EPS forecasts are more

accurate than current EPS. Research conducted by Schreiner and Spremann (2007:18)

confirmed that forward-looking multiples performed more accurate valuations than trailing

multiples.

6.7 CONCLUSION

This chapter set out to determine whether AltX, as a market to list small caps, was efficient or

not, given the poor performance of AltX listed companies (See Chapter 5). A variety of

methods were assessed, including whether companies conduct IPOs when management

hold back information to achieve a higher share price.

Given that AltX Listing Requirements Schedule 21 (Appendix 1 and Sections 4.5.2.2) sets out

clear guidelines for listing, this dissertation concluded that management could only have a

marginal influence over the share price at pre-IPO. However, in-depth analysis of Schedule

21 highlights the absence of pertinent rules relating to how a share price should be

determined pre-IPO.

If management only had a marginal influence over share prices, the next question was

whether specific sectors had an influence on how a share performed after listing. An analysis

of AltX companies within the defined sample dates (Chapter 4, Section 4.3.1) was

undertaken on different business focuses, as set out in this Chapter.

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A number of people were interviewed during the research phase of this dissertation and a

different set of viewpoints were given for the poor performance of AltX-listed companies

during the sample period. Johan Holtzhausen and Peter Todd stated that poor performance

was due to global markets, but this was disproved in Chapter 5, with an analysis of AltX

relative to AIM and TSX. AltX’s spokesperson Nicole Cheyne stated that AltX companies

were actually doing well, discounting the fact that such companies’ share prices fell by over

80% during the sample period.

The analysis was then taken to a new phase with an investigation of P/E multiples. An

assessment of the P/E ratios of the JSE Small Capitalisation Index and AltX for the period

October 2003 (launch of AltX) and November 15, 2012 graphically indicated that AltX

sentiment was far worse than that of the JSE Small Capitalisation Index. While the average

for AltX is 5.8 times with a current ratio of -12.24 times, the average P/E ratio for the Small

Capitalisation Index is 14.15 times and a current ratio of 12.95 times.

Consequently, the analysis led to an assessment of AltX’s efficiency as a market. After in-

depth analysis, results of statistical tests on share prices during the sample period (2008 to

2009) and after earnings announcements were made it was concluded that the evidence

supported the assumption that AltX is not an efficient market.

The next question was to ask if P/E multiples was an efficient means of determining share

price pre-IPO. Essentially, the dissertation assessed whether there was bias in the P/E

methodology, given that AltX was deemed to be inefficient. After various research literatures

was analysed, the PwC survey results (6th edition, 2012) confirmed that the P/E ratio was the

most frequently used multiple in practice.

In fact, while P/E is a popular method to establishing a pre-IPO share price, results of

analysis summarised in this chapter showed that the IPO pricing process was complicated by

many additional factors.

This dissertation took three years to complete and included analysis of 44 different countries’

IPO pricing methods (Appendix 2). It can thus be concluded that, despite the many different

method available to determine a pre-IPO share price, AltX has failed to establish and regulate

a fair and relevant methodology.

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This dissertation is summarised in Chapter 7, which includes conclusions on AltX’s pre-IPO

pricing methodology and ends with recommendations.

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CHAPTER 7: CONCLUSIONS AND RECOMMENDATIONS

7.1 GENERAL COMMENT

While the main focus of this dissertation is not an analysis of the JSE and how IPOs are price

on the Main Board (Appendix 1), it is important to assess how AltX IPOs have performed

relative to the JSE. To establish a fair and reasonable timeline, a sample database was used

whereby the AltX Index had its fastest growth (Figure 6.1). As such, this section looks at AltX

between its launch in 2003 to the end of 2007 and compares performance of the 33 JSE

IPOs during this period (Appendix 10, A and B).

The aim is thus to establish an average two year return performance of smaller capitalisation

JSE IPOs using nominal and risk-adjusted bases by analysing daily share price data.

The dissertation furthered the work that has been done on South African IPOs by other

authors, including Moodley (2009), Boles (2001) and M’kombe (2000); as consequence of

analysing a large sample of AltX companies’ share performance relative to other Junior

Boards (Table 5.4) and relative to financial results; taken during the 2008 and 2009 sample

period (Table 5.2). As part of the literature review, reference was made to studies in the

research of IPOs performance in South Africa and internationally.

The assessment was undertaken based on listed AltX companies (Appendix 11 A) and JSE

listed companies (Appendix 11 B) during the period 2003 to 2007. Previous research work on

IPOs in South Africa did not focus on the JSE AltX IPO performance and as such this study

attempts to be the final analysis for this dissertation to determine whether AltX IPOs are

being correctly priced at listing.

The returns data were found to be statistically significant. The risk profile of each IPO share

and the listing platforms were measured using the standard deviation and coefficient of

variation (Appendix 10). The JSE average return was 40.4% (Appendix 10 B), compared to

the AltX’s 20.6% (Appendix 10 A).

Conclusions were that AltX, which is a higher risk exchange, did not deliver higher returns

than the less risky JSE IPOs. The results revealed that even though JSE AltX IPO returns

were riskier on average as expected by corporate finance theory, they generated lower

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nominal and risk-adjusted returns than larger JSE Main Board IPOs, which would normally be

expected to be less risky and therefore generate relatively lower returns.

The above findings were consistent for the average two year period (Appendix 10). These

results mean that even though the JSE Main Board IPOs outperform JSE Alt-X IPOs on a two

year average, the difference in performance was not statistically significant.

Based on the above findings, it is therefore recommended that investors do not invest merely

on the assumption that riskier IPOs provide higher returns. There is need for due diligence

based on a variety of factors which affect IPO performance such as the objectives of the IPO

(Boles, 2001), the pricing (Loughran and Ritter, 2002) of the offer, to establish if there is

likelihood of mispricing as well as timing the market (M’kombe, 2000) pre- and post-listing

operating performance (Yi, 1992). According to Moodley (2009), primary investors are more

likely to earn higher returns than secondary investors.

It is therefore advisable for additional research to be undertaken to establish a set of pre-IPO

pricing guidelines.

7.2 CONCLUSION

Research undertaken over the past five years indicates that little attention has been paid to

the establishment of realistic pre-listing share prices for IPOs in South Africa. More

pertinently, the focus of this dissertation is that there does not appear to be any accepted set

of guidelines for establishing the pre-IPO share price on the Johannesburg Stock Exchange’s

AltX, a division of the JSE which allows small and medium-sized businesses in South Africa

to enter a public equity exchange. A complete analysis of the JSE’s Listing Requirements

Schedule 21 – specific to listing companies on AltX – was undertaken in Chapter 4, Sections

4.5.2.2 to 4.5.2.3.

This in-depth assessment of the legal requirements highlighted that the JSE does not

prescribe to designated advisors on how to determine a fair and realistic share price for an

entrepreneur’s company prior to listing. In fact, the Noah Greenhill is on record (Chapter 4) as

stating that the DA is responsible for determining such a price. Consequently, the legal

requirements of Schedule 21 relating to DAs was undertaken in Chapter 4, Sections 4.5.2.3

and 4.5.2.4.

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Findings suggest that DAs use a variety of methods to determine IPO pricing pre-listing and

these include book-building and fixed pricing (Chapter 2, Section 2.4.1). Both methodologies

are difficult to implement in South Africa, as listings tend to be too small for institutional

interest, as stated by a survey undertaken by the Efficiency Group in 2008; conducted during

the sample period of this dissertation.

Efficiency Group (The JSE Alternative, April 2009): “Institutional holdings accounted for

9.28% of the total market capitalisation of the AltX companies in the survey as at the end of

December 2008. This was down 3.71% from March 2008 where institutional holdings

accounted for 12.99% of the total market capitalisation of the companies in the survey.”

This research confirmed this finding, given that 11 AltX companies make up 70% of the 63

listed AltX companies (Table 4.6). Consequently, DAs tend to use a P/E ratio to determine

sharer price, after conducting peer group analysis. However, an analysis of the P/E ratio of

AltX relative to other JSE Indices (Table 5.5) highlights that multiples were not accurately

determined at listing.

The dissertation makes reference to DAs comments that pricing is a function of “getting the

client’s buy-in.” Greenhill (AltX Director’s Induction Program, 2011) is also on record as

stating that “A set of guidelines will deter entrepreneurs from wanting unrealistic P/E ratios at

listing.” The poor performance of AltX and the companies listed on the Exchange P/E ratios is

highlighted in Figures 6.2, 6.3 and 6.4 and Appendix 9.

It is thus concluded that, as a consequence of inaccurately determining a share price, more

than 50% of these 63 currently listed companies are in danger of being delisted. This means

that 31 companies will remain listed on AltX, out of 100 listed since its inception in 2003.

Since the global financial crisis of 2008, AltX has had difficulty securing investors. The

economic instability of the worldwide market leads to many investors choosing more

established companies, which are on the JSE Main Board. The current method of

establishing an IPO price is generally to the advantage of the company owners and larger

institutions. This means investors are usually the entity which suffers from the inaccurate

pricing. This exacerbates the reticence of investors to enter the AltX market.

Pricing methods for IPOs vary and can be contested. Part of the reason for this disagreement

regarding IPO prices is that the stocks are those of younger companies or privately owned

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firms, which have chosen to switch to a publicly traded status. This means there is no past

performance on the exchange. Therefore, conventional pricing methods cannot be used. The

traditional method for pricing and IPO involves the use of an underwriting firm. This firm

represents the company which is going public. However, there are alternative methods such

as book-building, auction style and price to earnings ratio techniques. These methods may

eliminate the need for an underwriter.

Consequently, if pricing methods are inefficient for AltX companies, then it is necessary to

explore the determinants of IPO pricing for AltX. These companies are influenced by thin

trading, low efficiency and information asymmetry. A sample of 63 AltX IPOs undertaken in

this dissertation indicates that the prices were inaccurate by as much as 93%. This was

nearly always to the disadvantage of investors.

The primary research objectives of this study were to complete in-depth research and

analysis of the major global houses in relation to IPO pricing (Appendix 2). The next goal

was to use the global database as a foundation to analyse the AltX IPO pricing methods to

establish whether the AltX pre-IPO share pricing methodologies are fair and relevant. The

final goal was to conclude that further research is necessary to establish a fair and relavant

pre-IPO pricing methodology.

The literature review revealed that auction style and book building IPOs represented a closer

link between investor demand and price than the fixed-price ideas. The fixed-price method

can be substantially affected by the intermediary, which is highlighted by poor P/E ratios

chosen at listing (Appendix 9).

Nevertheless, underwriters can be valuable for firms, which are seeking legitimacy. This

means that the book-building method may be preferable to the auction style for younger

firms, which will benefit from an underwriter that improves investor awareness. It has been

determined that the auction style methodology is not used in South Africa (Table 2.1 and

Appendix 2).

This is likely to be the reason that book-building is the most widely used method in both the

European and American markets. Overall, universal methods of IPO valuation do not exist

and would benefit the market.

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There are several theories regarding IPO valuation. These are wave, signalling and prospect

theories. All of these theories address information asymmetry and under-pricing. The

literature reveals several decision-making concerns for investors and stakeholders.

However, there are no agreed-upon concerns for the underwriters. Powerful internal

stakeholders in the IPO process appear to be motivated primarily by avoidance of wealth

loss. This results in considerable under-pricing of an IPO in order to reduce the probability of

loss.

7.2.1 AltX IPOs

Despite the insignificance of the model in explaining the variation in the IPO offer price, this

research should be informative because the conclusions are consistent with findings of prior

research regarding the relevance of IPO prospectus in guiding investors in making rational

investment choice.

This research is AltX-specific, the findings help clarify preceding empirical IPO research

regarding which factors determine IPO pricing. Since publicly available information provided

in the prospectus have little relevance, then the potential for the regulatory authorities to

protect potential investors is curtailed. Therefore, securities Exchange regulatory authorities

need to review the disclosure requirements for firms going public.

The IPO pricing is inconsistent with Efficient Market Hypothesis, as evidenced by under-

pricing phenomenon. Efficient Market Hypothesis postulates that security price reflects all

publicly and privately available information. Unfortunately, investment banks in South Africa

under-price IPOs and investors are able to make abnormal returns on the first day of trading

through flipping.

7.3 RECOMMENDATIONS

7.3.1 Need to Improve SA Equity Markets

The Institute of International Finance, (September 2007) moved to promote and develop

equity markets through the creation of AltX to attract small, growth-oriented companies that

are not able to list on the JSE Main Board but are looking to access capital.

The AltX has been successful in attracting about 100 companies with a combined market

capitalization of about R17-billion since its inception in October 2003. However, the share

Page | 157

price calamity suggests that the Institute needs to advocate an alternative pricing

methodology.

Listing requirements for AltX companies are less stringent than JSE listed companies (listing

Schedule 21), but new companies that want an AltX listing have to undergo a strong whetting

process and agree to appoint a Designated Advisor, who will advise the company on all its

responsibilities during the application process and beyond.

Many emerging market countries are struggling to find ways to improve corporate

governance in small- and medium-sized companies. By creating the AltX, the JSE has put in

place a system by which small- and medium-companies can access financial markets while

slowly evolving and improving their corporate governance structures.

Unrelated to systematic risk and that industries will be characterised with differences in the

level of under-pricing, with new industries (such as those in the new economy sector) having

more under-priced IPOs.

7.3.2 Need a Set of Guidelines to Eliminate Pricing Discrepancies

Litigation avoidance, signalling of firm quality, agency issues and information asymmetry

seem logical explanations of IPO under-pricing. However, it is still possible that despite the

substantial existing evidence on IPO listing day returns, investors are unable to efficiently

determine IPO value in the immediate aftermarket.

Specifically, due to the limited supply of IPO securities in the immediate aftermarket and the

resultant inability of investors to short-sell IPO shares, over-confident investors tend to

dominate initially with their demand in smaller offers (Miller, 1977). As a consequence, the

share price overshoots in the immediate IPO aftermarket, which is subsequently corrected by

rational investors in the long run, as manifested by the new issues underperformance relative

to various benchmark returns up to five years after listing (Loughran et al., 2004).

IPO under-pricing happens regardless of whether issuers use the auction, the fixed-price, or

the book-building method to go public. In the auction method, investors submit their desired

price and quantity bids. The offer price that will allow the firm to sell all its shares is

determined after bids are submitted and hence incorporates the demand for the shares. A

maximum price is usually chosen as well, so that unrealistic bids (bids well over the clearing

price) can be eliminated.

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This is done to prevent investors from placing very high bids to ensure that they are allocated

shares. Shares are then allocated, on a pro rata basis, to all the investors who placed bids

between these two prices. In a uniform price auction, all the investors receiving shares will

pay the same market clearing price. In the less common discriminatory price auction,

investors pay the prices they bid for.

In a fixed-price offer, the issuer and the underwriter jointly determine the offer price and

investors place orders for shares at this price. If the issue is oversubscribed, shares are

either allocated through lottery or on a pro rata basis.

In the book-building method, the underwriter promotes the IPO by disseminating information

about the issuing firm via road shows. They gather indications of interest by soliciting from

potential investors their desired prices and quantities for the issue. The underwriter then uses

this information to determine the final offer price. Under this method the underwriter has

complete discretion on the allocation of new shares.

Of the three allocation mechanisms, evidence has shown that IPOs under the auction method

show the lowest average under-pricing. However, firms that choose the auction method

sometimes fail to go public because bids for their shares are insufficient. This problem is

especially common for smaller, less known companies, which require substantial information

production and dissemination by the underwriters. For these firms, the book-building method

might be the only option that will allow them to go public. It is therefore not surprising to see

the book-building method, a method that is used predominantly in the United States, gaining

popularity around the world.

This is an area for further research.

In terms of the use of specific multiples, it is agreed that the P/E ratio is the superior multiple,

a fact which was reflected by the relatively small gap of -9% between academia and practice.

The P/BVE ratio should not be used frequently in the valuation of equity, constituting a -13%

gap.

In terms of value drivers, it is agreed that multiples that are based on earnings are the

multiples of choice, a sentiment which is in line with research findings.

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It may be concluded that this study could be viewed as a first step to develop a set of

corporate guidelines to establish a fair and reasonable share price prior to listing an AltX

company. As such, the research results provide an insight and guideline into current IPO

finance and investment practitioners, in terms of mispricing IPOs within the global

stockbroking arena.

The second step would then be to converge mainstream valuation practices in South Africa

with new practical guidelines.

7.3.3 More Variables Need to be Analysed

Because an IPO price is based on a company's market value, the price may change due to

intrinsic or extrinsic factors any time before the initial public offering. If strong investor

demand exists for a company's shares, the underwriters may price the shares higher. This

final offering price will be set after the SEC review process has concluded and shortly before

the initial public offering.

In addition, some underwriters are hesitant to price an initial offering at its full potential market

value. Because successful IPOs are commonly viewed as those producing an immediate

share price run-up, underwriters often will price the shares at a slight discount.

The following variables need to be researched in more detail, as there is no existing research

on how well the multiples that are advocated by academia are aligned with the multiples that

are applied in practice (Nel, 2010).

As such, the following variables need to be assessed to establish fairness in the pre-IPO

pricing methodology:

Initial Offering Size: A number of factors will affect the offering size.

Capital requirements: How much capital does the company need to develop or expand its

business? Such expenses may include costs to hire or retain personnel, lease office

facilities and purchase office equipment and supplies.

Shareholder dilution: If a company issues additional shares, the existing shareholders will

end up with a lower percentage of the outstanding shares. So, how much do the existing

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shareholders want to dilute their ownership? Do they want to retain a majority interest in

the company?

Market demand: How receptive is the investment community to the company's shares?

Miscellaneous: To arrive at a certain initial offering price, a company may split its stock or

affect a reverse split. Respectively, this will double or halve the number of outstanding

shares and likewise affect the initial offering size.

Liquidity: To achieve an active trading market, the company needs a large enough float.

Entrepreneurial ability: While a large body of research examines different aspects of the

post-IPO stock return performance of new listings, little has been documented regarding

the firm-specific characteristics that are associated with IPO failures.

This dissertation’s findings suggest that the risk of failure may not be fully priced into IPOs as

of their offering date, contributing to the IPO long-run returns anomaly.

Timing and cycles: Ibbotson and Jaffe (1975) and others show that IPOs come in waves.

In undertaking the research phase of this dissertation, theoretical domains, that explain

the timing of IPOs, was undertaken. An important issue investigated included the listing of

companies during bull markets to attempt to capture attractive share prices. Empirical

measures of bull markets include current overall market conditions (Lucas and McDonald,

1990), current industry conditions (Pagano et al., 1998), predicted overall market

conditions (Lucas and McDonald, 1990), predicted industry conditions (Lowry, 2002) and

recent historical market conditions (Ritter and Welch, 2002). The analysis thus conducted

is set out in Chapter 5 of this dissertation.

Cyclicality: Cyclicality may also temper the magnitude of observed relationships in the

IPO literature. Many empirical examinations of the IPO process rely on data derived over

an extended period (e.g., 1972-1992; 1975-1991; 1980-1994). Lowry and Schwert (2002)

demonstrate the cyclicality of the IPO market (see also, Ritter and Welch, 2002;

Subramanyam and Titman, 1999). They note a lead-lag relationship between new IPO

issues and initial returns/under-pricing. They suggest that periods of high initial returns

tend to be followed by an increase in IPOs, which are, in turn, followed by periods of

lower returns. In the period from 1980 to 1999, Lowry and Schwert (2002) illustrate at

least five of these patterns. This is consistent with Ritter and Welch's (2002) argument

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that high IPO activity may follow high under-pricing as underwriters may encourage

potential clients to pursue IPOs when valuations are higher than expected and

discourage them when valuations are depressed.

Firm Age: The age of the firm has served as a surrogate for risk in previous IPO research,

i.e., more established firms are less risky (Carter, Dark and Singh, 1998; Ritter, 1984,

1991). Less-seasoned firms will have fewer years of published financial data and are less

likely to have been assessed by financial analysts (Rasheed, Datta and Chinta, 1997).

The IPO literature reflects the posited relationship between firm age and performance

(e.g., Megginson and Weiss, 1991; Mikkelson, Partch and Shah, 1997; Ritter, 1991).

A clear lack of discernible and realistic set of guidelines to calculate a share price for AltX

companies is evident throughout this dissertation. Extensive research is required to develop

such guidelines, where shares will not lose 45% of its value over the short-term.

While DAs have the responsibility to ensure that the company lists successfully, many get

paid a fee in cash and shares. This practice alone endears a conflict that renders the AIR

principle fair game.

It is proposed that further studies are undertaken to establish a set of guidelines – in line with

King III set of Corporate Governance regulations – to be developed over time.

Page | 162

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APPENDICES

1: JSE MAIN BOARD AND ALTX: DIFFERENCES

No Issues MAIN BOARD ALTX

1 Profit record A satisfactory three-year profit

record, the last year must show a

pre-tax profit of R8 million.

Exceptions are Mining companies

and Property companies, provided

that property companies can show

that the performance of the

underlying properties complies.

No profit record required. At

this time, the AltX market is

not keen on venture capital

operations, but has not ruled

them out. A company that is

“merely an idea” is unlikely to

be accorded a listing. This

market is not intended for

applicants who qualify for the

main board.

2 Shareholder spread A minimum of 500 public

shareholders, holding a minimum of

20% of the issued share capital.

A minimum of 100 public

shareholders, holding a

minimum of 10% of the

issued share capital.

3 Minimum capital R25-million in tangible or

professionally valued net assets.

Revaluations of assets must be

accompanied by a valuation that is

less than six months old from a

valuer competent to value the type

of asset concerned.

R2-million in tangible or

professionally valued net

assets. Revaluations of

assets must be accompanied

by a valuation that is less

than six months old from a

valuer competent to value the

type of asset concerned.

4 Escrow shares There are no provisions for escrow

shares. All shares held by the

founder, promoter or controlling

shareholder may be sold

immediately on listing (obviously

subject to market conditions).

50% of the shares held by the

directors may be sold

immediately on listing

(obviously subject to market

conditions) and the balance

must be held in escrow and

can only be sold as to half of

the balance when results for

the remainder of the current

financial year and one more

year have been audited.

Page | 185

No Issues MAIN BOARD ALTX

The remainder (i.e. the last

quarter) can only be sold a

further one year later.

5 Link to JSE All listed companies are required to

have an appointed Sponsor at all

times. Provisions exist for a change

in Sponsor. There are only indirect

provisions for terminating the listing

of a company that does not have a

Sponsor.

All listed companies are

required to have an

appointed Designated

Advisor at all times.

Provisions exist for a change

in Designated Adviser, but

listing will be summarily

terminated if a company is

without a Designated Adviser

for two months.

6 Announcements Companies are required to publish

a number of types of announcement

in newspapers published in English

and one other official language as

well as on the Securities Exchange

News Service (“SENS”). These

announcements normally include:

abridged listing particulars; interim

and preliminary results (if

applicable); cautionary

announcements; trading updates;

acquisition announcements; rights

issue announcements; and dividend

announcements.

All announcements must be

published on SENS and do

not need to be published in

the press.

7 Directors’ induction

programme

There is no requirement for

directors to attend the Directors

induction programme.

All directors must attend the

Directors induction

programme.

8 Financial director Can be appointed by the company

without reference to the Sponsor.

The appointment needs to be

signed off by the Designated

Adviser.

9 Directors Require four directors.

Recommended to comply with the

King Code on Corporate

Governance – areas of non-

compliance must be detailed. King

Code requires more non-executive

25% of the board must be

non-executive. The

Designated Adviser can be a

director without being

disqualified to act as

Designated Adviser. The

Page | 186

No Issues MAIN BOARD ALTX

directors than executive directors. If

the Sponsor is a director, another

sponsor must also be appointed for

transactions.

Designated Advisor must

attend all board meetings.

10 Profit forecast at time

of listing

No profit forecast is required. The company must provide

the JSE with a profit forecast

for the remainder of the

current year and one

additional year. This does

not have to be published.

11 Presentation to JSE No presentation required. Full presentation to the AltX

Listing Advisory Committee

prior to being allowed to

proceed with the listing

process.

12 Shareholding by

Sponsor/Designated

Adviser

The Sponsor may hold shares in the

company, but if his holding is in

excess of 10%, another Sponsor

must be appointed for transactions.

The DA may hold up to 20%

of the shares in the company

without being rendered

unable to act as Designated

Adviser at all times.

13 “Health warning” No health warning required. A warning statement

regarding the risks of

investing in an AltX listed

company and the importance

of the Designated Adviser to

the company, must be on all

published documentation.

14 Issues of shares for

cash

General authority to issue shares

for cash enables the company to

issue up to 15% in any one year.

General authority to issue

shares for cash enables the

company to issue up to 50%

in any one year.

15 Revised listing

particulars

Companies are required to publish

revised listing particular statements

if they issue more than 30% of their

share capital in a three-month

period.

Companies are required to

publish revised listing

particular statements if they

issue more than 50% of their

share capital in a three-month

Page | 187

No Issues MAIN BOARD ALTX

period.

16 Related party

transactions

Any transaction with a related party

which involves greater than 0.25%

of the company’s market

capitalisation. Require shareholder

approval and a fair and reasonable

statement by an independent

financial adviser.

Any transaction with a related

party which involves greater

than 10%. If it involves

between 10% and 50%, the

Designated Adviser may

issue the fair and reasonable:

shareholder approval is

required. Above 50%, the fair

and reasonable must be

issued by an independent

financial adviser.

Shareholder approval is

required.

Page | 188

2: GLOBAL IPO RESEARCH SUMMARIES

COUNTRY UNITED KINGDOM UNITED STATESMain sources General sources;

Brennan and Franks (1997);Levis (1990)

General sources

Does gov't restrictmethods?

Yes, but three options No, although regulatory restrictions might make auctionsmore difficult in practice

Most commonly usedmethod

Public Offer (but book-building for large,international issues)

Book-Building; Hybrids gradually increasing; A few auctions

Public offer (Fixed-price)

Yes - most popular No

Advance payment? YesBook-Building Placing - similar in terms of

allocationYes

Is it gaining popularity? Already dominantTender/Auction Allowed, not popular Yes - 14 IPOs through August, 2005Discriminatory/uniform Uniform price Uniform priceHybrid Methods? Placing w/other method if

GBP 25 mn; tender followedby public offer alsopossible.

Yes, but rarely

General notes Auctions had periods ofheavy use in 1960s and1983-84.

Of 69 IPOs from 1986-89, 64were Public Offer, 4 tenderand 1 a hybrid tender/publicoffer.

Before the Big Bang on 27Oct. 1986, IPO placing wasnot allowed for issues overGBP 3mn.

Main methods: firm commitment (book-building) and bestefforts.

Book-building more common, used for larger issues.

W.R. Hambrecht has priced 13 IPOs thru uniform priceauctions as of August, 2005, plus the popular search enginecompany Google went public through an auction in Aug.,2004. Some auctions have priced at market-clearing, whileothers have been dirty.

COUNTRY ARGENTINA AUSTRALIA AUSTRIAMain sources The Economist

Intelligence Unit; "Black gold"by Katherine Conradt,Latin Finance 07/01/1993

Euroweek April 1998Supplement, Australia: ASpecial Report; Letter –Australian Stock Exchange,23 April 1996

Letter - Wiener Borse(Vienna Stock Exchange), 14June 1996

Does gov't restrictmethods?

No No No

Most commonly usedmethod

Hybrid Book-Building/PublicOffer

Book-Building

Public offer (Fixed-price)

Have virtually disappeared Yes - Usually for small firms

Advance payment? Yes NoBook-Building Yes Yes - "the norm" Yes - Traditional for large

IPOs, such as privatisationsIs it gaining popularity? Already dominant YesWhen was it first used? 1993 for Yacimientos

Petroliferos1992

Tender/AuctionFiscalesTried in 1992, thenabandoned

Never been used No

Discriminatory/uniform

Page | 189

COUNTRY ARGENTINA AUSTRALIA AUSTRIAHybrid Methods? Yes, at least for privatisations

- Hybrid Book-Building/PublicOffer

Yes: open priced book-building approach widespread

Yes: book-building for largerissues includes an openpricing public offer tranche

COUNTRY BANGLADESH BARBADOS BRAZILMain sources Global Investor; London; Dec

1999/Jan 2000, "After thedeluge only the fittest havesurvived"

Letter - Securities Exchangeof Barbados, 8/28/97

The Economist IntelligenceUnit

Does gov't restrictmethods?

No

Most commonly usedmethod

Public Offer Public Offer, but Book-Building taking over

Public offer (Fixed-price)

Yes Yes - only method used Yes, but usually with IBdiscretion in allocation

Advance payment? Yes Yes; some term pmtsBook-Building Yes - first used in global

offers; now also in somedomestic offers.

Is it gaining popularity? YesWhen was it first used? 1992, for global offeringsTender/Auction AllowedDiscriminatory/uniform Both have been usedHybrid Methods? No

COUNTRY CANADA CHILE CHINAMain sources E-mail, Commission des

valeurs mobilières duQuébec, 10/29/99

TSXV Exchange

E-mail, Superintendencia deValores y Seguros, Oct 7,1999;Santiago Stock Exchange

Euroweek, 01/29/99;Asian Business,April 2000, pp. 18-20;

"All Eyes on Baosteel;China's Mega-IPO HitsMarket Tue", by SophieRoell, DOW JONESNEWSWIRES, 12/10/2000

Does gov't restrictmethods?

Yes No (but pension funds canonly buy thru an exchange)

Yes

Most commonly usedmethod

Book-Building Hybrid Book-Building/Auction onExchange

Public Offer

Public offer (Fixed-price)

Sometimes, only incombination with bb

Allowed Yes

Advance payment? No YesBook-Building Yes - primary method Yes YesIs it gaining popularity? YesWhen was it first used? *1995 late 1999 for A share IPO;

earlier forTender/Auction No Yes - on stock exchange InternationalDiscriminatory/uniformHybrid Methods? Sometimes - bb with public

offer, but no pay in advance(similar to US bb w/ someshares sold to retail)

Yes - bb to determine priceand auction on exchange forpension fund investors

Yes, the recent local book-builds had public offertranches

COUNTRY CZECH REPUBLIC FINLAND FRANCEMain sources E-mail, the Czech Securities

Commission, 10/26/99E-mail, Financial SupervisionAuthority of Finland,11/29/99;Letter - Mandatum and Co.,30 May 1996; Also see webpage www.rata.bof.fi

E-mail - Listing Division,Paris Bourse SB F SA,7/28/2000, Derrien andWomack (1999)

Page | 190

COUNTRY CZECH REPUBLIC FINLAND FRANCEDoes gov't restrictmethods?

Yes No Yes, but many options

Most commonly usedmethod

Public Offer Hybrid Book-Building/PublicOffer

Hybrid Book-Building/PublicOffer

Public offer (Fixed-price)

Yes - must be used for firstround

Yes Yes - Offre a Prix Ferme(OPF) or Open Price Offer(OPO; only for hybrids)

Advance payment? Yes - 30% (instalment) Usually, for retail investors No, but need correspondingcash in account

Book-building No Yes Yes - Placement Garanti(PG), only as hybrid

Is it gaining popularity? Yes YesWhen was it first used? 1993

Tender/Auctionpossible for second round, ifnumber of

AllowedRare - Offre a Prix Minimal(OPM)

Discriminatory/uniform single, but rules of auctioncan be different

Uniform price Uniform price

Hybrid Methods? Possible to haveauction/public offer, but notcommon

Yes - bb for institutional,public offer for retail at priceset by bb - most commonover last 18 months

All book-building must becombined with either OPF orOPO

COUNTRY GERMANY HONG KONG HUNGARYMain sources: E-mail - BAWe

(Bundesaufsichtsamt furden Wertpapierhandl)2/2/2000, www.bawe.de;E-mail - DGBank, 11/18/99

General sources; AsianBusiness, Sep. 2000, "Entere-IPOs"

E-mail, Hungarian Bankingand Capital MarketSupervision, 11/30/99

Does gov't restrictmethods?

No Yes, but three options No

Most commonly usedmethod

Book-Building Public Offer, but HybridBook-Building/Public Offerincreasing

Hybrid Book-Building/PublicOffer

Public offer (Fixed-price)

Yes: Offentliches AngebotNow superseded by bb

Yes Yes

Advance payment? No Yes Yes - minimum 10%instalment

Book-Building Yes: used for almost everyIPO

Yes Yes

Is it gaining popularity? Yes Yes YesWhen was it first used? 1995 1994 1994

Tender/Auction NoAllowed since 1993 but neverused

Allowed, not used

Discriminatory/uniformHybrid Methods? Yes: "lottery" methods often

used for retail trancheallocations; IB discretion

Yes - bb only with public offer Yes - bb/public offer is themost common method

COUNTRY INDIA INDONESIA IRELANDMain sources: SEBI (Securities and

Exchange Board of India)web page, Dec. 99;*BombayStock Exchange, 4/13/96;Assoc. of Merchant Bankersof India, 5/27/96.

Indonesian Capital MarketSupervisory Agency(BAPEPAM) , 9/24/99; www.bapepam.go.id; alsowww.indoexchange.com.

E-mail, Irish Stock Exchange,9/15/ 99

Does gov't restrictmethods?

Yes Yes No

Most commonly usedmethod

Public Offer Public Offer - only methodallowed

Placing - similar to Book-Building

Public offer (Fixed-price)

Yes - most common Yes Used mainly for largerofferings

Advance payment? Usually; instalments common.Yes Yes

Page | 191

COUNTRY INDIA INDONESIA IRELANDBook-Building Yes - allowed in last few

years.No Only for institutional

tranche of internationalofferings. Not used often

Is it gaining popularity? Not yetWhen was it first used? 1995Tender/Auction No No Very rare.Discriminatory/uniformHybrid Methods? Yes - even under "100%

book-building", 10% must beallocated thru public offer

Yes - bb/placing with publicoffer. Used "now and then".

COUNTRY ISRAEL ITALY JAPANMain sources: e-mails - Tel Aviv Stock

Exchange, Feb., Sept. andOct. 1999

E-mail, Borsa Italiana S.p.A.11/24/99;Italian Stock ExchangeCommission (CONSOB) webpage, www.consob.it

Pettway (1999);Institutional Investor,June 2000, "OpeningJapan's Capital Markets"

Does gov't restrictmethods?

Yes - public offer or auctions Yes, but several options

Most commonly usedmethod

Auctions Hybrid Book-Building/PublicOffer

Book-Building

Public offer (Fixed-price)

Yes Yes - only for retail Yes, but w/ allocationdiscretion

Advance payment? No NoBook-Building no, but it is being considered Yes - only for institutional YesIs it gaining popularity? Already the only method usedYesWhen was it first used? 1997/1998Tender/Auction Yes - most common Not used YesDiscriminatory/uniform Uniform price DiscriminatoryHybrid Methods? bb/public offer - only method

in last few yearsYes - auctions up to 50% ofshares, with rest sold atweighted average bid pricefrom the auction.

COUNTRY JORDAN KENYA KOREAMain sources: E-mail, Amman Stock

Exchange, 24 June, 1997;

Amman Stock Exchange webpage (accessme.com/AFM).

Fax, Capital MarketsAuthority, 4/3/00

E-mail, Korea SecuritiesResearch Institute 10/26/99;Korea Stock Exchange fax,International Relations,April 13, 1996

Does gov't restrictmethods?

Yes Yes

Most commonly usedmethod

Public Offer - only methodallowed

Public Offer Book-Building

Public offer (Fixed-price)

Yes Yes, in hybrids; Was onlymethod until 1998

Advance payment? Yes Yes YesBook-Building Yes - most commonIs it gaining popularity? YesWhen was it first used? Required beg.1998 for KSE,

1999 for

Tender/AuctionKOSDAQ: Only if co. notlisting on an exchange

Discriminatory/uniformHybrid Methods? No Yes, at least for privatisations

Page | 192

COUNTRY MALAYSIA MEXICO NETHERLANDSMain sources: E-mail, Kuala Lumpur Stock

Exchange, 1996; KLSEweb page(www.klse.com.my)

E-mail, Bolsa Mexicana deValores (the Mexican StockExchange), Sept.& Nov.1999; www.bmv.comThe Economist IntelligenceUnit

E-mail, Stichting ToezichtEffectenverkeer(SECURITIES BOARD OFTHE NETHERLANDS), Oct.1999;KPN's Stock Won'tTrade Until Completion ofIPO", Wall Street Journal

Does gov't restrictmethods?

Europe 05/20/1994 No

Most commonly usedmethod

Public Offer Public Offer Hybrid Book-Building/PublicOffer

Public offer (Fixed-price)

Yes - most common Yes becoming obsolete

Advance payment? Yes NoBook-Building YesIs it gaining popularity? YesWhen was it first used? In recent years

Tender/AuctionOnly for privatisations and to1 buyer.

Allowed

Discriminatory/uniform DiscriminatoryHybrid Methods? Yes - bb with public offer

COUNTRY NEW ZEALAND NORWAY PAKISTANMain sources: Securities and Exchange

Commission of New Zealand;www.gplegislation.co.nz

Securities Commission ofNorway

Securities andExchange Commission ofPakistan web page - KarachiStock Exchange (Listingregulations), updated 30-05-1993;

Does gov't restrictmethods?

Yes No Yes

Most commonly usedmethod

Public Offer, but with brokerdiscretion in allocation

Hybrid Book-Building/PublicOffer

Public Offer - only allowedmethod

Public offer (Fixed-price)

Yes, but brokers haveallocation discretion.

Yes, but rare except for retailtranche of hybrid

Yes

Advance payment? Yes; instalments gettingpopular. Legal min. = 10%.

No, not usually Yes

Book-Building Yes Yes -mainly for institutional. NoIs it gaining popularity? Yes - last few years YesWhen was it first used? 1997 Increasingly popular over last

few years.

Tender/Auction "Not applicable in practice" Yes, but "rarely used"Only for privatisations to onebuyer

Discriminatory/uniform Uniform price Uniform priceHybrid Methods? Yes - bb for institutional,

public offer for retail at priceset by bb

Yes - bb for institutional andpublic offer for local retail withprice set by bb.

No (in privatisations, allshares auctioned to onebidder who then resells someshares w/ public offer togeneral public)

COUNTRY PARAGUAY PERU PORTUGALMain sources: E-mail - Comision Nacional

de Valores, Oct 99;

the Stock Exchange webpage iswww.pla.net.py/bvpasa

E-mail - Lima StockExchange, 10/20/99

E-mail, Comissão doMercado de ValoresMobiliários (www.cmvm.pt),11/11/99;

Euromoney '98,'99 PortugalGuides

Does gov't restrictmethods?

No No Yes - new rules coming tomake bb easier

Page | 193

COUNTRY PARAGUAY PERU PORTUGALMost commonly usedmethod

Public Offer (only methodused so far)

Hybrid Book -Building/PublicOffer

Public Offer, often as ahybrid with Book-Building

Public offer (Fixed-price)

Yes Yes - the most common

Advance payment? No Sometimes, but not usually YesBook-Building Allowed, not used Yes Yes, hybrid with public offer

trancheIs it gaining popularity? Yes, particularly for

institutional inv.Yes

When was it first used? June 1995: PortugalTelecom

Tender/Auction Allowed, not used Yes Privatisation very rareDiscriminatory/uniform Uniform priceHybrid Methods? Yes, particularly for

privatisations – Book-Building/Public Offer

Yes - bb for institutional,public offer for retail

COUNTRY SINGAPORE SOUTH AFRICA SPAINMain sources: E-mail - Stock Exchange of

Singapore,10/11/99;also the SES webpage: (www.ses.com.sg)

Web page and e-mail -Johannesburg StockExchange; www.jse.co.za

AltX: www.altx.co.za

COMISIÃN NACIONAL DELMERCADO DE VALORES9/23/99, 10/18/99;Euromoney, Apr.'99, p.99-102

Does gov't restrictmethods?

Yes Yes No

Most commonly usedmethod

Public Offer Placing (similar to Book-Building)

Hybrid Book-Building/PublicOffer

Public offer (Fixed-price)

Yes - most common Yes, but not popular Yes - retail tranche

Advance payment? Yes; sometimes a fixed feeinstead

Yes No; deposits sometimesrequired

Book-Building Yes Placing - similar to bb inallocations but price set inadvance

Yes - institutional andsometimes 100%

Is it gaining popularity? Yes YesWhen was it first used? 1st - 1995, 2nd - 1999;

Officially allowed

Tender/Auctionsince March 2000Allowed; not used since 1994.

NoAllowed, but not habituallyused

Discriminatory/uniform Uniform priceHybrid Methods? Yes - all auctions (and

probably bb) have a publicoffer tranche

Yes - placing and public offer.Yes - bb/public offer

COUNTRY SRI LANKA SWEDEN SWITZERLANDMain sources: Letter - Colombo Stock

Exchange, 26 May, 1997Stockholm Exchange,Letter - Finansinspektionen(the FinancialSupervisory Authority)

E-mail - - Switzerland StockExchange, 11/24/99; ^Letter -Zurcher Borse (Zurich StockExchange), 4 June 1996

Does gov't restrictmethods?

No No No

Most commonly usedmethod

Public Offer Hybrid Book-Building/PublicOffer

Book-Building

Public offer (Fixed-price)

Yes - only commonly usedmethod

Yes Yes - most common in 1980s

Advance payment? Yes Yes, usually "a couple ofdays" before delivery

No

Book-Building Allowed, not widely used Yes, for institutional tranche Yes - 1st for large, internat'lIPOs, now for domestic also

Is it gaining popularity? Yes YesWhen was it first used? Became popular in last 4

years

Page | 194

COUNTRY SRI LANKA SWEDEN SWITZERLANDTender/Auction Allowed, not widely used Not used Allowed - not used in 1990sDiscriminatory/uniformHybrid Methods? Yes - bb/public offer

COUNTRY TAIWAN THAILAND TURKEYMain sources: E-mail Chinese Securities

Association, 11/2/99; "Liaw,Liu and Wei (1999)

Securities andExchange Commission, 14May 1996; "Asiamoney, Nov.2000, "Ratchaburi bringsback sweet Thai memories"

Istanbul Stock Exchange(intercrd@imkb.gov.tr)

Does gov't restrictmethods?

Yes Yes Yes

Most commonly usedmethod

Public Offer, often as a hybridwith auction

Public Offer or HybridBook-Building/Public Offer

Public Offer

Public offer (Fixed-price)

Yes; about half of all IPOs Yes - most common Yes - most common

Advance payment? No - only processing fee ofNTD30

Yes Yes

Book-building Allowed - hybrid w/ 50%public offer

Yes: for large IPOs such asprivatisations.

Allowed; popular in mid-1990s but not since

Is it gaining popularity? No Yes, as market recovers fromAsia crisis

No

When was it first used? 1995 - first allowed

Tender/AuctionYes - hybrid w/ 50% publicoffer

Allowed; not used

Discriminatory/uniform Discriminatory Uniform priceHybrid Methods? Yes - auction or bb with

public offerYes - book-building withpublic offer; "priceset by bbbefore open of subscriptionperiod

Page | 195

3: THE ALTX SAMPLE DATABASE

NO ALTXIPO SHARE

PRICE(CENTS)

HIGH AFTERLISTING(CENTS)

DATE%

CHANGE

CURRENTPRICE

(CENTS)

%CHANGE

MARKETCAP(RM)

%OF TOTAL

1 AC Towers 120 173 22-07-07 44.17 65 -45.83 66 0.475

2 Accent 94 94 13-11-08 0.00 5 -94.68 19 0.137

3 Afdawn 5 5 06-01-04 0.00 12 140.00 59 0.425

4 Afeagle 225 244 10-09-07 8.44 26 -88.44 180 1.296

5 Ah-Vest 50 50 29-12-03 0.00 20 -60.00 20.4 0.147

6 Alert 135 215 12-04-07 59.26 3 -97.78 81.8 0.589

7 Alliance 130 135 05-04-05 3.85 215 65.38 233 1.678

8 Ansys 143 171 11-06-07 19.58 18 -87.41 29 0.209

9 B&W 185 215 12-07-07 16.22 70 -62.16 140 1.008

10 Beige 12 13 08-10-03 8.33 7 -41.67 114 0.821

11 Bioscience 75 87 27-09-05 16.00 1 -98.67 29.1 0.210

12 Blackstar 953 1100 23-08-11 15.42 1090 14.38 902.9 6.501

13 Blue 125 299 19-10-06 139.20 31 -75.20 2,500.00 17.999

14 Brickcor 165 175 13-08-07 6.06 6 -96.36 38.7 0.279

15 BSI-Steel 96 102 25-10-07 6.25 49 -48.96 331.1 2.384

16 Chemspec 110 118 09-11-07 7.27 57 -48.18 612.1 4.407

17 Chrometco 129 125 22-08-05 -3.10 23 -82.17 42.5 0.306

18 Diamondcp 1550 1550 08-04-08 0.00 80 -94.84 216.6 1.559

19 Erbacon 290 270 13-12-07 -6.90 40 -86.21 366 2.635

20 Finbond 225 220 21-06-07 -2.22 34 -84.89 221.2 1.593

21 Foneworx 12 10 21-11-03 -16.67 180 1400.00 251.6 1.811

22 Gooderson 85 85 02-10-06 0.00 66 -22.35 82.5 0.594

23 Hardware 113 100 12-10-07 -11.50 90 -20.35 70.1 0.505

24 Huge 310 345 17-08-07 11.29 100 -67.74 126 0.907

25 Imbalie 61 68 05-09-07 11.48 24 -60.66 82.9 0.597

26 Interwaste 178 195 18-06-07 9.55 63 -64.61 214.1 1.541

27 IPSA 585 700 25-10-06 19.66 46 -92.14 33 0.238

28 Iquad 600 597 15-08-07 -0.50 350 -41.67 98.2 0.707

29 ISA 3 3 14-10-03 0.00 59 1866.67 116 0.835

30 Kibo 50 50 22-06-11 0.00 35 -30.00 394.2 2.838

31 Lonrho 125 126 21-11-03 0.80 157 25.60 1,800.00 12.960

32MS

Holding163 180 27-12-06 10.43 33 -79.75 51 0.367

33 Moneyweb 173 95 06-07-99 -45.09 58 -66.47 62.5 0.450

34 MAS 125 130 14-10-03 4.00 157 25.60 505.5 3.639

35 MINERESI 19 26 20-07-12 36.84 25 31.58 118 0.850

36 Muvoni 110 136 15-11-07 23.64 11 -90.00 22.2 0.160

37 Nutrition 150 140 12-12-06 -6.67 3 -98.00 42 0.302

38 Oasis 1030 1550 05-12-05 50.49 1320 28.16 558.7 4.023

39 Onelogic 8 8 15-10-03 0.00 170 2025.00 400.7 2.885

40 Osiris 13 13 17-09-12 0.00 1350 10284.62 8.9 0.064

41 Pinpoint 110 75 24-02-06 -31.82 1 -99.09 83.1 0.598

42 Poynting 120 105 16-07-08 -12.50 87 -27.50 128 0.922

43 PSV 80 90 08-05-06 12.50 18 -77.50 49.1 0.354

44 Quantum 250 210 21-10-08 -16.00 19 -92.40 29 0.209

45 QLesiure 20 39 20-01-08 95.00 1 -87.5 18 0.103

46 Racec 149 190 24-10-07 27.52 46 -69.13 93 0.670

47 Rare 285 250 05-03-07 -12.28 8 -97.19 143.1 1.030

Page | 196

NO ALTXIPO SHARE

PRICE(CENTS)

HIGH AFTERLISTING(CENTS)

DATE%

CHANGE

CURRENTPRICE

(CENTS)

%CHANGE

MARKETCAP(RM)

%OF TOTAL

48 RBA 140 135 01-10-07 -3.57 13 -90.71 57.9 0.417

49 RGT 10 13 04-06-10 30.00 8 -20.00 48.6 0.350

50 Rockcastl 876 989 08-08-12 12.90 980 11.87 1,150.00 8.280

51 SA French 156 150 15-11-07 -3.85 11 -92.95 61.2 0.441

52 SABLE 520 545 545 4.81 2375 356.73 211 1.519

53 Shercap 58 49 19-12-06 -15.52 3 -94.83 18.2 0.131

54 Silverb 145 180 21-04-99 24.14 80 -44.83 27.8 0.200

55 Stratcorp 40 40 20-10-03 0.00 12 -70.00 21.6 0.156

56 Telemaster 260 298 27-03-07 14.62 65 -75.00 32 0.230

57 TCS 31 29 17-04-08 -6.45 4 -87.10 15.6 0.112

58 Ububele 200 150 17-11-09 -25.00 41 -79.50 78.5 0.565

59 Vunani 6250 5500 06-12-07 -12.00 180 -97.12 200 1.440

60 Wearne 171 250 07-03-06 46.20 12 -92.98 33.2 0.239

61 Willtell 429 500 19-07-07 16.55 9 -97.90 11.3 0.081

62 Workforce 140 148 27-11-06 5.71 50 -64.29 120 0.864

63 Zaptronix 3 4 16-09-03 33.33 2 -33.33 7.6 0.055

Source: PDSNet, Business Consultants International, JSE and AltX, 2012Stats as at 15 November 2012

Page | 197

4: ALTX DATABASE INFORMATION

NoAltX

COMPANIES

JSE

CodeISN No Reg no Founded Listed

1 Accentuate Limited AC Towers ATR ZAE000088084 ZAE000088084 2000 2006

2Africa Cellular Towers

LimitedAccent ASE ZAE000115986 2004/029691/06 1981 2006

3African Dawn Capital

LimitedAfdawn ADW ZAE000060703 1998/020520/06 1997 2004

4 African Eagle Resources Plc Afeagle AEG GB0003394813 3912362 2007 2007

5 Ah-Vest Limited Ah-Vest AHL ZAE000129177 1989/000100/06 1988 1998

6 Alert Steel Holdings Limited Alert AET ZAE000092847 2003/005144/06 2003 2007

7Alliance Mining Corporation

LimitedAlliance ALM ZAE000104733 1997/013402/06 1997 2005

8 Ansys Limited Ansys ANS ZAE000097028 1987/001222/06 1987 2007

9B&W Instrumentation and

Electrical LdB&W BWI ZAE000098687 2001/008548/06 1973 2007

10 Beige Holdings Limited Beige BEG ZAE000034161 1997/006871/06 1974 1997

11 Bioscience Brands Limited Bioscience BIO ZAE000115036 2005/005805/06 2005 2005

12 Blackstar Group Se Blackstar BCK MT0000620105 2011/008274/10 1989 2011

13Blue Financial Services

LimitedBlue BFS ZAE000083655 1996/006595/06 1996 2006

14 Brikor Limited Brickcor BIK ZAE000101945 1998/013247/06 1994 2007

15 Bsi Steel Limited BSI-Steel BSS ZAE000125134 2001/023164/06 1985 2007

16Chemical Specialities

LimitedChemspec CSP ZAE000109427 2005/039947/06 1957 2007

17 Chrometco Limited Chrometco CMO ZAE000070249 2002/026265/06 2002 2005

18 Diamondcorp Plc Diamondcp DMC GB00B183ZC46 2007/031444/10 2005 2008

19Erbacon Investment

Holdings LimitedErbacon ERB ZAE000111571 2007/014490/06 1987 2007

20 Finbond Group Limited Finbond FGL ZAE000138095 2001/015761/06 2001 2007

21 Foneworx Holdings Limited Foneworx FWX ZAE000086237 1997/010640/06 1997 1999

22Gooderson Leisure

Corporation LtdGooderson GDN ZAE000084984 1972/004241/06 1972 2006

23Hardware Warehouse

LimitedHardware HWW ZAE000104253 2007/004302/06 2007 2007

24 Huge Group Limited Huge HUG ZAE000102042 2006/023587/06 1993 2007

25 Imbalie Beauty Limited Imbalie ILE ZAE000165239 2003/025374/06 2003 2007

26 Interwaste Holdings Limited Interwaste IWE ZAE000097903 2006/037223/06 1989 2007

27 IPSA Group Plc IPSA IPS GB00B0CJ3F01 5496202 2005 2006

28 Iquad Group Limited Iquad IQG ZAE000101622 2004/025177/06 2004 2007

29 Isa Holdings Limited ISA ISA ZAE000067344 1998/009608/06 1998 1998

30 Kibo Mining Plc Kibo KBO IE00B61XQX41 451931 (Ireland) 2008 2011

31 Lonrho Plc Lonrho LAE GB0002568813 2805337 UK 1998 1998

32 M & S Holdings Limited MS Holding MSA ZAE000165411 2006/011359/06 2006 2006

33 Moneyweb Holdings Limited Moneyweb MNY ZAE000025409 1998/025067/06 1997 1999

34 Mas Plc MAS MSP IM00B4LFGH00 2893V 2008 2009

Page | 198

NoAltX

COMPANIES

JSE

CodeISN No Reg no Founded Listed

35Mine Restoration

Investments LtdMINERESI MRI ZAE000164562 1987/004821/06 1987 1988

36Muvoni Technology Group

LtdMuvoni MTG ZAE000167268 2001/023463/06 2004 2007

37 Nutritional Holdings Limited Nutrition NUT ZAE000156485 2004/002282/06 2006 2006

38Oasis Crescent Property

FundOasis OAS ZAE000074332 2003/012266/06 2005 2005

39 Onelogix Group Limited Onelogic OLG ZAE000026399 1998/004519/06 1998 2000

40Osiris Prop International Co

LtdOsiris OPI BMG6786C1038 BMG6786C1038 2012 2012

41Pinnacle Point Group

LimitedPinpoint PNG ZAE000127122 2000/000059/06 2000 2006

42 Poynting Holdings Limited Poynting POY ZAE000121299 1997/011142/06 1997 2008

43 Psv Holdings Limited PSV PSV ZAE000078705 1998/004365/06 1988 2006

44Quantum Property Group

LimitedQuantum QPG ZAE000125647 1984/002788/06 1972 1987

45Queensgate Hotels &

Leisure Limited

QLeisure QHL ZAE000113718 1998/013649/06 1997 2008

46 Racec Group Limited Racec RAC ZAE000105409 1998/006153/06 1956 2007

47 Rare Holdings Limited Rare RAR ZAE000092714 2002/025247/06 2002 2007

48 RBA Holdings Limited RBA RBA ZAE000104154 2002/025247/06 1997 2007

49RGT Smart Market

Intelligence LtdRGT RGT ZAE000143715 2008/014367/06 2008 2010

50Rockcastle Global Real Est

Co LtdRockcastl ROC MU0364N00003 108869C1/GBL 2012 2012

51 S A French Limited SA French SFH ZAE000108890 2008/014367/06 1982 2007

52 Sable Holdings Limited SABLE SBL ZAE000006383 1968/010620 1982 2007

53 Sherbourne Capital Limited Shercap SHB ZAE000165403 2006/030759/06 2006 2006

54Silverbridge Holdings

LimitedSilverb SVB ZAE000086229 1995/006315/06 1995 1999

55 Stratcorp Limited Stratcorp STA ZAE000034294 2000/031842/06 2000 2001

56Telemasters Holdings

LimitedTelemaster TLM ZAE000093324 2006/015734/06 2006 2007

57 Total Client Services Limited TCS TCS ZAE000116208 1998/025018/06 1979 2008

58 Ububele Holdings Limited Ububele UBU ZAE000144739 1998/011074/06 2002 2009

59 Vunani Limited Vunani VUN ZAE000163382 1997/020641/06 1997 2007

60 W G Wearne Limited Wearne WEA ZAE000078002 1994/005983/06 1910 2006

61 William Tell Holdings Limited Willtell WTL ZAE000098133 2004/030045/06 1980 2007

62 Workforce Holdings Limited Workforce WKE ZAE000087847 2006/018145/06 1972 2006

63 Zaptronix Limited Zaptronix ZPT ZAE000070934 1997/014928/06 1997 1998

Source: JSE, AltX websites, Business Consultants International Database, 2012 and PFDNet

Page | 199

5: ALTERNATIVE INVESTMENT MARKET DATABASE INFO

AIM STATISTICSNumber of companies

ListedMarketvalue(£m)

Number ofadmissions

Money raised(£m)

UK Global Total UK Global Total Total

1995 118 3 121 2,382.4 120 3 123 96.5

1996 235 17 252 5,298.5 131 14 145 823.6

1997 286 22 308 5,655.1 100 7 107 691.7

1998 291 21 312 4,437.9 68 7 75 585.2

1999 325 22 347 13,468.5 96 6 102 933.9

2000 493 31 524 14,935.2 265 12 277 3,092.4

2001 587 42 629 11,607.2 162 15 177 1,128.4

2002 654 50 704 10,252.3 147 13 160 1,090.2

2003 694 60 754 18,358.5 146 16 162 2,095.2

2004 905 116 1021 31,753.4 294 61 355 4,656.1

2005 1,179 220 1,399 56,618.5 399 120 519 8,942.4

2006 1330 304 1,634 90,666.4 338 124 462 15,678.1

2007 1347 347 1,694 97,561.0 197 87 284 16,183.9

2008 1233 317 1,550 37,731.9 87 27 114 4,322.3

2009 1052 241 1,293 56,632.0 30 6 36 5,601.6

Source: London Stock Exchange plc. 2012

Page | 200

6: TSX VENTURE STOCK EXCHANGE

Statistics as at December 2009 2008 % Change

At December

Value (US$) 2,055,458,258 559,767,559 -

Volume 4,690,194,429 4,048,979,261 -

Transactions 610,940 267,961 -

Issuers Listed 2,375 2,443 -

Number of New Listings 16 11 -

New Equity Financing (US$) 919,455,480 130,606,862 -

Market Cap of Listed Equity Issuers ($ Billion) 36.3 17.1 -

For the year to date

Value (US$) 16,092,576,249 23,796,145,949 -32.4%

Volume 46,825,340,177 44,052,175,503 +6.3%

Transactions 5,336,030 5,912,615 -9.8%

Issuers Listed 2,375 2,443 -2.8%

Number of New Listing 107 233 -54.01%

New Equity Financing (US$) 5,062,914,804 5,560,244,148 -8.9%

Market Cap of Listed Equity Issuers ($ Billion) 36.3 17.1 +112.3%

Source: Carolyn Quick, Director, Corporate Communications, TMX Group Inc

Page | 201

7: FOREIGN EXCHANGE RATES

MonthsRAND/US$ RAND /UK£

2008 2009 2008 2009

January 6.990245 9.873316 13.764008 14.284593

February 7.658076 9.977373 15.032124 14.398881

March 8.001026 9.952602 16.009807 14.110562

April 7.757902 8.963801 15.38143 13.190061

May 7.599029 8.358750 14.938202 12.894817

June 7.931564 8.029466 15.608924 13.139030

July 7.626597 7.960253 15.168634 13.022964

August 7.655050 7.927594 14.428695 13.106940

September 8.054844 7.504898 14.492771 12.250834

October 9.764072 7.483232 16.487716 12.114960

November 10.118034 7.514445 15.51095 12.461722

December 9.929670 7.492591 14.726222 12.145696

Annual Average 8.257176 8.419860 15.129124 13.093422

Source: X-Rates 2012: http://www.x-rates.com

Page | 202

8: TIME LINE IN ESTABLISHMENT OF THE JSE AND ALTX

1887: The JSE is established as a stock exchange.

1947: The first legislation applicable to the operation of exchanges is introduced with the

Stock Exchanges Control Act.

1963: JSE becomes a member of the World Federation of Exchanges.

1978: The JSE achieves a market capitalisation of R51 billion. This is eight times the

market size in 1961.

1979: Krugerrands are officially listed.

1995: amendments result in the deregulation of the JSE, through introduction of limited

liability corporate and foreign membership. The South African Institute of Stockbrokers is

formed to represent, train and set standards for the qualification of stockbrokers. In

December, the market capitalisation exceeds R1 trillion for the first time.

1996: The open outcry trading floor is closed in June and replaced by an order driven,

centralised, automated trading system known as the Johannesburg Equities Trading

(JET) system. Dual trading capacity and negotiated brokerage is introduced. The value of

shares traded annually reaches a new record of R117.4-billion and the new capital raised

during the year reaches R28.4-billion.

1997: SENS (Securities Exchange News Service – known then as Stock Exchange News

Service), a real time news service for the dissemination of company announcements and

price sensitive information, is introduced.

1999: new Insider Trading Act introduced after recommendations made by the King Task

Group on Corporate Governance. The JSE establishes the electronic settlement system,

STRATE.

2000: The JSE successfully lists Satrix 40, the JSE’s first Exchange traded fund, which

tracks the top 40 companies listed on the JSE’s Main Board.

Page | 203

2001: The JSE acquires SAFEX, the South African Futures Exchange. The JSE enters

into a joint venture with GL Trade SA to provide an internationally accepted trading front-

end to the equities market, known in South Africa as TALX.

2002: All listed securities are successfully dematerialised. The JET system is replaced by

the LSE’s SETS system, hosted by the LSE in London.

2003: The JSE launches AltX; developed in partnership with the DTI. The Exchange

launched in October 2003 as a nursery for the JSE Main Board, replacing the failed

Venture Capital and Development Capital Boards established as sub-sets of the main

board in the 1980s.

o Beige Holdings Limited and Insurance Outsourcing Managers' Holding Limited

were the first companies to list, in January 2004.

2004: The JSE launches the Socially Responsible Investment (SRI) Index, which

measures compliance by companies with triple bottom line criteria around economic,

environmental and social sustainability.

2005: The JSE launches Yield-X, which allows for the trading of both spot and derivative

interest rate products on one platform with multi-lateral netting across all products.

2006: the JSE Ltd lists on the Main Board

Page | 204

9: ALTX P/E RATIOS

NO ALTX P/E RATIO AT LISTING CURRENT P/E RATIO1 AC Towers 8.08 -492

2 Accent 4.49 6.33

3 Afdawn 6.82 7.63

4 Afeagle -23.64 -10.37

5 Ah-Vest 12.44 5.13

6 Alert 15.8 -0.7

7 Alliance 8.2 1.18

8 Ansys 22.81 0

9 B&W 15.36 46.51

10 Beige 2.53 217.39

11 Bioscience -31.25 -4.17

12 Blackstar -11.15 17.69

13 Blue 25.06 33.0

14 Brickcor 9.33 -2.06

15 BSI-Steel 7.79 13.44

16 Chemspec 11.49 39.37

17 Chrometco -44.25 -4.01

18 Diamondcp -8.72 -2.75

19 Erbacon 6.91 -0.53

20 Finbond -1.79 22.99

21 Foneworx 8.08 12.11

22 Gooderson 21.46 19.57

23 Hardware 4.49 11.05

24 Huge 76.92 -22.03

25 Imbalie 6.02 18.69

26 Interwaste 7.94 -222.22

27 IPSA -3.96 0.93

28 Iquad na Na

29 ISA 4.55 8.06

30 Kibo -11.95 -3.03

31 Lonrho 34.01 -3.15

32 MS Holding 24.57 -34.95

33 Moneyweb 14.84 -20.79

34 MAS -0.19 18.69

35 Mineresi 0 0

36 Muvoni 32.47 -2.54

37 Nutrition -6.95 -11.43

38 Oasis 14.12 15.77

39 Onelogic 6.93 8.35

40 Osiris na Na

41 Pinpoint 84.03 -0.33

42 Poynting 2.03 12.21

43 PSV 2.01 -2.47

44 QLeisure -0.21 -0.18

45 QPG 19.49 -0.41

46 Racec 7.2 -7.42

47 Rare 11.0 -0.26

48 RBA 5.41 3.85

49 RGT 10.34 12.15

50 Rockcastl -20.24 384.62

51 SA French 11.50 -10.28

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NO ALTX P/E RATIO AT LISTING CURRENT P/E RATIO52 Sable 30.77 13.57

53 Shercap 6.19 -0.15

54 Silverb 4.39 -3.84

55 Stratcorp 10.05 -0.15

56 Telemaster 8.71 -15.57

57 TCS 17.51 -4.49

58 Ububele 7.89 -9.03

59 Vunani 2.86 0.13

60 Wearne 17.15 -1.35

61 Willtell 15.87 -0.95

62 Workforce 9.77 4.6

63 Zaptronix -0.15 -0.3

Source: JSE, AltX websites, Business Consultants International Database, 2012 and PDSNet

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10: JSE VERSUS ALTX IPOS: 2003 TO 2007

A. ALTX LISTING PERFORMANCE

ALTXCODE

COMPANYListing

Date

2-YearMean

Return

StandardDeviation

2-Year MeanRisk- Free Rate

XAN Xantium Technology Holdings Limited 2004/08/20 -9.5% 9.6% 8.30%

MKX Milkworx Limited 2004/09/27 137.8% 191.5% 8.12%

DTP Datapro Group Limited 2004/10/18 5.5% 19.0% 8.03%

YBA Yomhlaba Resources Limited 2004/11/29 -15.1% 6.7% 8.04%

ACH Arch Equity Limited 2004/12/10 134.7% 103.7% 7.96%

ACD Alliance Data Corporation Limited 2005/03/30 20.6% 63.2% 7.98%

ENL Enaleni Pharmaceuticals Limited 2005/06/10 149.2% 103.0% 7.98%

CMO Chrometco Limited 2005/08/12 -47.4% 18.1% 7.96%

WLL Wellco Health Limited 2005/09/22 -59.6% 24.0% 7.99%

ACC Acc-Ross Holdings Limited 2006/02/16 -60.1% 18.4% 8.12%

WEA W G Wearne Limited 2006/02/21 135.9% 70.2% 8.13%

ESR Esor Limited 2006/03/14 127.8% 109.9% 8.18%

PSV Psv Holdings Limited 2006/04/21 -8.0% 14.0% 8.27%

SAN Sanyati Holdings Limited 2006/06/02 85.8% 54.3% 8.38%

TAS Taste Holdings Limited 2006/06/21 7.5% 31.1% 8.44%

DLG Dialogue Group Holdings Limited 2006/09/19 10.2% 44.6% 8.57%

GDN Gooderson Leisure Corporation Ltd 2006/09/26 5.2% 15.9% 8.57%

BFS Blue Financial Services Limited 2006/10/12 244.0% 105.0% 8.58%

MYD Myriad Medical Holdings Limited 2006/10/17 -10.9% 15.7% 8.58%

IPS Ipsa Group Plc 2006/10/19 50.8% 35.9% 8.58%

WKF Workforce Holdings Limited 2006/11/21 -10.9% 31.8% 8.62%

CEL Celcom Group Limited 2006/11/22 -32.0% 29.6% 8.63%

SIC Safic Holdings Limited 2006/11/23 63.8% 36.6% 8.29%

ATR Africa Cellular Towers Limited 2006/11/29 68.9% 55.5% 8.63%

SUL Sab&T Ubuntu Holdings Limited 2006/11/30 -18.2% 9.6% 8.48%

TFX Top Fix Holdings Limited 2006/12/06 12.1% 52.1% 8.63%

IFC Ifca Technologies Limited 2006/12/08 -46.1% 27.1% 8.63%

IMU Imuniti Holdings Limited 2006/12/12 -82.0% 22.2% 8.63%

RAR Rare Holdings Limited 2007/02/23 7.6% 17.7% 8.61%

AET Alert Steel Holdings Limited 2007/03/01 -13.7% 29.3% 8.61%

TLM Telemasters Holdings Limited 2007/03/12 -25.9% 16.5% 8.61%

RLF Rolfes Technology Holdings Limited 2007/05/23 -17.0% 36.9% 8.65%

ANS Ansys Limited 2007/06/07 10.4% 58.5% 8.66%

IWE Interwaste Holdings Limited 2007/06/14 -41.8% 25.6% 8.66%

FPF Finbond Property Finance Limited 2007/06/15 -57.3% 26.9% 8.66%

Average 20.6% 73.8% 8.4%

Source: JSE, AltX websites, Business Consultants International Database, 2012 and PDSNet

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B. JSE LISTING PERFORMANCE

JSECODE

COMPANY Listing Date2-YearMean

Return

StandardDeviation

2-YearMeanRisk-FreeRate

BCX Business Connexion Group Limited 2004/05/24 49.2% 45.1% 8.37%

PTG Peermont Global Limited 2004/09/09 57.7% 22.4% 8.13%

LEW Lewis Group Limited 2004/10/04 46.6% 29.0% 8.11%

SPP The Spar Group Limited 2004/10/18 47.2% 29.8% 8.10%

MOZ Metoz Holdings Limited 2004/11/08 33.7% 14.6% 8.29%

MVG Mvelaphanda Group Limited 2004/12/06 7.2% 15.0% 8.04%

AQP Aquarius Platinum Limited 2004/12/08 162.3% 148.7% 8.04%

CSL Consol Limited 2005/02/28 17.2% 22.6% 8.00%

NCA New Corpcapital Limited 2005/06/27 -41.6% 24.2% 7.93%

VMK Verimark Holdings Limited 2005/07/11 -10.4% 31.0% 7.93%

AER Amalgamated Electronics Corp Ltd 2005/08/29 4.6% 19.4% 7.97%

MMH Miranda Mineral Holdings Limited 2005/12/19 173.9% 51.3% 8.03%

SXR Sxr Uranium One Inc 2005/12/19 101.6% 67.7% 7.96%

IFH Ifa Hotels And Resorts Limited 2006/02/27 -24.9% 12.4% 8.15%

ELD Eland Platinum Holdings Limited 2006/03/29 154.1% 165.1% 8.12%

WGR Witwatersrand Cons Gold

Resources

2006/04/24 84.6% 58.6% 8.28%

ACT Afrocentric Investment Corp Limited 2006/05/15 -15.6% 42.0% 8.33%

MML Metmar Ltd 2006/05/22 133.1% 76.4% 8.34%

JSE Jse Limited 2006/06/05 153.2% 79.5% 8.39%

GBG Great Basin Gold Limited 2006/10/27 64.9% 40.7% 8.60%

AFT Afrimat Limited 2006/11/07 -1.0% 25.4% 8.61%

KIO Kumba Iron Ore Limited 2006/11/20 97.7% 68.4% 8.62%

ZED Zeder Investments Limited 2006/12/01 2.0% 17.3% 8.63%

PZG Pamodzi Gold Limited 2006/12/11 -37.7% 34.4% 8.63%

TAL Tiger Automotive Limited 2006/12/11 1.6% 13.6% 8.17%

ARQ Anooraq Resources Corporation 2006/12/19 125.8% 99.8% 8.62%

ASO Austro Group Limited 2007/02/01 30.0% 44.8% 8.65%

SOH South Ocean Holdings Limited 2007/02/28 -32.7% 28.1% 8.61%

RBX Raubex Group Limited 2007/03/20 72.0% 45.4% 8.62%

KEL Kelly Group Limited 2007/04/03 -17.1% 24.1% 8.62%

CBH Country Bird Holdings Limited 2007/05/03 -34.0% 30.0% 8.63%

EPS Eastern Platinum Limited 2007/05/21 -30.9% 40.7% 8.65%

HLM Hulamin Limited 2007/06/25 -40.9% 16.3% 8.67%

AVERAGE 40.4% 66.6% 8.33%

Source: JSE, AltX websites, Business Consultants International Database, 2012 and PDSNet

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11: GLOSSARY

Abnormal return: This is the difference between the actual return of a security and the

expected return of that share. Abnormal returns are sometimes triggered by, among

others, mergers, company earnings declarations or legal action.

Acceptance Date: Time limit given to a prospective shareholder to accept an offer of

shares in a "rights" issue.

Account: A trading period whose dates are fixed by the Stock Exchange authorities.

Accounts Payable: Bills which have to be paid as part of the normal course of business

Accounts Receivable: Debt owed to your company from credit sales

Accumulated Depreciation: Total accumulated depreciation reduces the book value

(formal accounting value) of assets. The value of an asset is reduced each month by a

predetermined amount and time frame. An asset worth R100, depreciated by R10 per

month, would be written off over 10 months.

Acid Test: A ratio used to determine how liquid a company is. It is determined by

subtracting short-term assets from accounts receivable and inventory, which is then

divided by short-term liabilities.

Aftermarket Performance: A term typically referring to the difference between a stock's

Offering Price and its current market price.

Agent: where a member acts on behalf of a client and has no personal interest in the

order.

AIM: The UK-based AltX version, called the Alternative Investment market.

All or Nothing: means the full order must be executed immediately or, if it is not possible

to do so, the order must be routed to the special terms order book.

Allotment Letter: Formal letter sent by a company to the investor to confirm that it will

allocate him shares in a new issue.

AltX: The new Alternative Exchange launched in South Africa in October 2003.

American Depositary Receipts (ADRs): These are offered by non-US companies who

want to list on a US exchange. Rather than constituting an actual share ADRs represent a

certain number of a company's regular shares.

Arbitrage: a purchase or sale by a member on his/her own account of securities on one

Stock Exchange with the intent to sell or buy those securities on another Stock Exchange

to profit by the difference between the prices of those securities on such stock

exchanges.

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Asset Swap: a transaction which complies with all the requirements of the South African

Reserve Bank in respect of an asset swap.

Asset Turnover: Sales divided by total assets. Important for comparison over time and to

other companies of the same industry.

At Best: An order to be transacted in a manner that will, in the discretion of the member

executing the order, achieve the best price for the client.

At Market: an order to be transacted immediately against the best opposite order in the

order book at the time of making such entry.

Authorized/Issued Share Capital: While the authorized share capital is the maximum

number of shares a company is permitted to issue over time, the issued share capital is

the actual number of shares in issue. These figures are specified in pre-incorporation

agreements (memorandum and articles of association). Investors can find these figures in

a company's annual report.

Bad Debts: An amount payable by debtors, which the firm determines is irrecoverable.

Balance Sheet: A statement that shows a company's financial position on a particular

date.

Bear Sales: the sale of listed securities of which the seller is not the owner at the date of

sale.

Bear Trend: When supply of shares outstrips demand and prices start to fall. If this trend

continues for a number of weeks, the general sentiment becomes bearish and prices

continue to fall.

Best Efforts: This term is used to describe a deal in which underwriters only agree to "do

their best" in selling shares to the public. An IPO is more commonly done on a Bought or

Firm Commitment basis in which the Underwriters are obligated to sell the allotted

shares.

Bid (Buyer's Price): offer to buy a number of securities at a certain stated price.

Bid, Not Offered: When shares are sought, but none are available. The opposite would be

"offered, not bid."

Blank Cheque: A company that indicates no specific industry, business or venture when

its securities are publicly offered for sale and the proceeds of the offering are not

specifically allocated.

Book Value: The net amount of an asset shown in the books of a company, i.e. the cost

of purchasing a fixed asset less the depreciation on that asset.

Break-Even Point: The unit sales volumes or actual sales amounts that a company needs

to equal its running expenses rate and not lose or make money in a given month. Break-

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even can either be based on regular running expenses, which is different from the

standard accounting formula based on technical fixed expenses.

Broker: The name given to a natural person recognised by the official stock exchange.

Institutions will, from 1995, be able to become corporate members.

Brokerage: commission charged by a member for the purchase or sale of securities.

Broker's Note: a note which a member is required to send to a client recording the details

of a purchase or sale of securities.

Bull Trend: When demand for shares outstrips supply and prices start to rise. If this trend

continues for a number of weeks, the general sentiment becomes bullish and prices

continue to rise.

Burden Rate: Refers to personnel burden, the sum of employer costs over and above

salaries, including employer taxes and benefits

Capital Assets: Long-term assets, also known as Fixed Assets (plant and equipment).

Capital Expenditure: Spending on capital asset (also called plant and equipment, or fixed

asset).

Capital Input: New money being invested in the business. New capital will increase your

cash and will also increase the total amount of paid-in capital.

Capital Structure: Usually refers to the structure of ordinary and preference shares and

long-term liabilities.

Capital: This is also known as total shares in issue, owner's equity or shareholders' funds.

Cash Flow: A statement which shows the net difference between cash received and paid

during the company's operating cycle.

Cash: The bank balance, or checking account balance, or real cash in bills and coins.

Closing Price: the last sale price or a higher bid or lower offer price for a particular

security.

Collection Period (Days): The average number of days that pass between delivering an

invoice and receiving the money.

Collections Days: See Collection period

Commission: The brokers charge a fee for buying and selling shares, which is brokerage

or commission earned on a deal.

Commissions Percent: An assumed percentage used to calculate commissions expense

as the product of this percentage multiplied by gross margin.

Convertible and Redeemable - Preference Shares: An alternative mechanism to ordinary

shares. It enables companies to issue other shares, which can either be bought back

from investors or converted into ordinary shares at a later date.

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Corporate Finance Transaction: a transaction which is entered into in writing and requires

public notification in the press in terms of the listings requirements of the JSE.

Cost of Sales: The costs associated with producing the sales. In a standard

manufacturing or distribution company, this is about the same as the costs for people

delivering the service, or subcontracting costs.

Creditors: People or companies that you owe money to. This is the old name for accounts

payable.

Crossed Market: where a bid price is higher than the offer price for a security

Cum Or Ex-Dividend: After a company has declared a dividend, it would close its books

to start paying dividends. The share will be marked ex-div, which means that any new

shareholder will be omitted from the past year's dividend pay-out. Before the company

declares a dividend pay-out, the share will be assumed to include possible dividends or to

be cum-div.

Cumulative abnormal return (CAR) is the sum of all abnormal returns.

Current Assets: Those assets which can be quickly converted into cash and include

accounts receivable, stock and debtors book. These are often called liquid assets.

Current Debt: Short-term debt, short-term liabilities.

Current Liabilities: A company's short-term debt, which must be paid within the firm's

operating cycle, i.e. less than one year.

Debentures: A bond which is not secured by fixed assets.

Debt And Equity: The sum of liabilities and capital. This should always be equal to total

asset.

Debtors: People or companies that owe your company money. It is the old name for

accounts receivable.

Depreciation: An accounting and tax concept used to estimate the loss of value of assets

over time. For example, cars depreciate with use.

Dividend Yield: ratio of the latest dividend to the cost or market price of a security

expressed as a percentage.

Dividends: Money distributed to the owners of a business as profits.

Double Top: This technical assessment is formed when a stock advances to a certain

price level only to retreat from that level and then rally again back to that level. The up

moves are accompanied by high volume and the recession from the top comes on

receding volume.

Due Diligence: A reasonable investigation conducted by the parties involved in preparing

a disclosure document to form a basis for believing that the statements contained therein

are true and that no material facts are omitted.

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Earnings Yield: ratio of net earnings per security to the market price expressed as a

percentage.

Earnings: Also called income or profits, earnings are the famous "bottom line": sales less

costs of sales and expenses.

EBIT: Earnings before interest and taxes.

Equity: Business ownership; capital. Equity can be calculated as the difference between

assets and liabilities.

Fill Or Kill: the full order must be executed immediately or otherwise cancelled

Financial Notes: Information explaining financial figures (balance sheet, income

statement and cash flow).

Fiscal Costs: Running costs that take time to wind down: usually rent, overhead, some

salaries. Technically, fixed costs are those that the business would continue to pay even

if it went bankrupt. In practice, fixed costs are usually considered the running costs.

Fiscal Year: Standard accounting practice allows the accounting year to begin in any

month. Fiscal years are numbered according to the year in which they end. For

example, a fiscal year ending in February of 1992 is Fiscal year 1992., even though most

of the year takes place in 1991

Fixed Assets: Includes all fixed (immovable) assets, namely property, vehicles, machinery

and equipment. It cannot usually be converted into cash within the firm's operating cycle.

Flipping: This is when an investor has acquired an IPO at its Offering Price and sells it

immediately for a quick gain soon after it starts trading on the open market. A practice

discouraged by underwriters, that can lead such investors to unfavourable relationships

with their underwriters with future IPOs.

Going Concern: A company which is operating, i.e. has not stopped producing goods or

providing a service and one which has not been placed under liquidation or curatorship.

Goodwill: An intangible asset reflected in balance sheets, which indicate an excess over

market value for assets paid by the firm.

Gross Geographic Product: A statistic which shows the remuneration received by the

production factors (land, labour, capital and entrepreneurship) for their participation in

production of goods and services in a defined area.

Gross Margin Percent: Gross margin divided by sales, displayed as a percentage.

Acceptable levels depend on the nature of the business.

Gross Margin: Sales less cost of sales.

Head and Shoulders: This technical pattern is typically characterised by one intermediate

top (left shoulder), followed by a second top higher than the previous top (head) and a

third rally that fails to exceed the head (right shoulder). The neckline is drawn connecting

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the reaction lows (support). The pattern is completed when prices break below the

neckline and the sell signal is given.

Immediate Deal: a transaction in a listed security where settlement is to take place the

next business day.

Income Statement: A statement showing net income or loss for a specified period.

Interest Expense: Interest is paid on debts and interest expense is deducted from profit

as expenses

Inventory Turnover: Sales divided by inventory. Usually calculated using the average

inventory over an accounting period, not an ending-inventory value.

Inventory Turns: Inventory turnover (above).

Inventory: This is another name for stock. Goods in stock, either finished goods or

materials to be used to manufacture goods.

Jobbers: These are the market's share merchants. They deal only with brokers and other

jobbers (i.e. not with dealers) and their main function is to maintain a market by quoting a

price.

Labour: In Business Plans the word "labour" often refers to the labour costs associated

with making goods to be sold. This labour is part of the cost of sales, part of the

manufacturing and assembly. In economic terms, labour often denotes the sale of a skill

to produce a good or service.

Leptokurtic: Investopedia states that this is a description of the kurtosis in a distribution in

which the statistical value is positive. Leptokurtic distributions have higher peaks around

the mean compared to normal distributions, which leads to thick tails on both sides.

These peaks result from the data being highly concentrated around the mean, due to

lower variations within observations.

Letter of Acceptance: The investor may receive such a letter if the company accepts his

application for shares.

Liabilities: Debts; money that must be paid. Usually debt on terms of less than five years

is called short-term liabilities and debt for longer than five years in long-term liabilities.

Limit Order: an order which may only be affected at prices equal to or better than the

price on the order.

Liquidity: A company's ability to pay short-term debt with short-term assets

Listing: official granting of a listing of a company's shares on the JSE.

Local Counter-party Transaction: a transaction where a member trades as a principal with

a person in South Africa other than a member.

Long-Term Assets: Assets like plant and equipment that are depreciated over terms of

more than five years and are likely to last that long too.

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Long-Term Interest Rate: The interest rate charged on long-term debt. This is usually

higher than the rate on short-term debt.

Long-Term Liabilities: This is the same as long-term loans. Most companies call a debt

long-term when it is on terms of five years or more.

Management Of Investments: the management of investments on behalf of a client, by a

member or an approved person.

Market Capitalisation: Used to denote a company's size and is calculated by multiplying a

company's issued share capital by its current share price.

Market Indicators: statistics that give an overall picture of how the market is performing.

Market Maker: a member which negotiates dealings in blocks of securities

Marketable Securities Tax (MST): the tax imposed in terms of the Marketable Securities

Act of 1948 in respect of every purchase of marketable securities through the agency of

or from a member at the rate of 0.25% of the consideration for which the securities are

purchased.

Marketable Securities: All instruments legally permitted to trade on the JSE. These

include shares (ordinary and preference), gilts, futures and options.

Materials: Included in the cost of sales. These are not just any materials, but materials

involved in the assembly or manufactured of goods for sale.

Monopoly: When one company controls and dominates a particular company.

Net Cash Flow: This is the projected change in cash position, an increase or decrease in

cash balance.

Net Profit: The operating income less taxes and interest. The same as earnings, or net

income.

Net Worth: This is the same as assets minus liabilities and the same as total equity.

Odd Lot: any quantity of securities which is less than a round lot (Krugerrands do not

have odd lots).

Offer (Seller's Price): price at which a dealer is prepared to sell securities on the market.

Offering Price: This is the price set by the sponsor, at which the company's stock is sold

to the first round of investors.

Offering Range: This is the price range which the company expects to sell its stock. This

can be found on the front page of the Prospectus. As with everything traded, market

conditions and demand dictate the final Offering Price.

Oligopoly: When a few companies controls and dominates a particular market.

Opening Price: This is the first price that the company's stock trades on its first day of

trading.

Order: an instruction to buy or sell a specified quantity of a security.

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Ordinary Shares: Commercial paper issued to investors to raise capital. Investors hold

these shares as part owners in the firm.

Other Short-Term Assets: These are securities and business equipment .

Other ST Liabilities: These are short-term debts that don't cause interest expenses. For

example, they might be loans from founders or accrued taxes (taxes owed, already

incurred, but not yet paid)

Overheads: Running expenses not directly associated with specific goods or services

sold, but with the general running of the business

Over-the-Counter Market (OTC): A market made up of dealers who make a market for

those securities not listed on an exchange. The over-the-counter market is made between

buyers and sellers over the telephone, rather than the electronic market found on the

JSE.

Paid-In Capital: Real money paid into the company as investments. This is not to be

confused with par value of stock, or market value of stock. This is actual money paid into

the money as equity investments by owners.

Paper Profit: A surplus income over expense, which has not yet been released, i.e. share

prices which have increased above the price at which they were bought, but not yet sold.

Par Value: The nominal value of a share and is an arbitrary amount placed on the share

by the company.

Payment Days: The average number of days that pass between receiving an invoice and

paying it

Payroll Burden: Payroll burden includes payroll taxes and benefits. It is calculated using

a percentage assumption that is applied to payroll. For example, if payroll is R1,000 and

the burden rate 10 percent, then the burden is and extra R100. Acceptable payroll

burden rates vary by market, by industry and by company.

Plant and Equipment: This is the same as long-term assets, or fixed assets, or capital

assets.

Portfolio: a schedule, normally computer generated, listing the relevant details in respect

of the securities held by an investor.

Price Earnings (P/E) Ratio: the market price of securities divided by its earnings. It

expresses the number of years' earnings (at the current rate) which a buyer is prepared to

pay for a security.

Primary Market: Where shares are distributed at the Offering Price to investors.

Principal Transaction: a member trades with a counterparty or another member.

Private Placement: An offering of a limited amount of shares or units, in which the

recipients receive restricted stock from the issuer.

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Product Development: Expenses incurred in development of new products; salaries,

laboratory equipment, test equipment, prototypes, research and development, etc.

Profit Before Interest and Taxes: This is also be called EBIT, for Earnings Before Interest

and Taxes. It is gross margin minus operating expenses

Prospectus: This document is an integral part of a documentation that must be filed with

the JSE. It defines, among many things, the company's type of business, use of

proceeds, competitive landscape, financial information, risk factors, strategy for future

growth and lists its directors and executive officers.

Receivable Turnover: Sales on credit for an accounting period divided by the average

accounts receivable balance.

Registration: A new shareholder is registered when his name is placed on the role of

shareholders for that specific company.

Renunciation Date: The company sets a date by which the shareholder has to decide

whether he will take up the rights issue.

Resistance: When stocks go up, they tend to reach a point where investors think they are

overvalued and sellers of the stock outnumber buyers. This causes the price of the stock

to stop dead in its tracks. It cannot go higher because there are no buyers. This point is

called “resistance”.

Retained Earnings: A figure which shows the sum of a company's net profit less dividends

paid to shareholders.

Return On Assets: Net profit dividend by total assets. A measure of profitability.

Return On Investment: Net profits dividend by net worth or total equity, yet another

measure of profitability. Also called ROI.

Return On Sales: Net profits dividend by sales, another measure of profitability.

Reverse Head and Shoulders: This is the same pattern as a head and shoulders except

that it has turned upside down and indicates a trend change from down to up. A buy

signal is given when prices carry up through the neckline.

Rights Issues: There are a number of methods which a company can use to increase the

size of its share capital. If it decides to offer its existing shareholders first option on the

issue, it is called a "rights" issue. The dealers would note that such an issue is in progress

as it would be quoted as cum-capitalisation and after completion of the issue it would be

noted as ex-capitalisation.

ROI: Return on investment; net profits dividend by net worth or total equity, yet another

measure of profitability.

Round Lot: the standard unit of trade - in all equities : one hundred shares

Sales Break-Even: This sales volume at which costs are exactly equal to sales

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Sales On Credit: Sales on credit are sales made on account, shipments against invoices

to be paid later.

Scrape Value: An amount left after an asset has been fully depreciated, i.e. If an asset of

R115 is depreciated by R10 per month over 11 months, the scrape value would be R5

Secondary Market: Better known as the Stock Market, where shares are openly traded.

Securities: includes stocks, shares, debentures (issued by a company having a share

capital), notes, units of stock issued in place of shares, options on stocks or shares or on

such debentures, notes or units and rights thereto and options on indices of information

as issued by a Stock Exchange on prices of any of the aforementioned instruments.

Settlement: Procedure for brokers to close off their books on a particular transaction. The

client is expected to pay for his new shares on or before the settlement date and he, in

turn, can expect to be paid (on selling shares) within the same period. (also called the

Settlement Period).

Short-Term Assets: Cash, securities, bank accounts, accounts receivable, inventory,

business equipment, assets that last less than five years or are depreciated over terms of

less than five years.

Short-Term Notes: This is the same as short-term loans. These are debts on terms of

five years or less.

Short-Term: Normally used to distinguish between short-term and long-term, when

referring to assets or liabilities. Definitions vary because different companies and

accountants handle this in different ways. Accounts payable is always short-term assets.

Most companies call any debt of less than five-year terms short-term debt. Assets that

depreciate over more than five years (e.g. plant and equipment) are usually long-term

assets.

Splitting Of Shares: At times a share could become too expensive for the private investor,

at which time the company may decide to split or sub-divide the shares into smaller

denominations. The aim is often to make the shares more tradeable and, at times, this

increases the share price on positive sentiment.

Spread: the differential between a bid and an offer price.

Stag: An investor who buys shares in a pre-listing or rights offer with the intention of

selling those shares at a profit as soon as trading starts.

Starting Year: A term to denote the year that a company started operations

Stock Exchanges Control Act Of 1985 (As Amended): an Act of Parliament in terms of

which stock exchanges in South Africa are governed. The Act is administered by the

Financial Services Board.

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Support: Over time, a stock tends to become attractive to investors at specific prices.

When a stock starts to decline to one of these prices, investors tend to come in and

purchase the stock, thereby halting its decline. When buyers outnumber sellers, the price

of the stock tends to go up. This point at which buyers enter the market is called

"support."

Tax Rate Percent: As assumed percentage applied against pre-tax income to determine

taxes.

Taxes Incurred: Taxes owed but not yet paid.

Tick Size: the specified parameter or its multiple by which the price of a security may vary

when trading at a different price from the last price, whether the movement is up or down

from the last price.

Unit Variable Cost: The specific labour and materials associated with single unit of goods

sold. Does not include general overhead.

Units Break-Even: The unit sales volume at which the fixed and variable costs are exactly

equal to sales

Withdrawn/Postponed: From time to time a company will decide that market conditions

are out of favour and not conducive to a successful IPO. There are many reasons why a

company will decide to Withdraw its IPO. Among these reasons are: a simple lack of

willing investors at that time, market volatility, or the emergence of a bear market.

Write-Off: Debt that cannot be collected and finally written-off as bad. The debt is a loss

to the company and the greater the level of bad debts, the less likely an entrepreneur will

be able to obtain bank financing. Maintaining bad debts to a minimum is seen as the

ability of a company to run efficiently and to have efficient systems in place.